Central banks operate to influence the behaviour of other banks and intermediaries in the financial system.
A central bank conducts monetary policy through its control of the monetary base and interest rates. It is also banker to the government and to the commercial banks.
The Bank of Canada is Canada's central bank. It is the source of the monetary base. It sets short-term interest rates, acts as banker to the commercial banks and the federal government, and is the lender of last resort to the banks.
Monetary policy in Canada is the responsibility of the Bank of Canada. The Bank uses its control of the monetary base and interest rates to promote economic stability at potential output and a low stable inflation rate.
Central banks have three main operating techniques: reserve requirements imposed on commercial banks, open-market operations, and bank rate setting. These techniques are used to manage the monetary base, the money multiplier, and interest rates.
Central banks can implement monetary policy through the monetary base and money supply control or through interest rate control, but cannot do both simultaneously.
In practice, the Bank cannot control money supply exactly. Thus, for most central banks, a short-term interest rate is the instrument of monetary policy.
The Bank of Canada uses the overnight interest rate as its policy instrument, and an inflation rate of 1 percent to 3 percent as its policy target.
The Bank of Canada uses SPRAs and SRAs to intervene in the market for overnight funds and to reinforce its setting of the overnight interest rate.
A monetary policy rule such as a rule for setting the interest rate provides a useful description of the way the central bank sets and adjusts its interest rate policy instrument.
Changes in the central bank's policy instrument change nominal and real interest rates and change aggregate demand through the transmission mechanism, which includes wealth effects, cost of financing effects, and exchange rate effects on the components of aggregate expenditure.
Quantitative easing is the use of central bank purchases of securities with the aim of increasing the monetary base to meet unusually high demands for liquid cash balances in times of financial and economic crisis.
Credit easing is the increase in specific kinds of central bank asset holdings (for example, commercial paper) designed to provide liquidity and support lending in specific markets facing shortages of funds.
Forward guidance: information on the timing of future changes in the central bank's interest rate setting.
Real and nominal interest rates, exchange rates and rates of growth of money aggregates relative to national income can be used as monetary policy indicators.
