Among the lessons it is taking from the global financial crisis, the Bank of Canada is trying to determine which financial markets are critical, and must be kept functioning, and which ones may not be as important to the overall financial system.

In a speech to the Greater Summerside Chamber of Commerce in Prince Edward Island Wednesday, Deputy Governor David Longworth noted the bank’s role in providing liquidity to ensure that financial markets remained functional throughout the financial crisis.

On Tuesday, the bank announced that a couple of those facilities are being dropped due to lack of demand, and another is going to be scaled back to bi-weekly auctions (from weekly operations), indicating that markets are much healthier.

Longworth said that there were times during the financial crisis when liquidity dried up in almost all financial markets. “However, not all markets are critical to the proper functioning of the financial system, so the Bank has been working to identify ‘core’ markets, markets that, through appropriate policies, we would strive to keep operating without interruption, even during a shock,” he said.

Additionally, it is focusing more overall systemic stability. “Because the regulatory system has tended to focus more on individual financial institutions than on interdependencies or systemic risk, the Bank of Canada, like many other central banks, has been looking at ways to strengthen financial regulation by adding a ‘macroprudential’ orientation – that is, more focus on the system as a whole,” he noted.

As for monetary policy, Longworth said that with the policy rate as low as it can go, in case additional stimulus might be required, “we researched and identified three additional monetary policy tools that we could use. The Bank has not used the first two tools – quantitative and credit easing, which involve the purchase of assets – but they remain available to us.”

“We have, however, employed the third tool identified, and that is the use of ‘conditional statements’ about the future path of monetary policy. In our April monetary policy decision, we said that, conditional on the outlook for inflation, the target overnight rate could be expected to remain at its current, very low level until the end of the second quarter of 2010. This longer-term guidance helps to influence interest rates at longer maturities,” he added.

Finally, he said that the Bank has also been examining whether the inflation-control framework might be improved. “Specifically, in advance of the next agreement that we’ll sign with the federal government in 2011, we’ve been studying whether 2% is the best target, and whether the target should be (as it currently is) the rate of inflation or the path of the price level,” he said.

IE