Introducing Multiple Interest Rates in ToTEM

Until recently, in keeping with standard practice in DSGE macroeconomic modelling, the Bank of Canada's main model for projection and policy analysis, ToTEM, had a single domestic interest rate. This short-term rate was treated as the instrument of monetary policy, and its current value and expected future path were key determinants of the behavior of economic agents in the model. However, the events of the recent global financial crisis highlighted the role that changes in credit market conditions, including risk spreads, can play in macroeconomic developments. This has led to accelerated work on multiple interest rate models at the Bank of Canada and elsewhere. This article provides an overview of the introduction of multiple interest rates in ToTEM. Adapted from the source document.