Amano, Robert, Paul Fenton, David Tesier, and Simon van Norden, 1996, “The Credibility of Monetary Policy: A Survey of the Literature with some Simple Applications to Canada,” (unpublished; Ottawa: Bank of Canada).
Bank of Canada 1995, Monetary Policy Report (May).
Bank of Canada, 1996, Monetary Policy Report (May).
Barker, William, 1996, “Daily Bank of Canada Operations and the Monetary Conditions Index,” in Money Markets and Central Bank Operations (Ottawa: Bank of Canada).
Black, Richard, Douglas Laxton, David Rose, and Robert Tetlow, 1994, The Bank of Canada’s New Quarterly Projection Model Part 1 The Steady-State Model: SSQPM, Technical Report No. 72 (Ottawa: Bank of Canada).
Clinton, Kevin, 1991, “Bank of Canada Cash Management: The Main Technique for Implementing Monetary Policy,” Bank of Canada Review (January).
Coletti, Donald, Benjamin Hunt, David Rose and Robert Tetlow, 1996, The Bank of Canada’s New Quarterly Projection Model Part 3 The Dynamic Model: QPM, Technical Report No. 75 (Ottawa: Bank of Canada).
Duguay, Pierre, 1994, “Empirical Evidence on the Strength of the Monetary Transmission Mechanism in Canada: An Aggregate Approach,” Journal of Monetary Economics (February).
Duguay, Pierre, Steve Poloz, 1994, “The Role of Economic Projections in Canadian Monetary Policy Formulation,” Canadian Public Policy-Analyse de Politiques (June).
Eika, Kari, Neil Ericsson, and Rgnar Nymoen, 1996, “Hazards in Implementing a Monetary Conditions Index,” International Finance Discussion Papers Board of Governors of the Federal Reserve System No. 568 (October).
Farahmand, Pascal, 1995, “Bank of Canada Operations and Their Influence on the Overnight Rate,” paper presented at the Bank of Canada conference “Money Markets and Central Bank Operations,” November.
Freedman, Charles, 1994, “The Use of Indicators and of the Monetary Conditions Index in Canada,” in Frameworks for Monetary Stability edited by Tomás Balifto Carlo Cottarelli (Washington: International Monetary Fund).
Freedman, Charles, 1995, “The Role of Monetary Conditions and the Monetary Conditions Index in the Conduct of Policy,” Bank of Canada Review (Autumn).
Freedman, Charles, 1996, “What Operating Procedures should be Adopted to Maintain Price Stability?—Practical Issues,” paper presented at the Federal Reserve Bank of Kansas City Symposium “Achieving Price Stability,” Jackson Hole Wyoming August 29–31.
Hansen, Lars Peter and James Heckman, “The Empirical Foundations of Calibration,” Journal of Economic Perspectives, Volume 10 Number 1 (Winter).
Johnson, David, 1995, “Expected Inflation in Canada 1988–1995: an Evaluation of Bank of Canada Credibility and the Effect of Inflation Targets” (unpublished; Waterloo: Wilfrid Laurier University).
Kydland, Finn and Edward Prescott, 1996, “The Computational Experiment: An Econometric Tool,” Journal of Economic Perspectives, Volume 10 Number 1 (Winter).
Laxton, Douglas, David Rose, and Robert Tetlow, 1993, “Is the Canadian Phillips Curve Nonlinear?” Working Paper 93–7 (Ottawa: Bank of Canada).
Zelmer, Mark, 1995, “Strategies versus Tactics for Monetary Policy Operations,” paper presented at the conference of the Bank of Canada “Money Markets and Central Bank Operations,” November.
Prepared by Brenda Gonzalez-Hermosillo and Takatoshi Ito.
The Bank Rate is the interest rate used by the Bank of Canada for advances to direct clearers (the major financial institutions that maintain accounts at the Bank for clearing and settlement purposes), and for purchase and resale transactions with a designated group of investment dealers and banks (known as “jobbers”).
The various alternative models used at the Bank of Canada are reviewed in Coletti, Hunt, Rose, and Tetlow (1996). Some of the published research at the Bank of Canada includes Duguay (1994) where a simple Phillips curve, based on the assumption that expectations are formed adaptedly, is estimated for Canada for the period 1968Q4–1990Q4.
