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1、Chapter 17Tools of Monetary Policy 2005 Pearson Education Canada Inc.OverviewSo far we derived a multiplicative relation between M and MBM=m MB and discussed three monetary policy tools that the Bank of Canada can use to manipulate i and M.These tools areopen market operationsBank of Canada advances
2、,andgovernment deposit shiftingIn recent years,however,the Bank conducts policy by setting an operating band for the overnight interest rate ior and targeting ior at the midpoint of the band.In doing so,the Bank permits M to do whatever necessary to keep ior on target.2 2005 Pearson Education Canada
3、 Inc.The Role of MoneyBefore we go on,we have to clear up a potential confusion:Although the Bank of Canada can control both i and M,it would be wrong to view i and M as distinct policy instruments.The reason is that a given i policy has to be supported by a given M policy.That is,the Bank influence
4、s i by adjusting M.To put it differently,i is the price of M and the Bank affects the price of M(that is,the interest rate)by controlling the quantity of money.With this in mind,lets discuss the institutional framework within which the Bank conducts monetary policy.3 2005 Pearson Education Canada In
5、c.The Large Value Transfer System,LVTSThe LVTS(introduced on February 4,1999)is an electronic,real-time net settlement network,designed to provide immediate finality and settlement to time-critical transactionsLVTS participants know in real time their large-value,wholesale transactions(over$50,000).
6、Although these transactions account for less than 1%of the total number of transactions,they account for about 94%of the value of transactions in Canada The LVTS uses multilateral netting only the net credit or debit position of each participant vis-vis all other participants is calculated for settl
7、ement 4 2005 Pearson Education Canada Inc.LVTS ParticipantsAs of November 2002,in addition to the Bank of Canada,there were 13 LVTS participants-members of the CPA who participate in the LVTS and maintain a settlement account at the Bank of Canada.These are:Big Six,Alberta Treasury Branches,Bank of
8、America Canada,Banque Nationale de Paris Canada,La Caisse centrale Desjardins du Qubec,Credit Union Central of Canada,HSBC Bank Canada,and the Laurentian Bank of Canada.5 2005 Pearson Education Canada Inc.Systemic RiskThe LVTS has been put in place to eliminate systemic risk.In fact,participants can
9、 make a payment only ifthey have positive settlement balances in their accounts with the Bank of Canada,posted collateral(such as T-bills and bonds),orexplicit lines of credit with other LVTS participants6 2005 Pearson Education Canada Inc.Real-Time Settlement Systems in Other CountriesCountryYear i
10、ntroducedU.S.(Fedwire)1918Sweden 1986Germany and Switzerland 1987Japan 1988Italy 1989Belgiumand U.K.1996France,Hong Kong,and NL1997The LVTS has been put in place in order to eliminate systemic risk the risk to the entire payments system due to the inability of one bank to fulfill its payment obligat
11、ions in a timely fashion.Of,course it is not just Canada that is concerned about systemic risk.7 2005 Pearson Education Canada Inc.Non-LVTS TransactionsThese are non-LVTS(paper-based)payment items,such as chequesThese items are cleared through the Automated Clearing Settlement System(ACSS),an electr
12、onic payments system also operated by the CPAThe ACSS aggregates interbank payments and calculates the net amounts to be transferred from and to each participants settlement account with the Bank of Canada 8 2005 Pearson Education Canada Inc.Direct and Indirect ClearersDirect Clearers:The subset of
13、LVTS participants who participate directly in the ACSS and are known as direct clearers Indirect Clearers:These are the deposit-taking financial institutions that are members of the CPA but do not have a clearing account with the Bank of Canada.Indirect clearers hold deposits in direct clearers in e
14、xchange for a variety of services,including cheque clearing,foreign exchange transactions,and help with securities purchases 9 2005 Pearson Education Canada Inc.The Operating Band of 50 Basis Points for the Overnight Interest Rate The upper limit defines the bank rate the rate the Bank charges LVTS
15、participants that require an overdraft loan to cover negative settlement balances The lower limit is the rate the Bank pays to LVTS participants with positive settlement balances 10 2005 Pearson Education Canada Inc.The Banks Standing Liquidity FacilitiesAt the end of each day,each LVTS participant
16、must bring its settlement balance with the Bank close to zero.The Bank therefore stands ready(we call this standing liquidity facilities)to provide or absorb liquidity with an overnight duration to participants facing unforeseen liquidity shocks.The initiative is on the side of the LVTS participant.
