Copyright  2011 Pearson Canada Inc Chapter 15 The Structure of Central Banking and the Bank of Canada

Copyright  2011 Pearson Canada Inc Origins of the Bank of Canada I The Bank was created by the Bank of Canada Act in 1934 and started operations in 1935 Initially the Bank was a private institution but was nationalized in 1938, so is now a national institution with headquarters in Ottawa The Bank also has regional offices in Toronto, Vancouver, Calgary, Montreal, and Halifax Unlike a private bank that operates in pursuit of profit, the Bank of Canada is responsible for the country’s monetary policy and for the regulation of Canada’s deposit-based financial institutions.

Copyright  2011 Pearson Canada Inc Origins of The Bank of Canada II

Copyright  2011 Pearson Canada Inc Formal Structure of the Bank of Canada I Responsibility for the operation of the Bank rests with a Board of Directors, which consists of fifteen members: the governor (currently Mark Carney, who is the chief executive officer and chairman of the Board of Directors) the senior deputy governor, the deputy minister of finance, and twelve outside directors

Copyright  2011 Pearson Canada Inc Formal Structure of the Bank of Canada II The Board appoints the governor and senior deputy governor with the government’s approval, for a renewable term of 7 years. The outside directors are appointed by the minister of finance, with cabinet approval, for a 3-year term. In 1994 the Board of directors established a new senior decision making authority called the Governing Council The Council is chaired by the governor and is composed of the senior deputy governor and four deputy governors

Copyright  2011 Pearson Canada Inc The Functions of the Bank The functions of the Bank of Canada are: Bank Note Issue Government Debt and Asset Management Services Central Banking Services Monetary Policy

Copyright  2011 Pearson Canada Inc Bank Note Issue Before the creation of the Bank, the federal government and the early banks issued notes designed to circulate as currency. By 1945, however, the Bank had a monopoly over note issue in the country. The Bank also conducts ongoing research, working closely with private sector partnerships and note- issuing authorities in other countries, in order to improve cost-effectiveness, increase the durability of bank notes, and reduce counterfeiting.

Copyright  2011 Pearson Canada Inc Government Debt and Asset Management Services As the federal government’s fiscal agent, the Bank: provides debt-management services for the federal government such as advising on borrowings, managing new debt offerings, and servicing outstanding debt manages the government’s foreign exchange reserves held by the Exchange Fund Account of the Department of Finance engages in international financial transactions, on behalf of the government, in order to influence exchange rates

Copyright  2011 Pearson Canada Inc Central Banking Services As Canada’s central bank, the Bank of Canada: serves as the lender of last resort if a bank faces a liquidity crisis, thereby preventing bank runs and panics. has explicit responsibility for the regulatory oversight of the national payments system, operated by the CPA acts as the holder of deposit accounts of the federal government, the directly clearing members of the CPA, international organizations such as the IMF, and other central banks.

Copyright  2011 Pearson Canada Inc Monetary Policy The Bank employs such tools as: open market operations (purchase/sale of Gov bonds) shifting of government balances between it and the direct clearing members of the CPA to implement changes in the money supply The Bank’s ultimate objective is to keep inflation low Low inflation is closely related to the goal of steady economic growth Low inflation protects the purchasing power of pensioners and those on fixed incomes.

Copyright  2011 Pearson Canada Inc Bank of Canada Independence I Bank has instrument (operational) independence but not goal independence (ability to set the goals of policy) “.. 1) in the ordinary course of events, the Bank has the responsibility for monetary policy, and 2) if the government disapproves of the monetary policy being carried out by the Bank, it has the right and responsibility to direct the bank as to the policy which the Bank is to carry out.” (Louis Rasminsky, July 24, 1961)

Copyright  2011 Pearson Canada Inc Bank of Canada Independence II Factors making Bank of Canada dependent 1.Joint responsibility system (since 1967 when the Bank of Canada Act was amended) 2.Minister of Finance can issue a directive to the Bank indicating the specific policy changes that the Bank must follow. -published, set out new policy, period that it applies. While the ultimate authority rests with the government, Bank of Canada is quite independent and no government directives have ever been issued

Copyright  2011 Pearson Canada Inc The Changing Face of the Bank of Canada Bank desires to explain and build confidence in the Bank’s actions Bank has moved towards greater transparency and accountability in its operations. The Bank’s Governing Council publishes (twice a year) the Monetary Policy Report and the Update to the Monetary Policy Report Has increased the number of press conferences/releases and speeches, and reorganized its regional offices, with the objective of improving communication Has a comprehensive website:

Copyright  2011 Pearson Canada Inc U.S. Federal Reserve System U.S. central bank, the Federal Reserve System (“The Fed”) Board of Governors of the Federal Reserve System Federal Reserve Banks Federal Open Market Committee (FOMC)

Copyright  2011 Pearson Canada Inc Structure and Independence of Foreign Central Banks

Copyright  2011 Pearson Canada Inc The Federal Reserve System

Copyright  2011 Pearson Canada Inc Federal Reserve Independence Factors making Fed independent 1.Members of Board have long terms 2.Fed is financially independent: This is most important Factors making Fed dependent 1.Congress can amend Fed legislation 2.President appoints Chairmen and Board members and can influence legislation Overall: Fed is one of the most independent central banks in the world

Copyright  2011 Pearson Canada Inc Central Bank Independence Other Central Banks 1.European Central Bank: highly independent 2.Bank of England: similar to Bank of Canada since Japan: increased formal independence since Trend to greater independence: New Zealand, European nations

Explaining Central Bank Behaviour Theory of bureaucratic behaviour 1.Is an example of principal-agent problem 2.Bureaucracy often acts in own interest Implications for Central Banks: 1.Act to preserve independence 2.Try to avoid controversy 3.Seek additional power over banks © 2005 Pearson Education Canada Inc.

The Case for Independence I Case For: 1. Independent Bank likely has longer-run objectives, politicians may not 2.Avoids political business cycle 3.Less likely deficits will be inflationary Case Against: 1.Bank may not be accountable 2.Hinders coordination of monetary and fiscal policy © 2005 Pearson Education Canada Inc.

The Case for Independence II Recent research shows that more independent central banks are better able to contain inflation and not at the expense of output fluctuations and high unemployment © 2005 Pearson Education Canada Inc.