QPM can be viewed as a “system” formed by two formal models: one of the steady state or long-run equilibrium and a set of dynamic relationships that provide paths linking starting conditions to the solutions implied by the steady state. The steady state QPM model is reviewed in Black, Laxton, Rose, and Tetlow (1994), while the dynamic properties of QPM are discussed in Coletti, Hunt, Rose, and Tetlow (1996). Some of the structural relationships in QPM are supported by satellite models which have more detailed analysis than the highly aggregated level in QPM.
The traditional methods of estimating a model’s parameters through econometric techniques (e.g., ordinary least squares, instrumental variables, etc) rely on standard measures of statistical inference (including, for example, the parameters’ signal-to-noise ratio or t-statistics). When a model is calibrated, certain parameter values are imposed while “fitting” the data. Many of the parameters used in QPM are derived from other empirical studies which are based on traditional econometric techniques. One of the main advantages of calibration is that some of the major difficulties in estimating a large macroeconomic model through traditional econometric methods (including, for example, high simultaneity of the system and the fact that some relevant data may not be directly observable) can be avoided. The principal disadvantage of calibration, however, is that there is no formal metric for rejecting null hypotheses embedded in the model and there is no standard metric to measure “goodness of fit.” (For a review of the key issues in calibration, see, for example, Kydland and Prescott (1996); and Hansen and Heckman (1996)).
Specifically, the monetary reaction function in QPM takes the form:
where Rs is the 3-month commercial paper rate, RL is the 10-year Government of Canada bond rate, πe is the rate of inflation expected by the monetary authorities, and πt is the target rate of inflation. The role of the lagged value of the (inverted) yield spread, RS-RL, is to smooth the reaction of short-term interest rates to shocks. Coletti, Hunt, Rose, and Tetlow (1996) note that this term can be viewed as reflecting constraints facing the central bank in how fast it can move in responding to shocks and the uncertainty that it faces in interpreting what is happening to the economy.
In QPM, the actual achievement of the inflation target would take longer (8 to 12 quarters, for most shocks).
Coletti, Hunt, Rose, and Tetlow (1996) provide examples of quantitative results (relative to control) of various types of shocks in the model’s simulations.
The response of the Bank of Canada to various types of shocks, higlighting the role of central bank credibility, is discussed in Freedman (1996). The remainer of this section roughly follows Freedman’s arguments.
Eika, Ericsson, and Nymoen (1996) provide a critical assessment of the use of monetary conditions indices by several central banks. They argue that the value of a monetary conditions index for conducting economic policy is doubtful because it relies on strong assumptions, which have not been thoroughly investigated, about parameter consistency, omitted variables, cointegration, dynamics, and exogeneity. While some of those technical arguments may be valid if the MCI were to be viewed as a long-run fundamental economic relationship, the usefulness of a MCI as a “short-hand,” short-term indicator of the stance of monetary policy (as it is used by the Bank of Canada) is not necessarily diminished even if it incorporates certain strong assumptions. In addition, in order to account for these potential problems, the desired path of the MCI is recalibrated with every quarterly update of the Bank of Canada staff s projection.
The weight of the U.S. dollar in the effective exchange rate is about 0.82.
The time of the day when a change in the overnight rate occurs can reflect the motivation for the shift. Noël (1995) notes that, generally, changes in the band to reflect economic fundamentals or to rebalance monetary conditions occur at around 9 a.m. Changes in the overnight rate to help stabilize markets can take place at any time during the day.
The operational framework at the Bank of Canada has been addressed, inter alia, in Noël (1995), Montador (1995), Clinton (1991), Clinton and Fettig (1989), Howard (1996), Stenger (1994), Farahmand (1995), and Zelmer (1995). Specific procedural details are provided in these sources.
The directly clearing members of the Canadian Payments Association (CPA) maintain accounts with the Bank of Canada in order to settle transactions among themselves.
These transactions are also called “specials” to differentiate them from regular Purchase and Repurchase Agreements (PRAs) which are a form of financing available up to a predetermined limit to dealer jobbers at the Bank Rate, on the initiative of the dealer. PRAs assist dealer jobbers in their overnight financing positions in government securities. However, this facility does not constitute an open market operation since the use of this facility is at the discretion of the dealer.
Given that the Bank targets a daily average of the overnight rate, some trades in the overnight market may occur outside of the trading band without prompting central bank intervention. Factors such as the size and concentration of liquidity needs in the market, the length of time since the last intervention on that day, and prospects for the overnight rate to return within the band also play a role in the decision of whether or not to intervene.