Text of major 1995 lecture by Bank Governor Gordon Thiessen, plus articles from Bank of Canada Review and other sources

From the 1996 Introduction

In response to an invitation from Glendon College to deliver the 1995 HERMES lecture, Governor Thiessen decided to use the occasion to set out the Bank of Canada's view of the transmission mechanism for monetary policy. The transmission mechanism is the chain of developments that begins with the Bank's actions in adjusting the supply of settlement balances to financial institutions, traces the effects of these actions on financial markets, and works through the resulting changes in spending, production, employment and prices. The widespread interest in the subject matter of the HERMES lecture inspired this volume.

Although over the past few years researchers at the Bank have published a number of papers on various stages in the transmission mechanism, this is the first time they have been gathered together in an effort to make the subject more accessible. The focus here is primarily on the early part of the transmission mechanism – that is, on the path between the actions of the Bank of Canada and financial market outcomes, since this is less researched and less widely understood than the links between financial market outcomes and spending and inflation.

In the HERMES lecture, the first paper in this volume, Governor Thiessen describes all the stages in the transmission mechanism, with an emphasis on the uncertainty at each stage and on the initiatives taken by the Bank to lessen this uncertainty by increasing the transparency of its objectives and the way it implementspolicy.

Bruce Montador provides an overview of the various instruments through which the Bank of Canada implements monetary policy. More detailed discussions of these instruments are presented in the article by Kevin Clinton on cash management techniques and in the article by Clinton and Fettig on buyback techniques. Clinton and Howard examine the effect of eliminating reserve requirements on the linkages between the one-day interest rate, over which the Bank has the most influence, and other rates of interest.

The first article by Charles Freedman sets out the rationale for use of the monetary conditions index (MCI), a construct that combines interest rate and exchange rate movements. Freedman's second article analyses the way in which strategic and tactical elements enter into the Bank's decisions regarding the MCI path. This is followed by Pierre Duguay's assessment of the empirical evidence on the links from interest rates and exchange rates to total spending in Canada and from total spending and the exchange rate to inflation. In another article, Duguay and Poloz discuss the role of economic projections in the formulation of Canadian monetary policy. The final text, by Tim Noël, describes some important changes that the Bank of Canada has recently made in the way it implements monetary policy and intervenes in financial markets.

This volume details the arrangements in place in the first half of the 1990s. Over the next couple of years there will be further important changes in the way monetary policy is implemented as a result of the expected introduction in the first half of 1997 of the Large Value Transfer System (a system for transferring large value payments currently under construction by the Canadian Payments Association). Articles describing and analysing these and other developments affecting the transmission mechanism will appear periodically in the Bank of Canada Review. Interested readers may also wish to refer to the Bank of Canada's forthcoming conference volume, Money Markets and Central Bank Operations.

Contents

Uncertainty and the transmission of monetary policy in Canada
by Gordon Thiessen

The implementation of monetary policy in Canada
by Bruce Montador

Bank of Canada cash management: The main techniques for implementing monetary policy
by Kevin Clinton

Buy-back techniques in the conduct of monetary policy
by Kevin Clinton and Kevin Fettig

From monetary policy instruments to administered interests rates: The transmission mechanism in Canada - A summary
by Kevin Clinton and Donna Howard

The use of indicators and of the monetary conditions index in Canada
by Charles Freedman

The role of monetary conditions and the monetary conditions index in the conduct of policy
by Charles Freedman

Empirical evidence on the strength of the monetary transmission mechanism in Canada: An aggregate approach
by Pierre Duguay

The role of economic projections in Canadian monetary policy formulation
by Pierre Duguay and Stephen Poloz

Bank of Canada operations in financial markets
by Tim Noël