Monetary Policy and Central Banking

Monetary Policy and Central Banking

New Directions in Post-Keynesian Theory

Edited by Louis-Philippe Rochon and Salewa ‘Yinka Olawoye

Divided into two parts, this book presents a detailed, multi-faceted analysis of banking and monetary policy. The first part examines the role of central banks within an endogenous money framework. These chapters address post-Keynesian interest rate policy, monetary mercantilism, financial market organization and developing economies. In the second part of the book, the focus switches to the analysis of the financial crisis that began in 2007. The chapters in this section discuss the role of central banks in times of crisis.

Chapter 9: Monetary Policy in a Period of Financial Chaos: The Political Economy of the Bank of Canada in Extraordinary Times

Marc Lavoie and Mario Seccareccia

Subjects: economics and finance, financial economics and regulation, money and banking, post-keynesian economics

Extract

Marc Lavoie and Mario Seccareccia* INTRODUCTION 1 The events that have unfolded since August 2007 were no doubt of an extraordinary magnitude. There were many troubling signs before that date but, with the exception of those closely involved with financial markets, few seemed to care. Furthermore, we kept being told by chief economists and regulators that “the fundamentals” were sound. Then, as European investors became nervous when it became known that two large German banks were on the brink of bankruptcy because of their large holdings of US mortgage-backed securities, no one felt safe. Banks that were in a surplus position in the clearing and settlement system refused to lend on the interbank market to banks in a debit-clearing position. As a gridlock developed, the interbank interest rate shot up, forcing the European Central Bank to provide almost unlimited amounts of clearing balances to money markets in an effort to keep the overnight interest rate near its benchmark level and to make sure that clearing accounts would be settled. In Canada, there was also a scare on the inter bank market, as the Bank of Canada was forced to engage in large repo operations on August 9 and 10, 2007, to keep the overnight rate at its target level, leaving nearly a billion and a half Canadian dollars in excess settlement balances on those two days, and hundreds of millions during the subsequent weeks, as shown in Figure 9.1. But the greatest impact was on the market for assetbacked commercial...

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