Bank of Canada Review Article

  • December 11, 1996

    The impact of exchange rate movements on consumer prices

    In the first, mostly theoretical, part of this article, the author analyses the factors that affect the pass-through of exchange rate movements to consumer prices. In the second part, she studies the recent Canadian experience in this area, starting from 1992. The analysis in the first part of the article is used to investigate why the depreciation of the Canadian dollar by almost 20 per cent between 1992 and 1994 did not produce as much of an increase in the inflation rate as predicted by conventional estimates of the exchange rate pass-through. The author first explains this phenomenon using the factors described in the theoretical part of the article: demand conditions, the costs of adjusting prices, and expectations about the depreciation's duration. She then examines the role of more specific factors, such as the abolition of customs duties on trade between Canada and the United States and the restructuring of the retail market. It is clear that the latter two factors helped neutralize the effect of the depreciation on prices.
  • December 10, 1996

    The maturity structure of household financial assets and liabilities

    In this article, the author examines the maturity structure of the household sector's balance sheet and the degree of interest rate variability of household loans and financial assets. The bulk of households' interest-bearing assets and financial liabilities consists of medium- and long-term, fixed-rate instruments. The pattern of personal consumption is therefore influenced more by the wealth effects of interest rate changes than by their income effects, and the full impact of a permnent shift in interest rates on consumption will become apparent only after a lag.
  • December 9, 1996

    The Canadian market for zero-coupon bonds

    A conventional bond is a debt instrument consisting of a series of periodic coupon payments plus the repayment of the principal at maturity. As the name suggests, a zero-coupon bond has no coupon payments. It has only a single payment consisting of the repayment of the principal at maturity. The zero-coupon bond is sold at a discount and then redeemed for its face value at maturity. The return to the investor is the difference between the face value of the bond and its discounted purchase price. In this article, the author examines the investment characteristics of zero-coupon bonds. In particular, a type of zero-coupon bond known as a strip bond is discussed. A strip bond is created by stripping coupon payments from conventional bonds. The strip bond market in Canada has grown substantially since the late 1980s and is now an integral part of Canadian fixed-income markets. As well, the opportunity to trade in the strip bond market improves the liquidity and efficiency of Canadian fixed-income markets, thus helping to reduce the overall cost of borrowing to the government.
  • November 11, 1996

    Productivity growth in the commercial service sector

    For over three decades, measured productivity growth in the commercial service sector has consistently lagged behind that of the goods-producing sector. At the same time, the service sector has greatly expanded its share of output and employment. Some commentators have suggested that this trend will reduce growth in total economy-wide productivity. In this article, the author reviews recent trends in productivity growth in services and the main factors affecting it. She concludes that services will likely contribute to increases in future productivity growth. There is a great diversity of experience within the service sector. While productivity is falling in some industries, factors such as technological change, deregulation, and increased competition have helped to increase it in others. Moreover, much of the growth in commercial service output is occurring in those industries with relatively high productivity growth. Difficulties in measuring output for some service activities may also be resulting in underestimation of output and productivity growth. To the extent that services are used as intermediate inputs in the production of goods, underestimating productivity growth in the service industry would cause an offsetting overestimation of productivity growth in goods-producing industries.
  • November 10, 1996

    The market for futures contracts on Canadian bankers' acceptances

    The Montreal Exchange introduced futures contracts on 3-month Canadian bankers' acceptances, known as BAX, in 1988. In this article, the author explains the nature of this new instrument, which is bought and sold on the floor of the Exchange, and its role in hedging, speculation, and arbitrage. She briefly reviews the technical aspects of the market and explains the difference between BAX contracts and forward rate agreements. She also examines the market's rapid growth and its relationship to the market for treasury bills.
  • November 9, 1996

    Canada and international financial institutions

    International financial institutions, such as the International Monetary Fund, the World Bank and the Bank for International Settlements, are important players in the global financial system. This article provides an overview of the major international financial institutions to which Canada belongs. The paper highlights their activities and the nature of Canada's involvement, including that of the Bank of Canada. Recent initiatives coming out of the Halifax and Lyon Summits to improve the effectiveness of international financial institutions are also noted.
  • November 8, 1996

    Money markets and central bank operations: Conference summary

    This article summarizes the proceedings of a conference hosted by the Bank of Canada in November 1995. The conference examined the interaction between monetary policy operations and the money market. It provided an opportunity to assess current operations before the introduction of a large-value transfer system leads the Bank to change the techniques it uses to implement monetary policy on a day-to-day basis. From the Bank's perspective, the papers prepared externally provided some useful insights into recent innovations in money markets and their implications for the implementation of monetary policy. Meanwhile, the sessions devoted to the Bank's operations in financial markets were designed to provide market practitioners and academics with further insight into how the Bank operates in these markets.
  • August 11, 1996

    Real short-term interest rates and expected inflation: Measurement and interpretation

    This article compares different measures of real short-term interest rates for Canada over the period from 1956 to 1995. A new measure for the expected real interest rate is constructed using a proxy for inflation expectations that is based on the properties of past inflation. The history of inflation in Canada suggests that the characteristics of inflation have changed considerably over time. Past inflation can be characterized by three different types of behaviour: an environment in which average inflation is low and shocks to inflation have only temporary effects; an environment of moderate inflation with more persistent disturbances; and an environment of drifting inflation in which shocks have permanent effects on the level of inflation. The proxy for inflation expectations uses a statistical model, called a Markov Switching Model, to take account of changes in the behaviour of inflation over time. It is found that uncertainty about the changing characteristics of inflation behaviour leads to uncertainty about estimates of inflation expectations and thus about measures of real interest rates. Target ranges for keeping inflation low should help reduce the uncertainty about inflation behaviour. The behaviour of inflation and interest rates suggests that the credibility of the Bank of Canada's inflation-control objectives is growing. This should reduce inflation uncertainty and lead to lower nominal interest rates over time.
  • August 10, 1996

    Inflation expectations and Real Return Bonds

    The existence of a market for Real Return Bonds in Canada provides a direct tool with which to measure market expectations of inflation by comparing the yields on these bonds with those on conventional Government of Canada long-term bonds. However, there are other factors besides inflation expectations that may affect the yield differential. After reviewing these factors, the authors note that they can lead to a potentially large bias in the level of inflation expectations. The changes in the differential over time may, nonetheless, be a good indicator of movements in long-run inflation expectations. Based on this measure, expectations of long-run inflation have declined since late 1994.
  • May 11, 1996

    Recent developments in monetary aggregates and their implications

    In 1995, the broad aggregate M2+ grew at an annual rate of 4.5 per cent—almost twice the rate recorded in 1994—as competition from mutual funds drew less money from personal savings deposits. An adjusted M2+ aggregate, which internalizes the effect of close substitutes such as CSBs and certain mutual funds, grew by only 3.4 per cent. Gross M1 grew by 8.2 per cent during the year, reflecting an increased demand for transactions balances as market interest rates declined and as banks offered more attractive rates of interest on corporate current account balances. The robust growth of gross M1 in the second half of 1995 suggests a moderate expansion of economic activity in the first half of 1996, while moderate growth in the broad aggregates indicates a rate of monetary expansion consistent with continued low inflation. In this annual review of the monetary aggregates, the authors also introduce a new model, based on calculated deviations of M1 from its long-run demand, which suggests that inflation should remain just below the midpoint of the inflation-control target range over the next couple of years.

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