Suppose that there is a net government disbursement of $80 (i.e., the government’s payments to the public exceed its receipts from the public by $80).
a) In the absence of any offsetting transactions by the Bank of Canada, explain the effects of this net government disbursement on settlement balances and on the overnight interest rate.
Use the reserve market diagram to explain your answer.
b) Explain how the Bank of Canada can use the auction of government deposits to neutralize the effects of this net government disbursement on settlement balances and on the overnight interest rate so that the Bank’s target for the overnight interest rate is maintained. Show the effects of this neutralizing procedure on the on the balance sheets (T-accounts) of the Bank of Canada and the LVTS Participants.