Chapter 25:
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
Copyright © 2004 McGraw-Hill Ryerson Limited. All rights reserved.
Why Central Banks?
 Emerged as lenders of last resort
 Are a fairly recent phenomenon in many
countries: see TABLE 25.1
 Function in part as regulators of the financial
system
 Function as fiscal agents of governments
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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
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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
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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

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Tools of Monetary Policy
The Overnight rate and the operating band: FIGURE
25.3
 The SPRA and SRAs as a device to influence liquidity
in the overnight market: FIGURE 25.5 and TABLE 25.4
 Open market operations: TABLE 25.7

sale (purchases) reduces (increases) the money supply
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The Overnight rate Operating Band
Interest Rate
Bank rate
T
3
T2
T1
Interest on + balances
-Net Borrower 0
Operating
band:
50 basis
points
Settlement
+ Net Lender Balances
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The Behaviour of the Operating rate,
1994-2001
9
Operating band (top)
Operating band (bottom)
Bank rate
Target
8
7
Percent
6
5
4
3
2
1
94
95
96
97
98
99
00
Year
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01
The Use of SPRAs and SRAs in Canada,
1994-2001
3000
LVTS
Millions of dollars
2500
SPRA
SRA
2000
1500
1000
500
0
-500
94
95
96
97
98
99
00
Year
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01
How an SPRA Works
Step 1: Loan called in
A
L
A
L
Call loan -100
Call loan -100
Step 2: SPRA offered by BOC
A
L
A
L
SPRA +100
Govt Sec +100
Step 3: Clearer affects deposits at BOC
A
Dep. BOC +100
L
A
L
Dep. by clearer +100
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Tools of Monetary Policy (cont’d)

Base control
Open Market Operations TABLE 25.6
debt monetization: buying the govt’s debt TABLE 25.7

Other tools
foreign exchange operations: a foreign exchange SWAP
TABLE25.5
reserve requirements and their demise
the Bank Rate & moral suasion
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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
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An Open market operation
BANK OF CANADA
Tbills +100
Dep. Chartered banks +100
CHARTERED BANKS
Reserves +100
Tbills
-100
No change
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Monetizing the Debt
BANK OF CANADA
Govt securities +100
Currency (BOC notes) +100
CHARTERED BANKS
Reserves +100
Govt of Canada Dep. +100
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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
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