Abstract
Between 1980 and 1995, labor productivity in the business sector grew at an average annual rate in Canada, which was slightly faster than productivity growth in Germany, but significantly slower than labor productivity growth in France, Italy, Japan, and the United States. To better understand developments in labor productivity, it is useful to decompose its growth rate into changes in the capital/labor ratio and in total factor productivity. The contribution of information technology to labor productivity growth has been more modest in Canada than in the United States.
III. Management of the Government Debt: Implications for Monetary Policy Implementation and Financial Markets1
1. In common with several other industrial countries, fiscal surpluses in recent years have contributed to a reduction in government debt in Canada (Table 1). At the same time, the Government has altered the composition of the debt, moving toward longer-term fixed-rate securities, with a view to reducing interest rate risk. The maturity structure has been lengthened through a substantial decline in short-term securities, especially treasury bills. Monetary policy makers and financial market participants have adapted to the changes in government debt without major disruptions. The prospect of substantial debt reduction in the future does, however, pose a number of questions arising from the role of government securities in monetary policy operations and in financial markets.
Selected Countries: Debt Developments, 1995-99 1/
(In percent of GDP)
Net debt of the federal/central government.
Fiscal year basis.
Selected Countries: Debt Developments, 1995-99 1/
(In percent of GDP)
| 1995 | 1996 | 1997 | 1998 | 1999 | |
|---|---|---|---|---|---|
| Canada | 69.8 | 68.9 | 64.9 | 62.3 | 58.2 |
| United States | 52.0 | 51.8 | 49.4 | 46.5 | 42.3 |
| United Kingdom | 50.5 | 51.3 | 49.9 | 46.9 | 44.7 |
| Australia 2/ | 18.9 | 18.0 | 14.7 | 11.9 | 9.0 |
| New Zealand 2/ | 48.7 | 43.8 | 37.0 | 38.5 | 36.0 |
Net debt of the federal/central government.
Fiscal year basis.
Selected Countries: Debt Developments, 1995-99 1/
(In percent of GDP)
| 1995 | 1996 | 1997 | 1998 | 1999 | |
|---|---|---|---|---|---|
| Canada | 69.8 | 68.9 | 64.9 | 62.3 | 58.2 |
| United States | 52.0 | 51.8 | 49.4 | 46.5 | 42.3 |
| United Kingdom | 50.5 | 51.3 | 49.9 | 46.9 | 44.7 |
| Australia 2/ | 18.9 | 18.0 | 14.7 | 11.9 | 9.0 |
| New Zealand 2/ | 48.7 | 43.8 | 37.0 | 38.5 | 36.0 |
Net debt of the federal/central government.
Fiscal year basis.
2. As the stock of government debt declines in Canada and other countries, alternative assets are emerging to fulfill some of the roles traditionally played by government securities, although it is not yet clear which asset will ultimately take the place of government securities in monetary operations and financial markets. In Canada, where the elimination of the government debt is a more distant prospect than in countries such as the United States, the question of alternatives to government securities is less immediate. Across countries, the assets through which central banks choose to inject liquidity are likely to become the de facto alternative to government securities, and the demand for those assets as safe havens will grow. It is possible that no alternative will emerge as a close substitute for government securities, in which case markets are likely to become more risky and less liquid, an externality that could be sufficiently significant to warrant the Government continuing to maintain an active market in government paper, even when the funds are not needed to finance current operations.2
A. Debt Developments
3. Gross federal government debt as a share of GDP declined from 73 percent in 1997/98 to 67 percent in 1999/2000 (Table 2).3 The decline was led by a fall in the ratio to GDP of marketable debt, while the share of nonmarketable debt fell only slightly.4 The share of marketable debt held by nonresidents declined from 28 percent to 24 percent. In terms of currency composition, the share of foreign currency debt in marketable debt rose moderately to 8 percent, largely reflecting a planned increase in gross international reserves, which in Canada are funded primarily by borrowing.
Canada: Gross Federal Government Debt, 1990-2000
Marketable debt includes treasury bills and marketable bonds.
Mainly Canada Savings Bonds.
Nonresidents do not hold nonmarket debt.