17、A participant may use the Banks 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.11 2005 Pearson Education Canada Inc.Pre-settlement Trading Participants can reduce the cos
18、ts of either positive or negative positions by trading with each other in the LVTS pre-settlement period at the end of the day(6:00-6:30 p.m.).In fact,the typical bid-ask spread on overnight funds in the interbank market has been less than 1/8%,much less than the 50 basis points on LVTS.Hence,partic
19、ipants can adjust positions with each other in the overnight market at a better return than can be achieved at the Banks standing facilities.12 2005 Pearson Education Canada Inc.The Market Timetable13 2005 Pearson Education Canada Inc.The Banks Implementation of the Operating Band for iorIf ior towa
20、rds the upper limit,then the Bank will lend at ib to put a ceiling on ior If ior towards the lower limit,then the Bank will accept deposits at ib less 50 basis points,to put a floor on ior 14 2005 Pearson Education Canada Inc.Supply and Demand for Settlement Balances and Overnight Interest Rate,iorT
21、he equilibrium ior is indeterminate and could be anywhere within the 50-basis-point band.This means that the actual ior will be somewhat different from the target ior indicated at the start of the banking day by the Bank.15 2005 Pearson Education Canada Inc.The Banks Current Approach to Monetary Pol
22、icyIn February 1991,the Banks governor and the minister of finance announced a series of declining targets.The targets were 3%by the end of 1992,falling to 2%by the end of 1995,to remain within a range of 1%-3%thereafter.The 1%-3%target range for was renewed in December 1995,in early 1998,and again
23、in May 2001,to apply until the end of 2006.The goal of the Banks current policy is to keep at the midpoint of the target range,2%.16 2005 Pearson Education Canada Inc.How the Bank Keeps From Falling Below the Target RangeThe Bank expects the economy to slow down and wishes to ease monetary condition
24、s.It lowers the operating band for ior,thereby encouraging banks to borrow R either from each other at ior or from the Bank at ibThe in i and E lead to an in M,AD,and P,thereby preventing from falling below the target range.17 2005 Pearson Education Canada Inc.How the Bank Keeps From Moving Above th
25、e Target RangeThe Bank expects the economy to be exceeding its capacity in the future and wishes to slow it down.It raises the operating band for ior in order to prevent inflationary pressures from building.The in i and E lead to an in M,AD,and P,thereby preventing from moving above the target range
26、.18 2005 Pearson Education Canada Inc.The Banks Influence on Long-Term Interest RatesBy changing the operating band for ior the Bank sends a signal regarding the direction that it would like i and M to take.A rise in the band and thus ib is a signal that the Bank would like to see i and M in the eco
27、nomy.A fall in the band is a signal that the Bank would like i and M.However,the Banks direct influence on long-term rates diminishes as the time period .Long-term rates can be either higher or lower than short-term rates depending on expectations about and the level of short-term rates in the futur
28、e,the relative balance between the demand for and supply of loanable funds,the level of i in the U.S.,and the relative stance of monetary policies in the two countries.19 2005 Pearson Education Canada Inc.Open Market OperationsTwo Types1.Dynamic:Meant to change MB2.Defensive:Meant to offset other fa
29、ctors affecting MBAdvantages of Open Market Operations1.Bank has complete control2.Flexible and precise3.Easily reversed4.Implemented quickly20 2005 Pearson Education Canada Inc.SPRAs and SRAsOver the years,the Bank introduced additional tools in its conduct of monetary policy.1.In 1985,the Bank int
30、roduced repos,which in Canada are known as Special Purchase and Resale Agreements(SPRAs)2.In 1986,the Bank introduced reverse repos,known in Canada as Sale and Repurchase Agreements(SRAs)By 1994,the Bank stopped conducting open market operations in government of Canada T-bills and bonds and its most
31、 common operations since then have been repurchase transactions,either SPRAs of SRAs.SPRAs and SRAs,are conducted with primary dealers(formerly known as jobbers)-the Big Six and the major investment dealers.21 2005 Pearson Education Canada Inc.The Banks Use of SPRAs to Reinforce the Target iorIf ove
32、rnight 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.Bank of CanadaAssets LiabilitiesSPRAs+100 Settlement Balances+100 Direct ClearersAssets LiabilitiesSettlement Balances+100 SPRAs+100 Hence,SPRAs relieve undesired upwar
33、d pressure on ior 22 2005 Pearson Education Canada Inc.The Banks Use of SRAs to Reinforce the Target iorIf overnight funds are traded at a rate below the target rate,the Bank enters into SRAs,at a price that works out to the target ior Bank of CanadaAssets LiabilitiesSettlement Balances -100 SRAs +1
