Monetary Policy in Canada

Monetary Policy in Canada

The Bank of Canada’s Control Over the Money Supply

· The ability of the central bank to affect the money supply is critically related to its ability to determine the reserves of the commercial banking system.

· One important tool that the Bank uses for influencing the supply of money is the purchase or sale of government securities on the open market. These actions are known as open-market operations.

· Whenever the Bank is involved in either the purchase or sale of government securities, the reserves of the entire banking system are altered, and this affects the money supply.

· When the Bank of Canada buys a treasury bill or a bond from a household or a firm, it pays for the bond with a cheque drawn on itself and payable to the seller. The seller deposits this cheque in a commercial bank, which then presents the cheque to the Bank of Canada for payment.

· The bank of Canada then makes a book entry, increasing the deposit of the commercial bank at the central bank, which adds to the commercial bank’s reserves.

· Typically, when the Bank buys securities on the open market, the reserves of the commercial banks are increased. These banks can then expand deposits, thereby increasing the money supply.

· When the Bank sells a security to a household or firm, it receives in return the buyers cheque drawn against a deposit in a bank. The Bank presents the cheque to the commercial bank for payment.

· Payment is made by a book entry that reduces the bank’s deposit at the central bank, and hence reduces its reserves.

· When the central bank sells securities on the open market, the reserves of the commercial banks are decreased. These banks must in turn contract deposits, thereby decreasing the money supply.

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· Cash management - the shifting of government deposits between the Bank of Canada and the chartered banks – is a major tool used by the Bank of Canada in its day-to-day operations.

· When the Bank transfers government deposits, it influences the reserves of the banking system relative to its target level of reserves, thereby inducing an expansion or contraction of commercial bank lending and thus an expansion or contraction of the money supply.

· Open-market operations and control of government deposits give the Bank of Canada potent weapons for affecting the size of commercial bank reserves and thus for affecting the money supply.

· Though the details of an open-market operation differ from