Chapter 22: Learning Objectives

2. 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

3. Why Central Banks? • Emerged as lenders of last resort • Are a fairly recent phenomenon in many countries: see TABLE 22.1

4. Origins of Central Banks

5. Why Central Banks? • Function in part as regulators of the financial system • Function as fiscal agents of governments

6. 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

7. The BOC’s Balance Sheet

8. 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

9. 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

10. The Rationale for Inflation Targeting

11. Inflation in Canada

12. Inflation Targeting: An International Phenomenon

13. 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

14. Overnight Operating Band

15. The Behaviour of the Operating rate, 1994-2004

16. 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:

17. Illustrating the SPRA

18. 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

19. 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

20. A Foreign Exchange SWAP ASSETS LIABILITIES INITIAL FOREIGN CURR +100 GOVT OF CANADA +100 AFTER REDEPOSIT GOVT OF CANADA –100 CHARTERED BANKS +100 No change CHARTERED BANKS RESERVES +100 GOVT OF CANADA +100

21. An Open market operation BANK OF CANADA Tbills +100 Dep. Chartered banks +100 CHARTERED BANKS No change Reserves +100 Tbills -100

22. Monetizing the Debt BANK OF CANADA Currency (BOC notes) +100 Govt securities +100 CHARTERED BANKS Govt of Canada Dep. +100 Reserves +100

23. 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