34、00Direct ClearersAssets LiabilitiesSettlement Balances-100 SRAs +100Hence,SRAs alleviate undesired downward pressure on ior 23 2005 Pearson Education Canada Inc.Bank of Canada Lending(Advances)Two Types1.Standing Liquidity Facility,to reinforce the operating band for ior 2.Last Resort LendingLender
35、of Last Resort Function1.To prevent banking panicsCDIC fund not big enoughExamples:Canadian Commercial Bank and Northland Bank2.To prevent nonbank financial panicsExamples:1987 Black Monday stock market crashAnnouncement Effect1.Problem:False signals24 2005 Pearson Education Canada Inc.Bank of Canad
36、a Advances to Members of the CPA25 2005 Pearson Education Canada Inc.Lending PolicyAdvantages1.Lender of Last Resort RoleDisadvantages1.Confusion interpreting bank rate changes2.Fluctuations in advances cause unintended fluctuations in money supply3.Not fully controlled by Bank26 2005 Pearson Educat
37、ion Canada Inc.Government Deposit ShiftingPrior to the introduction of the LVTS,the management of settlement balances(cash setting)was the main mechanism by which the Bank of Canada implemented monetary policy.In particular,using drawdowns(transfers of government deposits from the direct clearers to
38、 the Bank of Canada)and redeposits(transfers of government deposits from the Bank of Canada to the direct clearers),the Bank was essentially implementing its target band for the overnight interest rate.In the LVTS environment,however,the Bank uses twice-daily auctions of government term deposits(the
39、 first at 9:15 a.m.and the second at 4:15 p.m.)to effect the shifting of government funds and neutralize certain government flows.27 2005 Pearson Education Canada Inc.Neutralizing a Net Government ReceiptConsider a net government receipt of$100(i.e.,the governments receipts from the public exceed it
40、s payments to the public by$100).To prevent a in settlement balances and an in ior,the Bank neutralizes the net government receipt by morning(9:15 a.m.)and afternoon(4:00 p.m.)auctions of government term deposits,as follows:Bank of CanadaAssets LiabilitiesGovernment Deposits -100 Settlement Balances
41、 +100Direct ClearersAssets LiabilitiesSettlement Balances+100 Government Deposits+100 28 2005 Pearson Education Canada Inc.Neutralizing a Net Government DisbursementIf there were a net government disbursement of$100(i.e.,the governments payments to the public exceed its receipts from the public by$1
42、00),then settlement balances would by the same amount.To prevent a in ior,the Bank neutralizes the net government disbursement by a transfer of$100 from the governments accounts at the LVTS participants to the governments account at the Bank:Bank of CanadaAssets LiabilitiesGovernment Deposits +100 S
43、ettlement Balances -100Direct ClearersAssets LiabilitiesSettlement Balances-100 Government Deposits-100 29 2005 Pearson Education Canada Inc.Swaps With the Exchange Fund Account(EFA)The Bank usually brings onto its balance sheet EFA assets to back its liabilities.It does so,by arranging a swap with
44、the EFA.If the Bank temporarily buys$100 of FX from the EFA,then:Bank of CanadaAssets LiabilitiesForeign exchange+100Government Deposits +100 Government of CanadaAssets LiabilitiesEFA -100 Deposits at the Bank+100Government deposits at the Bank and now can be transferred to banks to settlement balan
45、ces.30 2005 Pearson Education Canada Inc.An Example of Monetary ControlSuppose that the operating band is 4.5%to 5%and the Bank wishes to tighten policy by raising the band by 25 basis pointsIn one of the eight fixed days for announcing changes to the band for ior,the Bank announces,at 9:00 a.m.,tha
46、t it is adjusting the band up from 4.5%to 5%to 4.75%to 5.25%From this announcement,LVTS participants know that the ib shifts from 5%to 5.25%,the rate on positive settlement balances shifts from 4.5%to 4.75%,and that the Banks new target ior,the midpoint of the operating band,shifts from 4.75%to 5%If
47、 later in the day overnight funds are trading below the target ior,the Bank enters into SRAs to enforce the new target for ior 31 2005 Pearson Education Canada Inc.(Continued)Assuming that the Bank enters into SRAs in the amount of$100,theT-accounts of the Bank and the direct clearers will be:Bank o
48、f CanadaAssets LiabilitiesSettlement Balances -100SRAs +100Direct ClearersAssets LiabilitiesSettlement Balances-100 SRAs +100 32 2005 Pearson Education Canada Inc.(Continued)Because settlement balances the Bank neutralizes the effect on settlement balances of its issue of SRAs,by auctioning off$100
49、of government deposits:Bank of CanadaAssets LiabilitiesSettlement Balances +100Government Deposits -100Direct ClearersAssets LiabilitiesSettlement Balances+100 Government Deposits +10033 2005 Pearson Education Canada Inc.(Continued)The end-of-day effect on the balance sheets of the Bank and the dire
50、ct clearers is as follows:Bank of CanadaAssets LiabilitiesSRAs +100Government Deposits -100Direct ClearersAssets LiabilitiesSRAs +100 Government Deposits +100The Banks monetary tightening has been effected through the management of settlement balances,during the course of the day,with no change in t