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Evaluating the Effect of the Bank of Canada's Conditional Commitment Policy

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  • Zhongfang He

Abstract

The author evaluates the effect of the Bank of Canada's conditional commitment regarding the target overnight rate on longer-term market interest rates by taking into account the relationship between interest rates, inflation, and unemployment rates. By using vector autoregressive models of monthly interest rates, month-over-month inflation, and unemployment rates for Canada and the United States, the author finds that the Canadian 1-year treasury bill rates and 1-year forward 3-month rates have generally been lower than their model-implied values since April 2009, while the difference between the U.S. realized rates and their model-implied values has been much smaller. The author also studies the effect of the conditional commitment on longer-term government bond yields with maturities of 2, 5, and 10 years, and finds lower actual Canadian longer-term interest rates than their model-implied values, though their difference diminishes as the maturities become longer. The evidence appears to suggest that the Bank of Canada's conditional commitment likely has produced a persistent effect in lowering Canadian interest rates relative to what their historical relationship with inflation and unemployment rates would imply. However, this finding is not statistically strong and is subject to caveats such as possible in-sample model instability and the dependence of the results on the choice of inflation variable.

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File URL: http://www.bankofcanada.ca/en/res/dp/2010/dp10-11.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Discussion Papers with number 10-11.

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Length: 31 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocadp:10-11

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Keywords: Interest rates; Monetary policy implementation; Transmission of monetary policy;

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Cited by:
  1. Yoshiyuki Nakazono & Kozo Ueda, 2011. "Policy Commitment and Market Expectations: Lessons Learned from Survey Based Evidence under Japan's Quantitative Easing Policy," IMES Discussion Paper Series, Institute for Monetary and Economic Studies, Bank of Japan 11-E-12, Institute for Monetary and Economic Studies, Bank of Japan.
  2. Moessner, Richhild, 2013. "Effects of explicit FOMC policy rate guidance on interest rate expectations," Economics Letters, Elsevier, Elsevier, vol. 121(2), pages 170-173.
  3. Diez, Federico J. & Presno, Ignacio, 2013. "Domestic and foreign announcements on unconventional monetary policy and exchange rates," Public Policy Brief, Federal Reserve Bank of Boston, Federal Reserve Bank of Boston.

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