t influences the reserves of the banking system relative to its target level of reserves, thereby inducing an expansion or contraction of commercial bank lending and thus an expansion or contraction of the money supply.Open-market operations and control of government deposits give the Bank of Canada potent weapons for affecting the size of commercial bank reserves and thus for affecting the money supply.Though the details of an open-market operation differ from the details of switching government deposits, both actions have the same basic result: they change the reserves of the banking system, and this change in reserves then gets transformed, through commercial-bank lending, into changes in the money supply.When commercial banks borrow from the Bank of Canada, they are charged interest on their loan – the interest they are charged is called the bank rate.Application 29-1The current Canadian policy of “zero reserves” is really a policy that requires the banks to have zero (or positive) reserves on average over a four-week averaging period.Given this legal requirement, the true cost of borrowing from the Bank ends up being twice the bank rate.AS a result, commercial banks target to hold some positive level of reserves that will make the return on the last dollar loaned out equal to the benefit of the last dollar added to the reserves.When the Bank of Canada buys government securities in the open market, the commercial banks find themselves with excess reserves. They will expand their loans until the excess reserves drain away.When the Bank sells government securities, the commercial banks find themselves short of reserves and hence suffer increased risk of being forced to borrow reserves from the Bank. They will cut down on their loans in an attempt to restore their reserves.A review of the transmission mechanism in an open economy.Policy Variables and Policy InstrumentsThe bank conducts monetary policy to influence r...
