THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 492

460

PA R T V

Central Banking and the Conduct of Monetary Policy

S U M M A RY
1. The Bank of Canada views the overnight interest rate
as the centrepiece of its monetary policy implementation. At 9:00 a.m. on the fixed action date, the Bank
announces an operating band of 50 basis points for
the overnight rate. The upper limit of the operating
band is the bank rate the rate the Bank charges
LVTS participants that require an overdraft loan to
cover negative settlement balances. The lower limit
is the rate the Bank pays LVTS participants with positive settlement balances.

4. In neutralizing the effects of open-market-buyback
operations and of public sector flows on the level of
settlement balances, and also in adjusting the level of
settlement balances, the Bank of Canada uses transfers of government deposits (balances) between the
government s account at the Bank of Canada and the
government s accounts at the LVTS participants.
These transfers are effected by twice daily auctions
of federal government (Receiver General) balances,
the first at 9:15 a.m. (which are collateralized) and
the second at 4:15 p.m. (which are uncollateralized).

2. The Bank of Canada targets the value of the overnight
interest rate within its operating band, at the midpoint
of the band. In doing so, the Bank intervenes in the
overnight market using open-market buyback operations at the target rate. If the overnight rate is trading

above the target rate, the Bank uses repos in which it
purchases Government of Canada securities from
primary dealers with an agreement to resell them on
the next business day. If the overnight rate is too low
relative to the target rate, the Bank uses reverse repos
in which it sells Government of Canada securities to
primary dealers with an agreement to buy them back
on the next day.

5. In normal times, the Bank of Canada relies mainly on
its traditional monetary policy tools standing liquidity facilities (lending and deposit facilities), settlement balances management, and lender-of-lastresort arrangements. At times of crisis, however, to
address market failure and financial instability the
Bank of Canada relies on discretionary liquidity
operations whose maturity depends on their objective, independent of the maturity of the reference
rate. For example, the Bank of Canada recently introduced new facilities to address aggregate system liquidity at times of financial instability term PRAs and
term securities lending.

3. The Bank uses government deposit shifting to neutralize public sector flows that affect LVTS participants settlement balances this in effect is a cash
setting, a cash setting that is typically $25 million.
Because its holdings of Government of Canada securities are often much smaller than its monetary liabilities, the Bank brings onto its balance sheet Exchange
Fund Account assets to back its liabilities. These
amounts are adjusted daily, depending on factors
such as the level of financial institution borrowings
and/or deposits.

6. A supply and demand analysis of the market for
reserves in the United States yields the following
results. When the Fed makes an open market purchase or lowers reserve requirements, the federal
funds rate declines. When the Fed makes an open
market sale or raises reserve requirements, the federal funds rate rises. Changes in the discount rate

may also affect the federal funds rate.

KEY TERMS
direct clearers,

p. 433

overnight interest rate (reference
rate), p. 433

Sale and Repurchase Agreements
(SRAs), p. 443

overnight rate,

LVTS participants, p. 432

policy rate, p. 433

Special Purchase and Resale
Agreements (SPRAs), p. 443

monetary conditions,

primary dealers,

standing lending facility,

Large Value Transfer System (LVTS),
p. 432

p. 440

multilateral netting, p. 433
operating band,

p. 434

repos,

p. 431
p. 443

standing liquidity facilities,

p. 443

reverse repos,

p. 443

systemic risk,

p. 452
p. 436

p. 432

QUESTIONS
You will find the answers to the questions marked with
an asterisk in the Textbook Resources section of your

MyEconLab.

*1. If government deposits at the Bank of Canada are
predicted to increase, what open market operations
could be undertaken to neutralize the effect on settlement balances?