Canada: Gross Federal Government Debt, 1990-2000
| 1990/91 | 1997/98 | 1999/00 | ||||
|---|---|---|---|---|---|---|
| As a percent of GDP | ||||||
| Total debt | 63.9 | 72.7 | 66.7 | |||
| Market | 47.8 | 53.2 | 47.6 | |||
| Marketable 1/ | 42.2 | 47.9 | 43.3 | |||
| Residents | 31.4 | 34.7 | 32.7 | |||
| Nonresidents | 10.9 | 13.3 | 10.6 | |||
| Nonmarketable 2/ | 5.5 | 5.3 | 4.4 | |||
| Nonmarket (residents) 3/ | 16.1 | 19.5 | 19.0 | |||
| As a percent of total debt | ||||||
| Total debt | 100.0 | 100.0 | 100.0 | |||
| Market | 74.8 | 73.2 | 71.5 | |||
| Marketable 1/ | 66.1 | 65.9 | 64.9 | |||
| Residents | 49.1 | 47.7 | 49.1 | |||
| Nonresidents | 17.0 | 18.2 | 15.8 | |||
| Nonmarketable 2/ | 8.7 | 7.3 | 6.6 | |||
| Nonmarket (residents) 3/ | 25.2 | 26.8 | 28.5 | |||
Marketable debt includes treasury bills and marketable bonds.
Mainly Canada Savings Bonds.
Nonresidents do not hold nonmarket debt.
Canada: Gross Federal Government Debt, 1990-2000
| 1990/91 | 1997/98 | 1999/00 | ||||
|---|---|---|---|---|---|---|
| As a percent of GDP | ||||||
| Total debt | 63.9 | 72.7 | 66.7 | |||
| Market | 47.8 | 53.2 | 47.6 | |||
| Marketable 1/ | 42.2 | 47.9 | 43.3 | |||
| Residents | 31.4 | 34.7 | 32.7 | |||
| Nonresidents | 10.9 | 13.3 | 10.6 | |||
| Nonmarketable 2/ | 5.5 | 5.3 | 4.4 | |||
| Nonmarket (residents) 3/ | 16.1 | 19.5 | 19.0 | |||
| As a percent of total debt | ||||||
| Total debt | 100.0 | 100.0 | 100.0 | |||
| Market | 74.8 | 73.2 | 71.5 | |||
| Marketable 1/ | 66.1 | 65.9 | 64.9 | |||
| Residents | 49.1 | 47.7 | 49.1 | |||
| Nonresidents | 17.0 | 18.2 | 15.8 | |||
| Nonmarketable 2/ | 8.7 | 7.3 | 6.6 | |||
| Nonmarket (residents) 3/ | 25.2 | 26.8 | 28.5 | |||
Marketable debt includes treasury bills and marketable bonds.
Mainly Canada Savings Bonds.
Nonresidents do not hold nonmarket debt.
4. A key change in the profile of government debt has been a substantial decline in shorter-term debt. One objective of debt management policy since 1990 has been to lengthen the maturity structure.5 The average term to maturity of government debt rose from around 4 years in 1990 to 6½ years in early 2000. In 1997, the latest year for which cross-country data were available, the average maturity of Canadian government debt was in the middle of the range for a group of industrial countries, but longer than in the United States (Figure 1). Consistent with the Government’s objective, the share of longer-term, fixed-rate debt increased steadily during the 1990s, reaching two-thirds of the total by 1998 and staying at that level subsequently.6 Reflecting the shift toward longer-term debt, the outstanding stock of treasury bills declined in absolute terms to $100 billion in 1999/2000, from $140 billion ten years earlier.
International Comparison: Average Term to Maturity of Government Debt, 1997
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Source: OCED5. Debt management strategy has tried to mitigate the reduction in liquidity in the government securities market. Treasury bill auctions have been moved from a weekly to a bi-weekly schedule in order to contain the decline in issuance size. At longer maturities (two years and over), debt management operations have included efforts to maintain liquidity in key “benchmark” maturities (2, 5, and 10 years).7 Debt issuance has been focused on these benchmark maturities; benchmark issues have periodically been reopened; and issuance in some other maturities has been stopped. In addition, under the Government’s buyback program, off-the-run issues have been bought back at the same time that new benchmark issues were being sold, helping to maintain benchmark issuance size (O’Regan (2000)).8
6. A notable respect in which Canada’s debt situation is different from other countries, including the United States, is that the prospect of the elimination of marketable government debt is less of an immediate issue in Canada.9 An illustrative exercise shows that, due to the relatively high initial level of debt in Canada as well as the possible pace of debt reduction, the time horizon over which the debt might decline to very low levels is longer in Canada (Figure 2). For the purposes of this exercise, it was assumed that debt is reduced by $10 billion in 2000/01 (as announced by the Government) and by $3 billion annually (equivalent to the contingency reserve in the budget) over the next decade. On this basis, by the end of the decade the ratio to GDP of Canadian federal government market debt would fall only to the level currently prevailing in the United States. For the United States, it was assumed that the surpluses of the Social Security and Medicare trust funds are devoted to reducing marketable debt, while the rest of the budget is balanced.
