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EC223 (81)
Chapter 17

Chapter 17 EC223.docx

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Department
Economics
Course
EC223
Professor
Angela Trimarchi
Semester
Winter

Description
EC223 Chapter 17 – Tools of Monetary Policy Week 10 Overnight rate – the interest rate on overnight loans of reserves from one bank to another, as the primary instrument of monetary policy The Framework for the Implementation of Monetary Policy -The tools used by the Bank of Canada to implement monetary policy are closely linked to the institutional arrangements regarding the clearing and settlement systems in the Canadian economy The Large Value Transfer System (LVTS) -An electronic, real-time net settlement network, designed to provide immediate finality and settlement to time-critical transactions -In addition to the Bank of Canada, there are 14 LVTS participants -The LVTS has been put into place in order to eliminate systematic risk – the risk to the entire payments system due to the inability of one financial institution to fulfill its payment obligations in a timely fashion -Each LVTS payment is subject to real time risk-control tests to confirm that sufficient collateral is available, and is final and irrevocable in real time -Participants know in real time their large-value, wholesale transactions -The LVTS is used to settle over 20 000 payments daily, with a value of over $185 billion -The LVTS uses multilateral netting in which only the net credit or debit position of each participant vis- à-vis all other participants is calculated for settlement, thereby reducing the need for a large amount of settlement balanced Non-LVTS (ACSS) Transactions -Paper based payment items (paper cheques, travellers’ cheques, gift certificates, money orders) and electronic payments items -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 – members of the Canadian Payments Association who participate directly in the Automated Clearing Settlement System (ACSS)and maintain a settlement account at the Bank of Canada The Bank of Canada’s Policy Rate -Overnight interest rate/reference rate – the interest rate at which participants borrow and lend overnight funds to each other in the money market -Policy rate – the target for the Bank of Canada’s overnight interest rate The Operating Bank for the Overnight Interest Rate -Operating band – the Bank’s operational objective is to keep the overnight rate within an operating band of twenty-five basis points The Bank of Canada’s Standing Facilities -The Bank of Canada stands ready to lend to or borrow from a participant to bring their settlement balanced to zero at the end of the banking day The Bank of Canada’s Implementation of the Operating Bank for the Overnight Interest Rate -If the overnight rate increases towards 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 declines towards the lower limit of the operating band, then the Bank will accept EC223 Chapter 17 – Tools of Monetary Policy Week 10 deposits from LVTS participants at the bank rate less 50 basis points, to put a floor on the overnight rate The Market for Settlement Balances and the Channel/Corridor System for Setting the Overnight Interest Rate -The market for settlement balances is where the overnight interest rate is determined -The market to analyze the markets for reserves proceeds in a similar fashion to the analysis of the bond market and describes determination of the overnight interest rate in a channel/corridor system of interest-rate control The Bank of Canada’s Approach to Monetary Policy -The goal of the Bank of Canada’s current monetary policy is to keep the inflation rate within a target range of 1% to 3% with the midpoint of the inflation target range, 2%, being the most desirable outcome How Monetary Policy Affects the Economy -The level of short-term interest rates and the exchange rate of the Canadian dollar determine the monetary conditions in which the economy operates -By changing the target and operating band for the overnight rate, the Bank of Canada sends a signal regarding the direction that it would like interest rates and the money supply to take Nominal Interest Rates and Monetary Policy -The Bank of Canada uses the nominal overnight interest rate as its operating instrument -Changes in the short-term nominal interest rates affect short- and long-term real interest rates Open Market Operations -An important monetary
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