class 10 Flashcards
what is the bank of Canadas main policy instrument?
setting the target for the policy rate
what is the goal of the bank of Canadas monetary policy?
to keep inflation within the range of 1%-3% with the midpoint being at 2%
what was the first country to adapt an inflation target rate?
new Zealand
what is a policy instrument?
changes in the policy rate that influence other interest rates and the exchange rate
what determines the monetary conditions that the canadian economy operates in?
the level of short-term interest rates and the exchange rate of the canadian dollar
how long are changes in monetary conditions felt?
they are felt over a period of several months to years
how does the bank of canada keep inflation from moving above the target range?
an increase in target for the overnight rate causes the dollar value and interest rates to go up, causing a decrease in aggregate demand and dollars, causing the rate of inflation to fall
how does the bank of Canada keep inflation from moving below the target rate?
a decrease in target for the overnight interest rate leads to the dollar value and interest rates going down, causing an increase in aggregate demand and dollars, causing the inflation rate to rise
what is the overnight interbank market?
the interbank market for funds with a maturity of 1 day
what is the overnight interest rate?
the interest rate at which participants (banks) borrow and lend overnight funds to each other in the overnight market
what is the policy rate?
the rate that the bank sets to keep the overnight rate within a band of 50 basis points (0.5%) with the midpoint being the target
what is the top of the operating band?
the bank rate
what is the bank rate?
the rate at which the bank of Canada will lend to banks
what is the bottom of the operating band?
the deposit rate
what is the deposit rate?
the rate at which banks can earn interest on excess reserves when they deposit it at the bank of canada
how does the top of the operating band and the bottom of the operating band keep the overnight rate in-between the operating band?
because the top being the bank rate, is higher than any other commercial bank could offer to another bank if a commercial bank tries to get a loan from another bank, and the deposit rate being the floor because no bank could offer the interest rate that the Bank of canada does if another bank would want to deposit their money at another bank
what is the operating band?
the objective to keep the overnight rate within a band of 50 basis points (0.5%)
what were 2 exceptions for the operating band?
during the 07 financial crisis, the band was 25 basis points (0.25%)
curing the covid-19 pandemic this happened again
what are the 2 conventional monetary policy tools?
the bank of Canada standing liquidity facilities
open market operations
what is the bank of canada standing liquidity facilitates?
the bank of canada stand ready with liquidity facilitates to lend or borrow from a lynx participant (bank) at the end of the banking day
who decides to initiate the bank of Canadas standing liquidity facilities?
it is on the lynx participant (the bank) may use the banks lending ti obtain overnight liquidity in case of a shortage or may use the deposit facilities to make deposits incase of excess liquidity
if the overnight rate increases toward the upper limit of the operating band, what will the bank of canada do?
they bank will lend at the bank rate, putting a ceiling on the the overnight rate and causing the other banks to lend at a Lower rate and pushing the overnight rate back to the midpoint
if the overnight rate falls towards the lower limit of the operating band, what will the bank of canada do?
the bank will accept deposits from lynx participants (banks) at the bank rate minus 50 basis points, putting a floor on the overnight rate, this causes other banks to increase their overnight rate
what determines the overnight rate?
the market for settlement balances (reserves) and the supply and demand in the market for reserves
what is the market equilibrium in the market for settlement balances?
the point at which the quantity of reserves demanded, equals the quantity of reserves supplied, determining the actual overnight rate
when the overnight rate is above the interest rate paid on excess reserves, how does that impact the demand curve of reserves?
as the overnight rate decreases, the opportunity cost of holding excess reserves falls, and the quantity of reserves demanded rises
when the overnight rate is below the interest rate paid on excess reserves, how does that impact the demand curve of reserves?
banks do not lend in the overnight market at the low rate. instead they just keep on adding to their holdings of excess reserves. causing quantity of reserves demanded to fall
does a downward sloping demand curve of reserves eventually become infinitely elastic?
yes because it his the floor
what is borrowing from the bank of canada a substitute for?
it is a substitute for commercial banks from borrowing other commercial banks
if the overnight rate is less than the bank rate, how will that impact the supply curve of reserves?
banks will not borrow from the bank of canada and borrowed reserves are 0, the supply curve will be vertical at the level of non-balanced reserves
if the overnight rate rises above the bank rate, how will that impact the supply curve of reserves?