Canada and the United States: Marketable Federal Government Debt Projections, 2000-11
(Fiscal Year, Percent of GDP)1/
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Source: IMF staff estimates, based on Department of Finance Canada Annual Financial Report of the Government of Canada, Fiscal Year 1999-2000, and U.S. Office of Management and Budget, FY 2002 Economic Outlook, Highlights from FY1994 to FY2001, FY Baseline Projections.1/For Canada, the projections assume that market debt is reduced by Can$10 billion in FY 2000/01 and by Can$3 billion annually in future years. balanced) are assumed to be devoted to reducing marketable debt.B. Implications for Monetary Policy Implementation
7. A reduction in public debt has the potential to affect monetary policy implementation directly because of the key role of government debt in open market operations. Permanent injections of liquidity into the financial system usually entail outright purchases of government securities (as well as, in some cases, other securities), while temporary liquidity management generally involves repurchase agreements (repos), in which the collateral is often government debt. Debt reduction can also affect monetary policy implementation indirectly by limiting the informational value of market signals. As liquidity declines, prices of government securities can become more volatile, imparting less information about market conditions and expectations.10
8. In Canada, the Bank of Canada implements monetary policy through its influence on short-term interest rates and thereby on monetary conditions, using its standing facilities to set a target band for money market rates. The interest rate charged on overnight lending (the bank rate) establishes the ceiling for overnight money market rates; the rate on the Bank of Canada’s overnight deposit facilities (remunerated at half a percentage point below the bank rate) establishes the floor. The Bank of Canada relies on open market operations to steer money market rates toward the middle of the band.11
9. The Bank uses both outright purchases/sales of Canadian government securities and repurchase agreements in its open market operations. Outright purchases of government securities are intended to provide liquidity for the issue of currency. Since the expansion in the demand for currency tends to be stable, the Bank of Canada rarely transacts in these securities after purchasing them at the auctions held by the Department of Finance. Repurchase agreements are used to guide overnight interest rates in the money market.12 Since this facility is only meant to influence overnight rates in case of deviations from the Bank of Canada’s target, the outstanding amount of repurchase agreements is rather small ($0.8 billion, as of mid-October 2000).
10. Traditionally, outright securities transactions mainly involved purchases of treasury bills. With the decline in the stock of treasury bills outstanding, however, their use has become less practical. Liquidity in the treasury bill market has declined, with the turnover ratio (annual turnover relative to the outstanding stock) falling from a peak of 60 percent in 1995 to below 25 percent in 1999 (Figure 3). With declining liquidity in treasury bills, the Bank’s outright purchases have shifted toward longer-term government bonds. Its holdings of treasury bills fell from a peak of $19 billion (over three quarters of total government securities held by the Bank of Canada) in 1994 to $9 billion (28 percent of the total) in the third quarter of 2000.13
Canada: Average Yearly Turnover of Treasury Bills
(As percent of outstanding stock of Treasury Bills)
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Sources: Bank of Canada; and staff estimates.1/ Data available until March 2000.11. With this switch in its portfolio by the Bank of Canada, prospective problems for monetary policy arising from a drying up of liquidity are not significant in the near term, although if government debt were indeed to fall substantially over the longer term, the Bank of Canada may need to consider alternative instruments for its operations. Liquidity at the longer end of the government yield curve has not fallen substantially.14 Trading volumes, for example, have declined by much less for longer-term government bonds than they have for treasury bills (Figure 4). In addition, as the Bank of Canada holds to maturity the bulk of the government securities that it purchases outright, there appears to be a sufficient stock of securities for monetary operations. An expansion of the eligible asset class for permanent operations to include nongovernment assets with a high credit rating may also be a practicable future measure. For temporary operations, although repos are currently based on treasury bills, they can in principle be based on any security with a high credit rating and liquid market.
