450 PA R T V Central Banking and the Conduct of Monetary Policy Bank of Canada Assets Primary Dealers Liabilities Settlement balances SRAs Assets *100 +100 Liabilities Settlement balances Government securities *100 +100 The clearing banks find that their settlement balances have declined by $100, and because they had not been holding any excess reserves, their holdings of settlement balances are $100 short of the desired amount Assuming that no other transactions occur during the day, at 4:15 p.m., the Bank of Canada neutralizes the effect on aggregate settlement balances of its issue of SRAs by auctioning off government deposits The Bank s neutralization process involves auctioning off $100 of government deposits and paying those LVTS participants taking government deposits with settlement balances, bringing the amount of aggregate settlement balances back to zero The balance sheets of the Bank of Canada and the LVTS participants now look like this: Bank of Canada Assets LVTS Participants Liabilities Settlement balances Government deposits Assets +100 Settlement balances Liabilities +100 Government deposits +100 *100 The Bank of Canada s monetary tightening has been effected through the management of settlement balances, during the course of the day, with no change in the aggregate settlement balances of deposit-taking institutions As already noted, the change in the overnight rate will influence other interest rates and the level of monetary conditions in which the economy operates Monetary Policy at the Effective Lower Bound for the Overnight Rate On April 21, 2009, the Bank of Canada lowered the overnight rate target by 0.25 of a percentage point to 0.25% and also made some changes to its operating framework for the implementation of monetary policy In particular, the Bank narrowed the operating band for the overnight interest rate to 25 basis points, from 0.25% to 0.5%, with 0.5% being the bank rate and 0.25% being the deposit rate The Bank also announced that the target for the overnight rate will be the bottom of the operating band (that is, 0.25%) rather than the midpoint of the operating band, thus setting an effective lower bound for the overnight rate As the policy rate has reached the effective lower bound, the Bank of Canada has lost its usual ability to signal policy changes via changes in the policy rate Moreover, with short-term interest rates close to zero, the Bank of Canada has also