banks will borrow more and more from the bank of canada and re-lend it at the overnight rate
when is the supply curve perfectly elastic?
when the interest rate is at the bank rate
what does a leftward shift of the demand curve of reserves do?
it lowers the overnight rate to a minimum of the interest rate on reserves
what does a rightward shift of the demand curve of reserves do?
it raises the overnight rate to a maximum of the bank rate
what does the lending facility of the bank of canada do to overnight interest rate?
it puts a ceiling on it
why is bank of canada lending important in financial crisis’s?
it helps prevent financial lending and the lender of last resort to help prevent financial crisis’s
how does the bank of canada act as a lender of last resort?
it provides lending assistance against collateral for a maximum of 6 months (can be extended) to solvent (but illiquid) deposit-taking institutions to prevent bank failures and financial panics
what rate do banks charge on loans of last resort?
they normally charge the bank rate although the bank of canned ahas discretion to charge a higher rate
how can the central bank lose money?
if the government securities they are holding have a lower interest rate than the coupon payments that the BoC are making for the government
what are the 4 things that open market operations purchases causes?
expand bank reserves and the monetary base
lower short-term interest rates
raise the money supply
overnight rate goes down
what are the 4 things that open market operations sales causes?
shrink bank reserves and monetary base
raise short-term interest rates
lower the money supply
overnight rate goes up
what did the bank change about their open market operations in 1994?
they stoped using government T-bills and bonds and instead uses special purchase and resale agreements (repos) and sale and repurchase agreements (SRA)
what do special purchase and resale agreements do?
used as tools to reduce undesired upward pressure on the overnight rate
what do sale and repurchase agreements do?
used as tools to reduce undesired downward pressure on the overnight rate, if overnight funds are traded at a rate above the target the BoC enters into SPRAs at a price that works out to the target interest overnight rate, the BoC buys T-bills or bonds with an agreement that the seller will buy them back one business day later, relieving undesired upward pressure on overnight interest rates
how do special purchase and resale agreements work?
the bank sells securities today to the bank of Canadas and receives the payment same day
the next way the bank of canada sells back the securities to the bank and the bank pays the price plus interest for the securities
if funds are traded at a rate above the target rate, what will the bank of canada do?
they will enter into special purchases and resale agreements
if overnight funds are traded at a rate below the target rate, what will the bank of canada do?
they will enter into sale and repurchase agreements to alleviate undesired downward pressure
in normal times are conventional monetary policy tools enough?
yes
in times of financial crisis, are conventional policy tools enough?
no they are not, the financial system seizes up to such an extent that it becomes unable to allocate capital to productive uses
what can the negative shock from a financial crisis lead to?
it can lead to the zero lower bound problem
what is the zero-lower bound problem?
when the central bank is unable to lower short-term interest rates, which have hit a floor of 0
what are nonconventional monetary policy tools?
ant non-interest rate monetary policy tools
what are 4 examples of non-conventional monetary policy tools?
liquidity provision
large-scale asset purchases (EQ)
commitment to future monetary policy actions
negative interest rates on reserves
what is liquidity provisions?
a new tools from the bank of Canada for financial crisis to address aggregate system liquidity issues
what is an example of liquidity provisions?
term purchase and resale agreements
what are term purchase and resale agreements?
when the bank of canada purchases securities from the banking system and has a term longer than one day (typically 28 days) before before the BoC purchases the securities back, this pumps liquid currency in to the economy to help stimulate it
what kind of acceptable collateral does the BoC accept for term purchase and resale agreements?
they expand the list of acceptable collateral
what is large scale asset purchases?
when the bank purchases or sells lots of government securities (mostly short-term)
what is another term for large-scale asset purchases?
quantitative easing
what does quantitate easing lead to?
a huge increase in the monetary base
will quantitative easing stimulate the economy in the near term and produce inflation down the road?
balacne sheet expansions (QE) does not necessarily increase the money supply that much since excess reserves can increase
does quantitative easing run the risk of creating inflation?
yes
what is forward guidance?
when they make commitments to keep policy rates at 0 for a long period of time, this lower expectations of future short-term rates
what are the 2 kinds of forward guidance?
conditional
unconditional
what is an example of conditional forward guidance?
the BoC lowered the policy rate to 0.25% and also committed to holding the rate at 0.25% until the 2nd quarter of 2010, conditional on the outlook for inflation
when there is an excess supply of reserves, how does the impact the overnight rate?
it will fall
when there is an excess of demand of reserves, how does that impact the overnight rate?
it will rise
what are negative interest rates on reserves?
when central banks charge banks for depositing their funds at the central bank and they have a negative interest rate
if the central bank were to set a negative interest rate, what would it be?
it would be -0.5% to -0.25%
why would the central bank set negative interest rates on reserves?
to encourage banks to lend more and buy more securities
who was the first bank to implement negative interest rates on reserves?