Canada: Trading Volume of Treasury Bills and Bonds
(In billions of Canadian dollars)
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Source: Bank of Canada.12. Cross-country experience does indeed suggest that monetary policy operations need not be based only on short-term government securities. In the euro area, open market operations are based on a range of assets, so-called “tier one” and “tier two” assets, which must fulfill certain criteria (such as meeting high credit standards) but are not restricted to government securities.15 In the United Kingdom, the class of eligible securities for monetary operations by the Bank of England includes, in addition to various government securities, securities accepted by the ESCB and eligible bank bills.
13. In the United States, the U.S. Federal Reserve has started to adapt its operations to the declining stock of government debt, and some aspects of its approach may be relevant for Canada. 16 Open market operations are similar to those in Canada, with permanent operations, comprising outright open market purchases, being used to meet the expanding demand for currency and reserves; and temporary operations, through repos and matched-sale-purchase transactions (MSPs), being used to move the federal funds rate toward the target rate. Permanent operations principally involve treasury securities.17 Temporary operations traditionally were conducted using only Treasuries and government-sponsored enterprise (GSE, or “agency”) debt as collateral. In 1999, partly in response to the declining stock of Treasuries, the Federal Reserve temporarily expanded the asset class for eligible collateral to include mortgage-backed securities; it also expanded the eligible maturity of repos to include term repos. These changes have facilitated an increased reliance on the use of temporary operations and minimized disruptions in monetary policy operations.18
14. Several issues remain open, however, in considering whether nongovernment assets can replace government debt in monetary policy operations. Although they could represent an effective substitute for government securities in monetary operations, the use of nongovernment assets could have implications that are problematic from a broader policy perspective. Principally, the use of nongovernment assets in open market operations, as well as the central bank’s willingness to buy them during periods of financial turmoil, would in effect provide the issuers of such assets with an implicit subsidy, which may have implications beyond the scope of monetary operations and may not always be regarded as appropriate. Additionally, the central bank’s balance sheet would take on the credit risk that is associated with nongovernment assets.
C. Implications for Financial Markets
15. A reduction in government debt has the potential to affect financial markets because of the important roles that government paper plays in most countries with mature financial systems. Government securities represent a key benchmark asset against which other fixed-income assets are priced, and they are also used as a reference rate against which yields on other fixed-income securities are quoted. In addition, government bonds are important vehicles for hedging private sector credit risk, and are used in day-to-day liquidity management and as collateral. Moreover, government securities represent a “safe haven” during periods of market turmoil, and their value in such situations is enhanced by the fact that central banks typically ease liquidity by buying up such securities.
16. In Canada, as noted, the reduction in government debt thus far has been confined to treasury bills. Treasury bills have, however, accounted for a larger share of the money market in Canada at times during the 1990s than they have in several other industrial countries.19 At the longer end, although there has been no decline in the stock of government bonds, government debt has fallen in relation to GDP. Overall, the reduction in government debt, and the change in its profile, have not caused significant disruptions in Canadian financial markets, which are adapting smoothly to the changes.
17. The reduction in the stock of treasury bills in recent years has been accompanied by a decline in liquidity in the treasury bill market. Turnover in the treasury bill market has declined, and bid-ask spreads have increased. Treasury bill yields have risen and spreads with other money market instruments, such as bankers’ acceptances and corporate commercial paper, have increased (Figures 5 and 6). These changes have complicated transactions for investors in treasury bills, as the reduction in liquidity has made it more risky for investors to take short positions. The reduction in inventories held by the main market dealers has made it more difficult for investors to acquire specific maturities or to make large purchases, and treasury bill prices have been increasingly susceptible to “technical factors.”20
Canada: Yields on Various Marketable Government Securities
(In percentage points)
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Sources: Bank of Canada.Canada: Yield Spreads on Corporate Commercial Paper and Bankers’ Acceptances Relative to Three-Month Treasury Bills
(In percentage points)
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Sources: Bank of Canada; and staff estimates.18. Nevertheless, the reduction in treasury bills has not caused wide disruptions in the Canadian money market, as private security issues have grown to fill the void. There has not been a major impact on the pricing of short-term assets and the hedging of short-term private risk. Activity in other money market instruments, such as bankers’ acceptances and commercial paper, has expanded (Figure 7). Bankers’ acceptances and acceptance futures have become important pricing benchmarks and hedging vehicles. In addition, there has been a substantial increase in short-term interest rate derivatives.”21 As an investment vehicle, treasury bills are increasingly being replaced in investors” portfolios by short-term asset-backed securities, with the stock of such paper rising sharply from $5 billion in 1995 to $53 billion in 1999.22 Finally, repo transactions have also increased, in part due to a gradual expansion in the range of assets included in the Debt Clearing Service of the Canadian Depository of Securities, which started to include bankers’ acceptances and commercial paper in 1998.
