11.

Monetary Policy

1. The Bank of Canada

a) Core Functions

(1)
(2)

(3)


(4)

Note:

(5)


Bank of Canada (relative) independence:

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 b) The Monetary Policy Framework

Objective:

Policy:



𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 𝑡𝑎𝑟𝑔𝑒𝑡𝑖𝑛𝑔

Policy Instrument: Overnight money market interest rate

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 2. The Conduct of Monetary Policy

a) The Overnight Money Market

□ 16 participating banks in Lynx (high-value payment system)

□ Multilateral netting at end of day
►

supply
𝑖

∗
𝑖

demand

𝑟𝑒𝑠𝑒𝑟𝑣𝑒𝑠

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 b) Setting the Policy Rate

(1) Cut off demand with deposit and bank rate


𝑑𝑒𝑝𝑜𝑠𝑖𝑡 𝑟𝑎𝑡𝑒

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(2) Fine tune supply with open-market operations

𝑠𝑢𝑝𝑝𝑙𝑦 𝑠𝑒𝑡 𝑏𝑦 𝐶𝐵

Repo:
(1)
(2)
(3)

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 Reverse Repo: CB sells bond, buys it back tomorrow
(1)
(2)
(3)

Note:

c) Propagation of short-term to long-term interest rates

Option 1: 2-year term Option 2: 2 times 1-year term

(1 + 𝑖 )𝐵

Both should yield the same return, but option 1 is riskier:

!
(1 + 𝑖 ) =

□ Expectations theory of interest rates:

!
(1 + 𝑖 ) = (1 − 𝑖 ) 1 + 𝑖 1+𝑖 1+𝑖 …+ 𝛾

!
(1 + 𝑖 ) = 1+𝑖 +𝛾

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 3. Monetary Policy Transmission

a) Conventional Monetary Policy

□ Transmission Channels

(1)


(2)


(3)



(4)


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 □ The Taylor Rule

𝑟 +𝛾 𝑀𝑃𝑅

𝛾
𝑟∗

π∗ 𝜋

𝑖 = 𝑟∗ + 𝜋 + 𝜙 (π − π∗ ) + ϕ (𝑦 − 𝑦)
( )

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b) Non-Conventional Monetary Policy

□ The Liquidity Trap

IS-MP
𝑟

𝑀𝑃

𝐼𝑆
0 𝑦

Solution:



(1) Negative Interest Rates

IS-MP
𝑟 •

𝑀𝑃

𝐼𝑆
0 𝑦

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 (2) Quantitative Easing

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 (3) Forward Guidance

(1 + 𝑖 ) = (1 − 𝑖 ) 1+𝑖 1+𝑖 1+𝑖 …+𝛾

Note:

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