Answer to Question #217457 in Marketing for saleemaslam

Question

1.     What is the service provided by the LVTS? why is it important?

 

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2.     Explain the Bank of Canada's open market operations? What are SPRAs and SRAs? How are they used to impact the overnight rate?

 

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3.     What are the advantages inflation targeting?

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Answer 1

 The service provided by the LVTS and its importance

LVTS (Large value transfer system) refers to an electronic payment system used in Canada to transfer funds between large financial institutions, including the Canadian central bank. LVTS processes most transactions made in Canada in Canadian dollars, (McRae, et al., 2017). LVTS clears on average 28000 payments on a business day which totals CAD 153.5 billion. The Large value transfer system began in 1999, and sixteen Canadian banks are currently participating in it. 

LTVS transactions include those for banks or their customers. All banks that are using the system need to settle up their LTVS at the close of every day. The process might leave some banks with additional funds while other banks may require more funds to cover their transactions. Banks with extra money can lend to other banks in need through a program called overnight loans. Overnight loans take place in the overnight market at an overnight special rate determined by the bank of Canada.

Canada's open market operations, SPRAs and SRAs and the way they impact the overnight rates

Open market operation refers to a central bank of Canada's policy that facilitates the sales and purchases of government securities. The open market operation aims to expand or contract money in the Canadian banking system and control interest rates, (McRae, et al., 2017).

The bank of Canada cannot directly control the money supply since the deposit part of the money supply depends on the decisions made by the private banking system. Money supply control is an influential tool that greatly commands the Canadian economy's overall performance. As a result of strong relations between the American and the Canadian financial markets, monetary policy significantly impacts the Canadian-United States dollar exchange rate.

The Bank of Canada (BOC) uses SPRAs (special purchase and resale agreement) and SRA (sale and repurchase agreement) to cover shortages or remove surplus money that can push the interest rates beyond the target band. SPRA refers to a transaction instigated by BOC that injects money into the system on a very short-term basis, mainly for offsetting upward pressure on the interest rate. In SPRA, the bank proposes to purchase the Canadian government's securities from main financial institutions with an arrangement to resell them the following business day at a preset price, (McRae, et al., 2017). The purchase and resale prices' difference dictate the overnight's interest rates. Banks willingly enter into such an agreement with BOC because cash is provided for the banks at interest rates lower than what they would have paid in the overnight market.

On the contrary, SRA comes to play in case the monetary base's demand falls. SRA is the sale of securities to main financial institutions and repurchased the following day. It entails a day's decrease on the monetary base to offset the demand for cash's drop, creating downward pressure on the overnight loans interest rate, (McRae, et al., 2017).

Advantages of inflation targeting

Inflation–targeting's advantages are:

• The Inflation targeting permits the monetary policy to concentrate on the domestic concerns and respond to domestic economy's shocks which is impossible under a fixed exchange rate structure.
• Inflation targeting reduces investor uncertainty.
• Inflation–targeting fosters transparency.
• A specific numerical inflation target tends to increase the central bank's accountability, thus reducing the likelihood of the central bank falling into a time-inconsistency trap.

References

McRae, K., Durr, S., & Manzo, D. (2017). An Initial Assessment of Changes to the Bank of Canada’s Framework for Market Operations. Bank of Canada Review,2017(Autumn), 42-52.