The Bank of Canada, which is a crown corporation, is responsible for all monetary policies.  Most policies are implemented based on decisions related to altering the Canadian money supply, which is defined as the portion of Canadian household income considered liquid.  This includes all forms of cash, money on hand and on deposit at any one of the banks, credit unions, or trust companies that can be readily accessed.

Customer’s A, B, and C each deposit $50,000 into the bank for a total of $150,000.  The bank in turn lends $100,000 to Customer D and $50,000 to Customer E.  Customer D then re-deposits the $100,000 back into the bank and Customer E re-deposits the $50,000 into the bank – the process has in essence created money, yet really, there is still only the original $150,000 at play.

Moreover, the bank has two factors that affect their ability to create money – Interest and the Economy.  Let’s look at these two factors in detail.

Let’s start with interest.  When the interest rate paid on financial assets increases, Canadians generally choose to keep a smaller share of their wealth in the form of cash currency, and a larger portion of their wealth as money on deposit with the financial institutes. 

When it comes to expanding their loan programs, the bank is limited by the requirement that they must retain reserves.  Reserves are basically cash kept in vaults from deposits made by the different banks to the Bank of Canada; where it is kept on reserve to cover the portion of investments they are required to cover by law.

The Bank of Canada is able to alter interest rates as well as the level of banking reserves by manipulating the money supply indirectly with an amazing amount of precision especially over the short term of 6 months or less.  One method that the Bank of Canada uses to manipulate the supply of money is called open market operations which involves Canadian Government Securities trading in the treasury bills markets and secondary bond market. 

When the Bank of Canada purchases Government Bonds it immediately creates an increase in the amount of money held by the general public, which in turn raises the banking system reserves, having an indirect effect on the total money supply.