Cash Setting, the Call Loan Rate, and the Liquidity Effect in Canada

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.Abstract. In this paper, we use the vector autoregression method to examine the effects of monetary policy in Canada including, in particular, the empirical evidence of the liquidity effect. We use the excess cash reserves of the chartered banks and the surprise component of excess cash reserves as measures of liquidity. Shocks to monetary policy are measured by the orthogonalized innovations to the liquidity variables and by the orthogonalized innovations to the call loan rate. We find that the effects of these shocks conform to monetary policy shocks and the results support the presence of the liquidity effect in Canada.Etat des reserves-encaisse, le taux des prets a vue, et l'effet de liquidite au Canada. Les auteurs font appel a un mod&le vectoriel autor6gressif en vue d'examiner les effets de la politique mon6taire au Canada, en particulier, sur le plan empirique, l'effet de liquidit6. Les variables qu'ils utilisent pour mesurer le volume des liquidit6s sont les r6serves-encaisse exc6dentaires des banques et l'6cart entre le montant pr6vu de ces r6serves et l'offre effective de r6serves. Les chocs de politique mon6taire sont represent6s par des chocs orthogonaux appliqu6s aux mesures de liquidit6 et au taux des prets a vue. Selon les r6sultats obtenus, les effets des chocs appliqu6s a ces variables sont analogues a ceux qu'un choc de politique mon6taire est susceptible de produire, ce qui corrobore l'existence de l'effet de liquidit6 au Canada.The purpose of this paper is to study the effects of monetary policy in Canada, in particular, the empirical evidence of the liquidity effect. We investigate how strong and persistent the liquidity effect is. In the presence of such an effect, the initial impact of an unanticipated expansionary monetary policy is to lower nominal and real interest rates for a short period of time. As a result, labour employment, investment, and output increase. Eventually, however, the anticipated inflation effect will come into force and dominate the liquidity effect as people adjust their inflation expectations to the new money growth rate. Therefore, interest rates will then increase and the expansion in economic activity will stop. The strength of the liquidity effect can be measured by the size of the negative response of interest rates to expansionary policy, and its persistence can be measured by the time elapsed before interest rates start to rise. Recently, there has been a surge of interest and significant progress in the study of the liquidity effect. Empirical studies by Christiano and Eichenbaum (1992) and Strongin (1995) find strong evidence supporting the presence of liquidity effects in the United States. General equilibrium models by Luc...

Bank loan portfolios and the Canadian monetary transmission mechanism

“…Fung and Gupta (1997) find using Canadian data a strong significant increase in the price level when monetary tightenings are identified as negative innovations to a liquidity variable, but their price response is similar to ours when monetary shocks are identified as innovations to an interest rate.…”

Credit channel and credit shocks in Canadian macrodynamics - a structural VAR approach

“…For the second class of models (Class R) it is the bank rate (r). In somewhat similar work using a standard (atheoretical) VAR approach to estimate credit channel effects in Canada, Fung and Gupta (1997) used excess cash reserves of the chartered banks instead of the monetary base, and the call loan rate instead of the bank rate. Three alternative measures of bank credit are also used -credit to persons, credit to businesses and total bank credit -with each definition of monetary policy variable.…”

Further Evidence on SIMS's Argument Concerning Monetary Policy Shocks

“…Fifth, the "liquidity effect" discovered in many studies, e.g. Gordon and Leeper (1994), Fung and Gupta (1997), Kim and Ghazali (1999), is nonexistent in the case of Greece. 9 Interest rates do not respond to money, shocks at all horizons.…”