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Estimating the Appropriate Quantity of Settlement Balances in a Floor System

Author

Listed:
  • Narayan Bulusu
  • Matthew McNeely
  • Kaetlynd McRae
  • Jonathan Witmer

Abstract

In April 2022, the Bank of Canada announced that it would continue to use a floor system to implement monetary policy by providing a sufficiently large quantity of settlement balances to enable the overnight repo rate to trade at close to the deposit rate. In contrast, the Bank’s guiding principles of prudence, transparency and neutrality, which govern the management of its balance sheet, favour maintaining settlement balances as low as possible. In this context, this paper describes two complementary approaches to estimating the appropriate quantity of settlement balances needed to effectively maintain a floor system. The first is a regression-based analysis to estimate the quantity required to maintain the overnight repo rate close to the Bank’s policy interest rate (which is equal to the deposit rate in a floor system). The second is an analysis of operational considerations in implementing a floor system in Canada. Both approaches highlight that considerable uncertainty exists in determining the demand for settlement balances. Such uncertainty emphasizes the need for the Bank to monitor money market conditions as it continues to normalize its balance sheet after undertaking quantitative easing operations related to the COVID-19 pandemic.

Suggested Citation

  • Narayan Bulusu & Matthew McNeely & Kaetlynd McRae & Jonathan Witmer, 2023. "Estimating the Appropriate Quantity of Settlement Balances in a Floor System," Discussion Papers 2023-26, Bank of Canada.
    • Handle: RePEc:bca:bocadp:23-26
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    References listed on IDEAS

    as
    1. Gara Afonso & Darrell Duffie & Lorenzo Rigon & Hyun Song Shin, 2022. "How Abundant Are Reserves? Evidence from the Wholesale Payment System," Staff Reports 1040, Federal Reserve Bank of New York.
    2. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2012. "The Aggregate Demand for Treasury Debt," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 233-267.
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    4. Bech, Morten L. & Garratt, Rod, 2003. "The intraday liquidity management game," Journal of Economic Theory, Elsevier, vol. 109(2), pages 198-219, April.
    5. Heller, Daniel & Lengwiler, Yvan, 2003. "Payment obligations, reserve requirements, and the demand for central bank balances," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 419-432, March.
    6. Ricardo Lagos & Gastón Navarro, 2023. "Monetary Policy Operations: Theory, Evidence, and Tools for Quantitative Analysis," NBER Working Papers 31370, National Bureau of Economic Research, Inc.
    7. Furfine, Craig H & Stehm, Jeff, 1998. "Analyzing Alternative Intraday Credit Policies in Real-Time Gross Settlement Systems," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 832-848, November.
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    More about this item

    Keywords

    Financial institutions; Financial markets; Financial system regulation and policies; Monetary policy implementation; Payment clearing and settlement systems;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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