I read the following quote about the Bank of Canada's "operating band" for inducing target overnight loan rates:

The Bank of Canada has a system of an "operating band" for overnight trading.” This band is one-half of a percentage point wide and at the center of the bank is the target for the overnight rate. For example, if the operating band is from 2.25 to 2.75%, the target for the overnight rate is 2.5%. The top of that band, 2.75%, is the bank rate—the interest rate that the bank charges on one-day loans to LVTS participants. The bottom of the band, 2.25%, is the deposit rate—the interest rate that the bank pays on any surplus left on deposit overnight at the bank.

What I Want To Know: Would making the bank rate higher than 2.75 and the deposit rate lower than 2.25 achieve the same goal? For instance, if you made the operating band 2.0 - 3.0 instead of 2.25 - 2.75.

  • $\begingroup$ It’s not exactly clear to me what you mean by achieving the same goal. The middle of the band is unchanged, but the band is wider. $\endgroup$ – Brian Romanchuk Apr 3 at 19:52
  • $\begingroup$ Achieving the same goal as in, when the Bank of Canada imposes the bank rate and deposit rate 0.25 above and below the target overnight rate, the goal is to create the given overnight loan rate, right? So what I'm wondering is would it achieve the same overnight loan rate if you made the bank rate and deposit rate 0.5% above and below, or does it have to be 0.25%? $\endgroup$ – RNdev Apr 6 at 16:16

Widening the acceptable band for the overnight rate would reduce the effectiveness of monetary policy to a certain extent. If the actual market rate is near the middle of the band, then it would be possible for the policy rate band to be moved by 50 basis points, and the actual rate could remain unchanged. This implies a potential need for greater movements in the policy rate band to achieve the same overnight rate trajectory.

Furthermore, allowing more variation in the overnight rate creates greater uncertainty about the average over time, even with the policy stance unchanged. This creates greater risk for fixed income instruments of maturities greater than overnight. Under the assumption that investors are risk averse, this would raise term premia.

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  • $\begingroup$ Got it, thanks! $\endgroup$ – RNdev Apr 7 at 21:24

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