Bank of Canada
About the Bank
Frequently Asked Questions
Monetary policy
- Who is responsible for monetary policy?
- How does the Bank implement monetary policy?
- What is the difference between monetary and fiscal policy?
- Why doesn't the Bank just print enough money to pay off our national debt?
- Does the Bank of Canada set the "prime rate"?
- What is the Bank Rate?
- What is the target for the overnight rate?
- What is the connection between the target for the overnight rate and the Bank Rate?
- Why is the target for the overnight rate the preferred monetary policy indicator?
- What happens when the policy interest rate approaches zero?
- What is quantitative easing?
- What is credit easing?
- How should the Bank of Canada's existing liquidity facilities be viewed?
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1. Who is responsible for monetary policy?
The inflation-control target — one of the two cornerstones of Canada's monetary policy — is set jointly by the Bank and federal government. However, the day-to-day administration of monetary policy is the responsibility of the Bank's Governing Council, composed of the Governor, Senior Deputy Governor, and Deputy Governors.
The Bank of Canada Act requires regular consultations between the Governor and the Minister of Finance on the direction of monetary policy. If a profound disagreement were to occur between the Bank and the government, the Minister of Finance could issue a written directive to the Governor specifying a change in policy. This would most likely result in the Governor's resignation. However, such a directive has never been issued.
2. How does the Bank of Canada implement monetary policy?
The Bank implements monetary policy by influencing short-term interest rates. It does this by raising and lowering the target for the overnight rate (also known as the key policy rate.) This is the interest rate at which major financial institutions borrow and lend one-day (or overnight) funds among themselves.
See How Monetary Policy Works for a detailed explanation of the process.
3. What is the difference between monetary and fiscal policy?
Monetary policy refers to the measures taken by the Bank of Canada to influence the economy by regulating the amount of money in circulation.
Fiscal policy (budgetary policy) refers to the measures taken by the government to increase or decrease public spending and taxes.
4. Why doesn't the Bank of Canada just print enough money to pay off the national debt?
Because doing so would reduce the value of our money, raise interest rates, and undermine the growth of the economy — the exact opposite of our goals.
If the Bank were to print money to repay the national debt or to finance government programs, it would be adding greatly to the amount of money in circulation. This would encourage people to spend and borrow more, and the economy would receive a temporary boost. But overall demand for goods and services would grow faster than the economy's ability to produce, and this would inevitably lead to higher inflation.
5. Does the Bank of Canada set the "prime rate"?
No. Financial institutions set their own prime rates based on the cost of short-term funds, and on competitive pressures among them. The Bank influences the cost of short-term funds by setting the target for the overnight rate.
6. What is the Bank Rate?
The Bank Rate is the rate at which the Bank of Canada lends funds to financial institutions. It is set at 0.25 per cent above the target for the overnight rate, which is the Bank's key policy rate (see below.)
7. What is the target for the overnight rate?
The target for the overnight rate is the average interest rate that the Bank wants to see in the marketplace for one-day (or "overnight") loans between financial institutions. Changes in this rate influence other interest rates, such as those for consumer loans and mortgages.
8. What is the connection between the target for the overnight rate and the Bank Rate?
The Bank has refined the way it conducts monetary policy over the years. In 1994, it established an operating band for the overnight rate, and in 1996 it changed the way it sets the Bank Rate.
The Bank Rate is now set at the top of the operating band. It is always one-quarter of a percentage point above the target for the overnight rate, which is at the middle of the band. The Bank Rate is also the rate at which the Bank will lend money overnight to the financial institutions that take part in Canada's most important payments system, the Large Value Transfer System.
The bottom of the operating band is the interest rate the Bank pays on deposits that financial insitutions have with us.
The Bank always changes the target for the overnight rate, the operating band, and the Bank Rate at the same time, and by the same amount (see diagram below.)
9. Why is the target for the overnight rate the preferred monetary policy indicator?
The target is the appropriate rate to use when comparing the levels of interest rates with those of other countries. It corresponds directly to the U.S. Federal Reserve's "target for the federal funds rate," the Bank of England's two-week "repo rate," and the minimum bid rate for refinancing operations (the repo rate) at the European Central Bank.
Related information
Fact Sheets:
10. What happens when the policy interest rate approaches zero?
The traditional monetary policy instrument used by central banks to stabilize the economy and maintain price stability is the policy interest rate. When the policy rate moves towards zero, a central bank may consider using other tools to provide stimulus to the economy and achieve its inflation objective. This can include consideration of so-called 'unconventional' monetary measures such as quantitative easing and credit easing.
11. What is quantitative easing?
Quantitative easing is the purchase by a central bank of financial assets through creation of central bank reserves. As a result, the price of the purchased assets (which can include government securities or private assets) rises and the yield on the assets falls. The expansion of reserves available to commercial banks also encourages them to increase the supply of credit to households and businesses.
In economic terminology, quantitative easing uses 'unsterilized' funding; in other words, the reserves of the central bank are increased to finance asset purchases.
12. What is credit easing?
Credit easing is the targeted purchase by a central bank of private sector assets in certain credit markets which are important to the functioning of the financial system. The goal of credit easing is to reduce risk premiums and improve liquidity and trading activity in specific markets so that credit will flow and demand in the economy will expand.
Credit easing can be done on a 'sterilized' basis; in other words, there is no need to increase central bank reserves in order to undertake credit easing. If undertaken on an unsterilized basis, this amounts to combining credit easing with quantitative easing.
13. How should the Bank of Canada's existing liquidity facilities be viewed?
In the context of the current global financial crisis, the Bank of Canada has expanded its liquidity facilities to support the efficient functioning of financial markets. These facilities have been structured as buyback operations (term purchase and resale agreements) or loans (term loan facility) and the transactions have been undertaken on a sterilized basis.