Chapter 22:Learning Objectives

The Original Purpose of Central Banks The Bank of Canada: Origins, History &

Operations Bank of Canada Transactions with the

Financial Sector & Government An Overview of the Bank of Canada’s

Performance from its Inception to Today

Why Central Banks?

Emerged as lenders of last resort Are a fairly recent phenomenon in

many countries: see TABLE 22.1

Origins of Central Banks

Why Central Banks?

Function in part as regulators of the financial system

Function as fiscal agents of governments

The Bank of Canada

Origins political influences rather than purely economic led

to the formation of the Canadian central bank Responsibilities

conducts open market operations responsible for the conduct of monetary policy and

maintenance of an inflation target fiscal agent of the federal government lender of last resort manages government’s foreign exchange reserves

The BOC’s Balance Sheet

Bank of Canada: Performance

The pre-war era smoothing seasonal interest rate fluctuations creating a market for government debt the use of moral suasion to influence bank behaviour

Post-war era the Coyne affair and the autonomy of the Bank: the

Rasminsky Directive the era of monetary targeting the era of stagflation and high inflation a mandate for price stability: inflation targeting

Inflation Targeting

Failure of exchange rate and monetary targeting led to inflation control targets in 1991

No change was made to Bank of Canada Act but inflation targets are joint agreement between the federal government and the BOC

Current targets to end of 2006 is to keep CPI inflation in 1-3% range

Inflation targeting also requires improvements in accountability and monetary policy transparency

The Rationale for Inflation Targeting

Inflation in Canada

Inflation Targeting: An International Phenomenon

Tools of Monetary Policy

The Overnight rate and the operating band: Used by the Bank of Canada to set the stance of

monetary policy Basically defines a “zone” in which interest rates

are permitted to fluctuate The central bank “intervenes” at the top and

bottom ends of the operating band

Overnight Operating Band

The Behaviour of the Operating rate, 1994-2004

1

2

3

4

5

6

7

8

9

94 95 96 97 98 99 00 01 02 03 04

Operating band (top)Operating band (bottom)TargetBank rate

Per

cent

Year

Tools of Monetary Policy

The Overnight rate and the operating band The SPRA and SRAs as a device to influence

liquidity in the overnight market:

Illustrating the SPRA

Tools of Monetary Policy

The Overnight rate and the operating band: The SPRA and SRAs as a device to influence

liquidity in the overnight market: Open market operations:

sale (purchases) reduces (increases) the money supply

Tools of Monetary Policy (cont’d)

Some Key tools foreign exchange operations: a foreign exchange

SWAP TABLE 22.5 reserve requirements and their demise the Bank Rate & moral suasion

Base control Open Market Operations TABLE 22.6 debt monetization: buying the govt’s debt TABLE

22.7

A Foreign Exchange SWAP

ASSETS LIABILITIES

INITIAL

AFTER REDEPOSIT

CHARTERED BANKS

FOREIGN CURR +100 GOVT OF CANADA +100

No change GOVT OF CANADA –100CHARTERED BANKS +100

RESERVES +100 GOVT OF CANADA +100

An Open market operation

BANK OF CANADA

CHARTERED BANKS

Tbills +100 Dep. Chartered banks +100

Reserves +100Tbills -100

No change

Monetizing the Debt

BANK OF CANADA

CHARTERED BANKS

Govt securities +100 Currency (BOC notes) +100

Reserves +100 Govt of Canada Dep. +100

Summary

Central banking is mostly a 20th century phenomenon The Bank of Canada was created in the 1930s to help

manage monetary policy, act as a lender of last resort, and fiscal agent for the federal government

The bank of Canada can influence the economy through monetary policy using a number of tools: open market operations, base control, foreign exchange operations are examples

The history of BOC operations is full of important policy milestones