Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. Chapter 25: 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

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. Why Central Banks?  Emerged as lenders of last resort  Are a fairly recent phenomenon in many countries: see TABLE 25.1  Function in part as regulators of the financial system  Function as fiscal agents of governments

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. 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

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. 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

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. 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

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. Tools of Monetary Policy  The Overnight rate and the operating band: FIGURE 25.3  The SPRA and SRAs as a device to influence liquidity in the overnight market: FIGURE 25.5 and TABLE 25.4  Open market operations: TABLE 25.7 sale (purchases) reduces (increases) the money supply

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. The Overnight rate Operating Band T1T1 T2T2 T3T3 Bank rate Interest on + balances 0 + Net Lender-Net Borrower Operating band: 50 basis points Settlement Balances Interest Rate

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. The Behaviour of the Operating rate,

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. The Use of SPRAs and SRAs in Canada,

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. How an SPRA Works ALA L A L A L A L AL Call loan -100 Govt Sec +100 Dep. BOC +100 Call loan -100 SPRA +100 Dep. by clearer +100 Step 1: Loan called in Step 2: SPRA offered by BOC Step 3: Clearer affects deposits at BOC

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. Tools of Monetary Policy (cont’d)  Base control Open Market Operations TABLE 25.6 debt monetization: buying the govt’s debt TABLE 25.7  Other tools foreign exchange operations: a foreign exchange SWAP TABLE25.5 reserve requirements and their demise the Bank Rate & moral suasion

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. A Foreign Exchange SWAP ASSETSLIABILITIES INITIAL AFTER REDEPOSIT CHARTERED BANKS FOREIGN CURR +100GOVT OF CANADA +100 No change GOVT OF CANADA –100 CHARTERED BANKS +100 RESERVES +100GOVT OF CANADA +100

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. An Open market operation BANK OF CANADA CHARTERED BANKS Tbills +100Dep. Chartered banks +100 Reserves +100 Tbills -100 No change

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. Monetizing the Debt BANK OF CANADA CHARTERED BANKS Govt securities +100 Currency (BOC notes) +100 Reserves +100 Govt of Canada Dep. +100

Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved. 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