Importance of the Overnight Interest Rate

The Importance of the Overnight Interest Rate

The Bank of Canada pays banks a low interest rate on their reserve

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deposits, which (during normal times) is the bank rate less 50 basis points, i b − 0.50, so banks normally have an incentive to invest reserves above the desired amounts.

The Bank of Canada does not set the overnight interest rate. Instead, it sets an

operating band of 50 basis points wide for the overnight interest rate, and the rate is determined by the supply of reserves relative to the demand for them.

Choosing a Monetary Policy Target

There are many different interest rates in the economy, but for purposes of monetary policy, the Bank of Canada has targeted the interest rate known as the overnight interest rate.

The overnight interest rate is the interest rate banks charge one another on loans in the overnight funds market. The loans in that market are usually very short term, often just overnight.

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Use aggregate demand and aggregate supply graphs to show the effects of monetary policy on real GDP and the price level.


Monetary Policy and Economic Activity

Open market buyback operations – Agreements in which the Bank of Canada, or another party, purchase securities with the understanding that the seller will repurchase them in a short period of time, usually less than a week.

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