Question

Suppose the overnight market rate is below the target rate set by the Bank of Canada (BoC). To reduce the downward pressure on overnight rate, the Bank of Canada decides to use open market operations with a target volume of 100 million dollars.
(a) Describe the actions BoC can undertake to intervene in the overnight market.

(b) Using T-accounts, record the changes in balance sheets of BoC and the financial system following BoC’s intervention.

Answer 1

ANSWER:

GIVEN THAT:

THE TARGET RATE SET BY THE BANK OF CANADA (BOC).

A. THE ACTIONS BOC CAN UNDERTAKE TO INTERVENE:

1. If overnight rates are being very low that means there are sufficient funds with the banks and there is no immediate need to pay high interest rate for the same. 2. but somtimes it is not good for economy to have very high money supply level in the economy as it increases inflation.

3. So to reduce the downward pressure on overnight rate BOC will sell bonds in open market operations because this will reduce the money supply in the economy and banks will have to pay higher interset rate to acquire more funds.

4. So increasing overnight rate can be used as a tool to tighten the money supply in the economy

B. THE USING T-ACCOUNTS RECORD THE CHANGES IN BALANCE:

1. Balance sheet - in BOC balance sheet bonds will be on liability side($100million) and cash reserves will increase by $100million.

2. Financial system's balance sheet - bonds will increase the asset side by $100 million.