Canada: Major Money Market Instruments Outstanding
(In billions of dollars)
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Source: Bank of Canada.1/ Data available until October/November 2000.19. At the longer end of the yield curve (maturities beyond two years), marketable government bonds have continued to serve as a pricing benchmark, as an important investment vehicle, and as a safe haven.23 However, with the decline in the stock of government bonds relative to economic activity, and an associated decline in the correlation between government and private bond yields in recent years (Figure 8), their use in hedging private interest rate risk has declined. In Canada, however, there are few alternative hedging instruments to government bonds. Rates on interest rate swaps (the favored hedging alternativc in the United States) have not tended to move closely with private yields in Canada, in part owing to the relatively early stage of development of the Canadian swap market.
Canada: Correlation Between Corporate and Long-Term Government Bond Yields, 1995-2000
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Sources: Bloomberg; and Statistics Canada.20. Several other industrial countries have also experienced a decline in government debt in recent years. In Australia and the United Kingdom, a liquid government bond market is considered desirable in terms of allowing government bonds to continue to fulfill their traditional roles, especially as benchmark assets and hedging vehicles. While no firm plans have been announced, consideration is being given in both countries to a range of options, including to devote fiscal surpluses partly to asset accumulation in order to maintain a minimum amount of government debt outstanding. The assets could include asset-backed securities and foreign fixed-income instruments (including sovereign paper and possibly high-rated private paper), with less consideration being given to domestic private assets in light of the difficult question of which assets to buy. In the interim, the debt management strategy has included efforts to maintain liquidity in government securities markets. In Australia the Government has sought to maintain liquidity across the government yield curve, while in the United Kingdom, like in Canada, efforts have been focused on maintaining liquidity in key issues, mainly by concentrating new debt in those issues.
21. In the United States, fiscal surpluses since 1998 have resulted in a reduction of government debt, which (unlike in Canada) has occurred across maturities.24 The U.S. experience may be useful in terms of assessing the implications of a broader-based debt reduction in Canada in the future, although differences between Canadian and U.S. financial markets make a direct comparison difficult. In the United States, the complexity and depth of financial markets provide for a more important role for government securities. With large derivatives markets and the dominance of security finance (as opposed to bank finance), a substantial amount of hedging activity takes place, with U.S. Treasury securities traditionally representing the main hedging instrument.
22. The changes in U.S. federal government debt have affected financial markets in various dimensions, especially since 1997-98. The relationship among different Treasury securities has changed, reflected most visibly in an inversion of the Treasury yield curve since early 2000. With markets sometimes treating U.S. and Canadian government securities as substitutes, the inversion of the U.S. Treasury yield curve contributed to a change in the shape of the government yield curve in Canada, which also became inverted in 2000 before shifting back toward a more normal upward slope in recent months (Figure 9). The relationship between Treasuries and other fixed-income securities has also changed, with the spreads between interest rate swaps, agency securities, and corporate debt versus the ten-year Treasury note all widening since 1998, as well as becoming more volatile (Figure 10). Trading volumes in the government bond market have declined and, like in Canada, the correlation between yields on Treasuries and other fixed-income securities has decreased. In sum, the greater disparity between the performance of Treasuries and other fixed-income securities has reduced the usefulness of Treasuries for referencing and hedging.
