Chapter 16.docx - Chapter 16 pages 390-419 Tools of...

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Chapter 16: pages 390-419 Tools of monetary policy -In this chapter we examine the tools of monetary policy used by the BOC to control the money supply and interest rates. -overnight interest rate: the interest rate at which participants borrow and lend overnight funds to each other in the money market. The framework for the implementation of the monetary policy: The large value transfer system (LVTS): - the core of the Canadian payment system Is the LVTS. - LVTS: an electronic, net settlement system for the transfer of large sums of money. It permits the participating clients to send large sums of money securely in a real time. It was Introduced in February 1999. It is a real time net settlement network, designed to provide immediate finality and settlement to time critical transactions. - in addition to BOC, there are 15 LVTS participants. - the LVTS has been put together to eliminate the systematic risk - systematic risk: the risk to the entire payments system due to the inability of one financial institution to fulfill its payment obligations in a timely fashion. - this system was implemented by Sweden in 1986 (first). Non LVTS (ACSS) transactions: - non LVTS paper based payment items are paper cheques, travellers’ cheques, gift certificates and money orders. -small value electronic payment items are preauthorized debits and fund transfers, direct deposit items, debit card transactions. - the above items are cleared and settled through (ACSS automated clearing settlement system) The bank of Canada policy rate: - the overnight market is the key market for finance and monetary policy. -this market is very liquid, with many participants. - overnight interest rate : the interest rate at which participants borrow and lend overnight funds to each other in the monetary market. It is known as the reference rate. - the BOC signals the monetary policy by announcing a target for the overnight interest rate. - policy rate: the target for the overnight rate, which is the main tool the bank uses to conduct monetary policy. -the implementation of the monetary policy is more successful when the reference rate is closer to the policy rate. That is the closer the overnight rate is to the target overnight rate. the operating band for the overnight interest rate: - the BOC implements monetary policy by changing the policy rate. - the banks operational objective is to keep the overnight rate within an operational band (operating band of 50 basis points).
- in response to the subprime financial crisis, the BOC temporarily narrowed the operating band for the overnight interest rate to 25 basis points. The bank of Canada’s standing facilities: - at the end of each banking day, LVTS participants must bring their settlement balance with the BOC close to zero. - in order to do this, the BOC stands ready with standing liquidity balances.

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