460 PA R T V Central Banking and the Conduct of Monetary Policy S U M M A RY The Bank of Canada views the overnight interest rate as the centrepiece of its monetary policy implementation At 9:00 a.m on the fixed action date, the Bank announces an operating band of 50 basis points for the overnight rate The upper limit of the operating band is the bank rate the rate the Bank charges LVTS participants that require an overdraft loan to cover negative settlement balances The lower limit is the rate the Bank pays LVTS participants with positive settlement balances In neutralizing the effects of open-market-buyback operations and of public sector flows on the level of settlement balances, and also in adjusting the level of settlement balances, the Bank of Canada uses transfers of government deposits (balances) between the government s account at the Bank of Canada and the government s accounts at the LVTS participants These transfers are effected by twice daily auctions of federal government (Receiver General) balances, the first at 9:15 a.m (which are collateralized) and the second at 4:15 p.m (which are uncollateralized) The Bank of Canada targets the value of the overnight interest rate within its operating band, at the midpoint of the band In doing so, the Bank intervenes in the overnight market using open-market buyback operations at the target rate If the overnight rate is trading above the target rate, the Bank uses repos in which it purchases Government of Canada securities from primary dealers with an agreement to resell them on the next business day If the overnight rate is too low relative to the target rate, the Bank uses reverse repos in which it sells Government of Canada securities to primary dealers with an agreement to buy them back on the next day In normal times, the Bank of Canada relies mainly on its traditional monetary policy tools standing liquidity facilities (lending and deposit facilities), settlement balances management, and lender-of-lastresort arrangements At times of crisis, however, to address market failure and financial instability the Bank of Canada relies on discretionary liquidity operations whose maturity depends on their objective, independent of the maturity of the reference rate For example, the Bank of Canada recently introduced new facilities to address aggregate system liquidity at times of financial instability term PRAs and term securities lending The Bank uses government deposit shifting to neutralize public sector flows that affect LVTS participants settlement balances this in effect is a cash setting, a cash setting that is typically $25 million Because its holdings of Government of Canada securities are often much smaller than its monetary liabilities, the Bank brings onto its balance sheet Exchange Fund Account assets to back its liabilities These amounts are adjusted daily, depending on factors such as the level of financial institution borrowings and/or deposits A supply and demand analysis of the market for reserves in the United States yields the following results When the Fed makes an open market purchase or lowers reserve requirements, the federal funds rate declines When the Fed makes an open market sale or raises reserve requirements, the federal funds rate rises Changes in the discount rate may also affect the federal funds rate KEY TERMS direct clearers, p 433 overnight interest rate (reference rate), p 433 Sale and Repurchase Agreements (SRAs), p 443 overnight rate, LVTS participants, p 432 policy rate, p 433 Special Purchase and Resale Agreements (SPRAs), p 443 monetary conditions, primary dealers, standing lending facility, Large Value Transfer System (LVTS), p 432 p 440 multilateral netting, p 433 operating band, p 434 repos, p 431 p 443 standing liquidity facilities, p 443 reverse repos, p 443 systemic risk, p 452 p 436 p 432 QUESTIONS You will find the answers to the questions marked with an asterisk in the Textbook Resources section of your MyEconLab *1 If government deposits at the Bank of Canada are predicted to increase, what open market operations could be undertaken to neutralize the effect on settlement balances?