Canada: Yield Curve for Government Debt Instruments, 1997-2000
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Source: Bank of Canada.United States: Debt Developments, 1997-2000
Citation: IMF Staff Country Reports 2001, 157; 10.5089/9781451806939.002.A003
Sources: U.S. Department of the Treasury (Monthly Statement); Bloomberg.23. Financial markets in the United States have started to assess the usefulness of interest rate swaps, government agency debt, and corporate debt as the main alternatives to Treasuries, with interest rate swaps appearing to be the favored alternative at present.25 Despite differences between U.S. and Canadian financial markets, the U.S. experience may be informative from a Canadian perspective given the prospects of continued Canadian government debt reduction and the rapid growth in financial markets, including the swap market, in Canada in recent years.
24. Swap rates in the United States have tended to move closely with other fixed-income yields, increasing their attractiveness for referencing and hedging. Increasingly, fixed-income positions are hedged with swaps. Corporate issues also are being priced off swap rates, and swap rates are being used to evaluate other fixed-income securities. The predominance of swaps is consistent with the experience in the euro area, where there is no uniform government asset to play a benchmark role and where pricing and hedging are typically done with swaps. Swaps are not, however, a perfect substitute for Treasuries. Being bilateral contracts for a fixed period of time, they are costly to unwind. Being over-the-counter instruments, they are not as widely accessible as Treasuries.26 Moreover, unlike Treasuries, swaps entail a default risk (“counterparty risk”), which is not transparent and is likely to rise sharply in periods of constraints on market liquidity.
List of References
Auditor General of Canada 2000, Report of the Auditor General of Canada to the House of Commons, April.
Bank of Canada, 1996, The Transmission of Monetary Policy in Canada.
Boisvert, S., and Harvey, N., 1998, “The Declining Supply of Treasury Bills and the Canadian Money Market,” Bank of Canada Review, Summer 1998, pp. 53–69.
Branion, A., 1995, “The Government of Canada Bond Market since 1980” Bank of Canada Review, Autumn 1995, pp. 3–21.
Department of Finance Canada, 2000a, Debt Management Report, 1999-2000.
Department of Finance Canada, 2000b, Annual Financial Report of the Government of Canada, Fiscal Year 1999-2000.
European Central Bank, 1998, “The Single Monetary Policy in Stage Three: General Documentation on ESCB Monetary Policy Instruments and Procedures,” September.
Fleming, M., Hall, G., and Krieger, S., 2000, “The Macroeconomic and Financial Market Implications of the Pending Debt Paydown,” Draft prepared for the Brookings Panel on Economic Activity, September.
Fleming, M., 2000, “The Benchmark U.S. Treasury Market: Recent Performance and Possible Alternatives,” in Federal Reserve Bank of New York Economic Policy Review, April, Volume 6, Number 1, pp. 129–145.
Gravelle, T., 1999, “Markets for Government of Canada Securities in the 1990s: Liquidity and Cross-Country Comparisons,” Bank of Canada Review, Autumn 1999, pp. 9–18.
Harvey, N., 1999, “Recent Initiatives in the Canadian Market for Government of Canada Securities,” Bank of Canada Review, Summer 1999, pp. 27–35.
Jones, D., 2000, “The Demise of the 30-Year Treasury Bond as a Benchmark for Pricing Fixed-Income Securities,” Business Economics, October, pp. 16–24.
Miville, M., and Bernier, A., 1999, “The Corporate Bond Market in Canada,” Bank of Canada Review, Autumn 1999, pp. 3–8.
Morrow, R., 1995, “Repo, Reverse Repo, and Securities Lending Markets in Canada,” Bank of Canada Review, Winter 1994-95, pp. 61–70.
O’Regan, V., 2000, “Commentary” on “Enhancing the Liquidity of U.S. Treasury Securities in an Era of Surpluses,” by Bennett, P. et al., in Federal Reserve Bank of New York Economic Policy Review, April, Volume 6, Number 1, pp. 121–122.
Wojnilower, A., 2000, “Life Without Treasury Securities,” Business Economics, October, pp. 10–15.
Zamsky, S., 2000, “Diminishing Treasury Supply: Implications and Benchmark Alternatives,” Business Economics, October, pp. 25–32.
Prepared by Vivek Arora, Rodolfo Luzio, and Anders Matzen.
This would require decisions on whether and how the Government would manage investments in private assets.
In Canada, the fiscal year begins April 1.