Sweden in July of 2009
when did Denmark implement negative interest rates on reserves?
July 2012
when the the ECB implement negative interest rates on reserves?
June 2014
when did Switzerland implement negative interest rates on reserves?
December 2014
when did Japan implement negative interest rates on reserves?
January 2016
what are the 4 conventional tools of the federal reserve?
reserve requirements
open market operations
discount window lending (lending to commercial banks)
fed pays interest on excess reserves (taking deposits from commercial banks)
do all US banks have the same reserve requirement rate?
no, more then 80% has a reserve requirement of 10% but smaller banks that have less than 120M in deposits have a small reserve rate around 3%-0%
when US banks borrow from the federal reserve, who do they borrow from?
they borrow from the federal reserve bank in their district not from the federal reserve board in wachington
when excess supply of reserves, how does that impact the federal funds rate?
it will fall
when there is excess demand of reserves, how does that impact the federal fund rate?
it will rise
how will an open market purchase impact the quantity of reserves?
it will cause the supply of reserves to shift to the right (increase) and causes the federal fund rate to fall
how will an open market sale impact the quantity of reserves?
it will cause the supply of reserves to shift to the left (decrease) and causes the federal fund rate to increase
how will lowering the discount impact the supply of reserves?
it will cause the supply of reserves to shift down (decrease) and will not impact the federal fund rate unless it drops the supply of reserves a lot
how will raising the discount rate impact the supply of reserves?
it will cause the supply of reserves to shift up (increase) and will not impact the federal funds rate
how will an increase of required reserves impact the demand of reserves?
it will cause the demand of reserves to shift right (increase) and cause the federal funds rate to increase
how will a decrease of required reserves impact the demand of reserves?
it will cause the demand of reserves to shift left (decrease) and will cause the federal funds rate to decrease
what is the policy instrument for European banks to enact monetary policy?
a target for the overnight cash rate at 2%
what are the 4 conventional monetary policy tools of the European central bank?
open market operations (shorter and longer term operations)
lending to banks and taking deposits from banks
interest rate on excess reserve
reserve requirements (only 2% of the total amount of checking deposits and other short term deposits)
during the holiday season, when the publics holdings of currency increase, what open market operations typically occur and why?
there would be open market purchases by the bank of canada because people would withdraw money decreasing reserves, so the open market purchase by the bank of canada would give the banks more reserves
what his the main advantage of an unconditional monetary policy?
gives people certainty and helps them with decision making
what is the main disadvantage of unconditional monetary policy?
if something drastic happens and they cannot change the policy rate to fight the shock, so they have to deal with the consequences or they change it and then people would lose trust in them
if the economy is surprisingly strong, leading to an incense in checkable deposits, how will that impact the federal funds rate?
it will cause the federal funds rate to increase, because they want to pull some money from the economy to make sure its not growing to fast
if banks expect an unusually large increase in withdrawals from checking deposit accounts In the near future, how will that impact the federal funds rate?
it will cause the federal funds rate to increase because they want to make sure that the banking system will hav enough reserves to prepare for the withdrawals
if the federal reserve reduces reserve requirements, how will that impact the federal funds rate?
it will casus the federal funds rate to decrease
true or false, the bank of canada maintains the stability of money supply in Canada?
true, they make sure that the money supply isn’t growing to fast
true or false, the bank of canada controls the money supply?
false, they control a portion of it, but they cannot control how much currency people hold
true or false, the bank of canada provides funds to the government in the case of a budget deficit?
false, if they need money in a budget deficit they have to issue bonds but the bank of canada cannot purchase them
why is it bad if the federal bank provides the government funds in the case of a budget deficit?
because that would cause tons of inflation
true of false, the bank of Canada control the inflation?
false, they cannot control inflation, they are a player of controlling it but they cannot control inflation as a whole
true or false, the bank of canada control the inflation target?
false, it is a joint determination between the bank of Canada and the department of finance on behalf of the government
