What happens after Governing Council sets the policy interest rate: Inside the implementation framework that makes monetary policy work
What happens after Governing Council sets the target for the policy interest rate? Setting the target rate is the most visible part of monetary policy, but it is only the first step in transmitting the rate decision to the Canadian economy. This paper explains how the Bank of Canada uses its monetary policy implementation framework (MPI) to ensure that the rate decision is reflected in financial markets by keeping short-term interest rates close to the target policy rate.
Interest rate control is shaped by the structure of the overnight money market in Canada. The Bank assesses interest rate control primarily through the Canadian Overnight Repo Rate Average (CORRA), a secured overnight repo rate. As a result, implementing monetary policy depends not only on the supply of central bank reserves (or settlement balances) but also on conditions in the repo market where CORRA is determined. Imbalances in the repo market can move CORRA away from the target policy rate even when the overall level of reserves is within the estimated range of steady-state demand. The Bank therefore uses targeted tools to respond when pressures threaten effective rate control, while allowing some deviations from target to preserve useful market signals and incentivize market participants to manage their own liquidity and to trade with each other.
The design and use of these tools reflect the trade-offs at the core of the MPI framework: maintaining interest rate control, preserving market incentives and keeping the Bank’s balance sheet no larger than necessary. The Bank's tools and standing facilities support an approach of supplying just enough reserves—enough liquidity for efficient payment settlement, market functioning and monetary policy implementation, without supplying more than necessary. When market pressures warrant a response, the Bank relies on targeted and discretionary operations rather than on a larger supply of reserves.
The Bank has refined its tools as market conditions have evolved in recent years. Examples include the introduction and more active use of the two-week term repo and the January 2025 adjustment to the deposit rate. These changes show how the Bank can adapt its tools to maintain effective interest rate control while preserving market incentives.