Transcript Chapter 17

Chapter 17
Tools of Monetary Policy
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The Large Value Transfer System (LVTS) I
• The LVTS (introduced in 1999)
– electronic, real-time net settlement network
– designed to provide immediate finality and
settlement to time-critical transactions
• LVTS participants know in real time their largevalue, wholesale transactions (over $50,000).
• Transactions account for < 1% of the total
number of transactions
• They make up 94% of the value of transactions
in Canada
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The Large Value Transfer System (LVTS) II
• The LVTS uses multilateral netting — only the
net credit or debit position of each participant
vis-à-vis all other participants is calculated for
settlement
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Systemic Risk
• The LVTS has been put in place to eliminate
systemic risk. In fact, participants can make a
payment only if:
• they have positive settlement balances in their
accounts with the Bank of Canada,
• posted collateral (such as T-bills and bonds), or
• explicit lines of credit with other LVTS participants
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Non-LVTS Transactions
•
•
•
•
These are non-LVTS (paper-based) payment items,
such as cheques
These items are cleared through the Automated
Clearing Settlement System (ACSS), an electronic
payments system also operated by the CPA
The ACSS aggregates interbank payments and
calculates the net amounts to be transferred from
and to each participant's settlement account with
the Bank of Canada
Direct Clearers are subset of LVTS participants who
participate directly in the ACSS
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The Operating Band for the Overnight
Interest Rate I
• The interest rate at which participants borrow
and lend overnight funds to each other is
known as the overnight interest rate
• The Bank of Canada implements monetary
policy by changing the overnight interest rate.
• Such changes influence other short-term
interest rates and the exchange rate
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The Operating Band for the Overnight
Interest Rate II
• The Bank’s objective is to keep the overnight
rate within a band of 50 basis points
• Since December 2000, the Bank operates
under a system of eight “fixed” dates
throughout the year for announcing changes
to the operating band
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The Operating Band for the Overnight
Interest Rate III
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The Bank’s Standing Liquidity Facilities I
• At the end of each day, each LVTS participant must
bring its settlement balance with the Bank close to
zero.
• The Bank therefore stands ready (standing facilities)
to provide or absorb liquidity with an overnight
duration to participants facing unforeseen liquidity
shocks.
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The Bank’s Standing Liquidity Facilities II
• The initiative is on the side of the LVTS participant. A
participant may use the Bank’s lending facility to
obtain (against eligible collateral) overnight liquidity
in case of a shortage, or it may use the deposit
facility to make deposits in case of excess liquidity.
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The Bank of Canada and the Operating band
• If the overnight rate increases toward the upper limit
of the operating band, then the Bank will lend at the
bank rate to put a ceiling on the overnight rate
• If the overnight rate falls toward the lower limit of
the operating band, then the Bank will accept
deposits from LVTS participants at the bank rate less
50 basis points – putting a floor on the overnight
rate
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The Channel/Corridor System for the Overnight Rate
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Demand for Reserves
• Demand Curve
– As the overnight interest rate decreases the
opportunity cost of holding desired reserves falls
and ceteris paribus, the quantity of reserves
demanded rises.
– Rd slopes downward
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Supply Curve for Reserves
• Supply Curve
– quantity of reserves supplied is infinitely elastic at
ib
– Also flat at ib -0.50 because banks would not ledn
in the overnight market
– Between ib -0.50 and ib, banks will not borrow
from the Bank and borrowed reserves (BR) equal
zero (cheaper to borrow in overnight market)
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The Channel/Corridor System for the Overnight Rate
• In terms of Figure 17-2, the equilibrium
interest rate will always be within the
operating band
• The system enables the Bank to keep the
overnight interest rate in the narrow
channel/corridor with an upper limit of ib and
a lower limit of ib- 0.50
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How Monetary Policy Affects the Economy I
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How Monetary Policy Affects the Economy II
• Changes in the overnight rate influences other
interest rates and the exchange rate
• The level of short term interest rates and the
exchange rate of the Canadian dollar
determine the monetary conditions in which
the economy operates
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How Monetary Policy Affects the Economy III
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How Monetary Policy Affects the Economy IV
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Nominal Interest Rates and Monetary Policy
• Bank of Canada uses nominal overnight
interest rate as operating instrument
• Effects on the monetary policy on economic
activity are from the real interest rate
affecting consumption and investment
• Short term nominal rates affect short and
long-term real interest rates under
assumption of sticky prices
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Open Market Operations I
• Open market operations relate to the Bank of
Canada selling/buying government bonds
• Open market purchases expand bank reserves
and the monetary base, lowering interest rates
and raising the money supply
• Open market sales reduce bank reserves and the
monetary base, increasing interest rates and
reducing the money supply
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Open Market Operations II
• Two Types
1. Dynamic:
Meant to change MB
2. Defensive:
Meant to offset other factors affecting MB
The Bank conducts open market operations on
government bills and bonds as the market for
these instruments is most liquid and have the
largest trading volume
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SPRAs and SRAs
•
Special Purchase and Resale Agreements (SPRAs) are a
tool to reduce undesired upward pressure on the
overnight rate
•
Sale and Repurchase Agreements (SRAs) are a tool to
reduce undesired downward pressure on the
overnight rate
•
SPRAs and SRAs are conducted with primary dealers
(formerly known as jobbers) --- the Big Six and the
major investment dealers.
