THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 482

450

PA R T V

Central Banking and the Conduct of Monetary Policy

Bank of Canada
Assets

Primary Dealers

Liabilities
Settlement
balances
SRAs

Assets
*100
+100

Liabilities

Settlement
balances
Government
securities

*100
+100

The clearing banks find that their settlement balances have declined by $100, and

because they had not been holding any excess reserves, their holdings of settlement
balances are $100 short of the desired amount. Assuming that no other transactions
occur during the day, at 4:15 p.m., the Bank of Canada neutralizes the effect on
aggregate settlement balances of its issue of SRAs by auctioning off government
deposits. The Bank s neutralization process involves auctioning off $100 of government deposits and paying those LVTS participants taking government deposits with
settlement balances, bringing the amount of aggregate settlement balances back to
zero. The balance sheets of the Bank of Canada and the LVTS participants now look
like this:
Bank of Canada
Assets

LVTS Participants

Liabilities
Settlement
balances
Government
deposits

Assets
+100

Settlement
balances

Liabilities
+100

Government
deposits

+100

*100

The Bank of Canada s monetary tightening has been effected through the
management of settlement balances, during the course of the day, with no
change in the aggregate settlement balances of deposit-taking institutions.
As already noted, the change in the overnight rate will influence other interest
rates and the level of monetary conditions in which the economy operates.

Monetary
Policy at the
Effective Lower
Bound for the
Overnight Rate

On April 21, 2009, the Bank of Canada lowered the overnight rate target by 0.25
of a percentage point to 0.25% and also made some changes to its operating framework for the implementation of monetary policy. In particular, the Bank narrowed
the operating band for the overnight interest rate to 25 basis points, from 0.25% to
0.5%, with 0.5% being the bank rate and 0.25% being the deposit rate. The Bank
also announced that the target for the overnight rate will be the bottom of the
operating band (that is, 0.25%) rather than the midpoint of the operating band,
thus setting an effective lower bound for the overnight rate.
As the policy rate has reached the effective lower bound, the Bank of Canada
has lost its usual ability to signal policy changes via changes in the policy rate.
Moreover, with short-term interest rates close to zero, the Bank of Canada has also