In Canadian terminology, marketable debt is debt which the Government raises in financial markets and which is sold via public tender or syndication and can be traded among investors. It comprises marketable bonds, treasury bills, bonds and bills in foreign currencies, and bonds issued to the Canada Pension Plan. Nonmarketable debt is not tradable, and is issued to retail investors; it mainly comprises Canada Savings Bonds. Both marketable and nonmarketable debt are categorized officially as “market debt,” since they are raised in financial markets, and are distinct from “nonmarket debt,” which consists of past federal public sector pension liabilities (not funded in the public markets) and the Government’s current liabilities (such as accounts payable). See Department of Finance Canada (2000a) and Auditor General of Canada (2000).
In this respect, the approach to debt reduction in Canada is different from that in the United States, where efforts have been directed instead toward avoiding a lengthening in the maturity structure of the debt.
The main advantages of longer-term fixed-rate debt, which is generally more costly than short-term floating rate debt (since long-term interest rates are usually higher), were seen to be greater predictability in interest costs and lower rollover risk (see Auditor General of Canada (2000)).
See Harvey (1999) for a further discussion of recent initiatives to maintain liquidity, efficiency, and integrity in the market for Government of Canada securities.
Several other industrial countries have also implemented buyback programs during the past ten years, including the United States, France, Italy, the United Kingdom, Australia, and New Zealand.
The differential treatment of public pension plans in Canada and the United States also has some bearing on the pace of debt reduction in the two countries. The Canada Pension Plan (CPP), which is not part of the federal government budget, has no impact on the borrowing requirement of the federal government and its debt management operations. In contrast, in the United States, Social Security is included in the unified federal government budget, and its surpluses contribute to reducing the Government’s borrowing requirement. This differences in the treatment of the public pension plans in the two countries would contribute to a slower pace of reduction of marketable debt in Canada compared to the United States.
See Gravelle (1999).
The Bank of Canada does not impose reserve requirements on the credit institutions (see Bank of Canada, 1996).
Repurchase agreements comprise liquidity-providing “special purchase and resale agreements” (SPRA) and liquidity-absorbing “sale and repurchase agreements” (SRA).
Bank of Canada, Weekly Financial Statistics (various issues).
Gravelle (1999) argues that liquidity in longer-term bonds has benefited from the Government’s debt management strategy, including the efforts to lengthen the maturity structure of outstanding debt and to maintain adequate size in benchmark issues, as well as from greater competition among dealers.
The most important instruments are refinancing operations in the form of reverse transactions, which are conducted on the basis of either repurchase agreements or collateralized loans (ECB, 1998). In addition to refinancing operations, the European System of Central Banks (ESCB) may use outright transactions, issuance of debt certificates, foreign exchange swaps, and collection of fixed-term deposits (see European Central Bank (1998)). These instruments have not, however, been used thus far.
Under the Federal Reserve Act, the Federal Reserve is also allowed to buy agency securities, some municipal securities, foreign exchange, and sovereign debt. In practice, however, its holdings of these assets are very small.
A so-called “broad gauge” study, launched by the Federal Reserve to examine in detail the implications of debt reduction for monetary policy operations, will help to provide further guidelines on how monetary policy operations should respond to further debt reduction.
In 1997, treasury bills represented 50 percent of the money market in Canada, compared with 31 percent in the United States, 21 percent in Japan, and 2 percent in the United Kingdom (Boisvert and Harvey (1998)). By 1999, the proportion had declined to 20 percent in Canada.
The monthly volume of trading in short-term interest derivatives increased from $193 billion in 1995 to $504 billion in 1999. Interest rate derivatives provide a useful hedging vehicle for security dealers and thus improve dealers’ ability to conduct inventory risk management in the cash market, which in turn promotes market liquidity (Gravelle (1999)).
Asset-backed securities represent commercial bank issues of short-term paper collateralized by high quality (investment grade) assets, such as mortgages and auto loans.
See Branion (1995).
See Fleming et al. (2000), Jones (2000), Wojnilower (2000), and Zamsky (2000) for further analytical discussion, and market perspectives, on the implications of debt reduction for financial markets in the United States.
See Fleming (2000) and Zamsky (2000).
Steps that would widen the tradability and accessibility of swaps could include the establishment of a clearing house as well as of a swap futures market.
