Suppose the overnight market is currently in equilibrium with the equilibrium overnight interest rate iON equal to the Bank of Canada’s (BOC) target (or policy) interest rate iT. Suppose due to some bad financial news banks become less willing to lend overnight to other banks due to concerns about their solvency. What will happen to the demand for settlement balance held overnight at the BOC? How will the BOC react to this situation to insure the overnight interest rate remains at it target level? Briefly explain with the aid of a diagram.

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