THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 485

CHAPTER 17 Tools of Monetary Policy 453 INSIDE THE CENTRAL BANK Monetary Policy at Times of Crisis At times of turmoil in financial markets, central banks face a number of challenges In the Canadian case, for example, challenges involve keeping the overnight rate near the policy rate, keeping spreads in the term interbank market low by influencing interbank term rates, and deciding how to respond to the potential macroeconomic effects of the crisis by changing the monetary policy stance (that is, the target and operating band for the overnight rate) Against the backdrop of the recent turmoil in financial markets, the Bank of Canada faced widening spreads and increased volatility in the term interbank market and took extraordinary measures to stabilize the financial system In its efforts to influence interbank term rates, the Bank introduced term PRAs and increased the frequency and size of its discretionary liquidity operations Moreover, the Bank expanded its list of acceptable collateral (for both its standing lending facility as well as for its term PRA operations) to include bank-sponsored asset-backed commercial paper and U.S Treasuries These discretionary liquidity operations not represent a change in the stance of monetary policy However, in order to support the Canadian economy, the Bank of Canada, acting in concert with other major central banks, also changed its policy stance by lowering the target and operating band for the overnight interest rate in a series of announcements In fact, in the first ten months of 2008 alone, the policy rate was reduced by 300 basis points to 1.5% by the end of 2008 and then to 0.25% by April 2009 Moreover, the Bank is now considering quantitative measures of monetary policy, and has identified alternative instruments that it would consider using at the effective lower bound for the overnight interest rate Overnight Interest Rate, i or Bank rate, i ff * i or ib Rs Rd2 0.50 Rd1 NBR F I G U R E 17- 10 BR Quantity of Reserves, R How the Standing Lending Facility Puts a Ceiling on the Overnight Interest Rate The rightward shift of the demand curve for reserves from R d1 to R d2 moves the equilibrium from point to point where ior = ib and borrowed reserves incease from zero to BR