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The Bank’s Use of SPRAs to Reinforce the Target ior I
1. If overnight funds are traded at a rate higher
than the target ior, the Bank enters into SPRAs at
a price that works out to the target ior.
2. Hence, SPRAs relieve undesired upward
pressure on ior
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The Bank’s Use of SPRAs to Reinforce the Target ior,II
Bank of Canada
Assets
Liabilities
SPRAs +100
Settlement Balances +100
Direct Clearers
Assets
Settlement Balances +100
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Liabilities
SPRAs +100
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The Mechanics of a Special PRA Operation
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The Bank’s Use of SRAs to Reinforce the Target ior, I
1. If overnight funds are traded at a rate below the
target ior, the Bank enters into SRAs at a price
that works out to the target ior.
2. Hence, SRAs relieve undesired downward
pressure on ior
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The Bank’s Use of SRAs to Reinforce the Target ior , II
Bank of Canada
Assets
Liabilities
Settlement Balances -100
SRAs
+100
Primary Dealers
Assets
Liabilities
Settlement Balances -100
Government Securities +100
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Advantages of SPRAs and SRAs
1. Bank of Canada has complete control over
their volume
2. Are flexible and precise
3. Are easily reversed
4. Can be implemented quickly
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Settlement Balances Management
• Bank of Canada also targets the level of
settlement balances in the system
• Typically, target level is announced the
previous day
• Bank neutralizes the impact on settlement
balances via open-market buyback
operations.
• Bank neutralizes SRA operations as well.
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Special PRA and SRA Operations
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Target Level of Settlement Balances
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Receiver General Auctions I
• Bank of Canada neutralizes public auctions of
Receiver General balances
• E.g. net government receipt of $100
Bank of Canada
Assets
Liabilities
Government Deposits -100
Settlement Balances +100
LVTS Participants
Assets
Liabilities
Settlement Balances -100 Government Deposits +100
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Receiver General Auctions II
Net disbursement of $ 100
Bank of Canada
Assets
Liabilities
Government Deposits +100
Settlement Balances -100
LVTS Participants
Assets
Settlement Balances -100
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Liabilities
Government Deposits -100
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Swaps with the Exchange Fund Account
Bank of Canada
Assets
Foreign Exchange +100
Liabilities
Government Deposits +100
Government of Canada
Assets
Exchange Fund Account -100
Deposits at the Bank of Canada +100
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Liabilities
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Target Level of Settlement Balances
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Monetary Policy at the Effective Lower Bound
• Conditional Statements
– Bank makes statements about future path of its
policy rate in order to influence long-term rates
• Quantitative Easing
– purchase of financial assets by the central bank
through creation of excess reserves (settlement
balances)
• Credit Easing
– purchase of private sector assets by central bank
in critical markets
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Standing Lending Facility
•
Bank stands ready to lend (given suitable collateral)
overnight settlement balances to LVTS participants
with negative clearing balances.
•
Lending rate is ib (25 points higher than target
overnight rate)
•
Large increase in demand for reserves shifts demand
right and equilibrium ior increases
•
At ib, standing lending facility puts ceiling on
overnight rate (point 2)
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Standing Lending Facility Puts Ceiling on ior
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Discretionary Liquidity Operations
• Bank can be lender of last resort to entire
financial system
• Has authority to provide liquid funds to any
financial or non-financial Canadian or foreign
entity to promote stability of the financial
system
– Term PRAs
– Term Securities Lending
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Bank Advances to CPA Members 1975-2008
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Advantages and Disadvantages of Bank’s Lending
Policy
Advantages
• Lender of Last Resort Role
Disadvantages
• Financial institutions may take on more risk knowing
that the Bank will provide them with advances if
they get into trouble (moral hazard problem)
• Volume of normal advances not fully controlled by
Bank
• Not easily reversed
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