Copyright 2011 Pearson Canada Inc. 15 - 1 Chapter 15 The Structure of Central Banking and the Bank of Canada.

Copyright 2011 Pearson Canada Inc. 15 - 1

Chapter 15

The Structure of Central Banking and the Bank of Canada


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.


Origins of The Bank of Canada II


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


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


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


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.


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


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.


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.


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)


Bank of Canada Independence II

Factors making Bank of Canada dependent1. 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


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: www.bankofcanada.ca


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)


Structure and Independence of Foreign Central Banks


The Federal Reserve System


Federal Reserve IndependenceFactors making Fed independent1. Members of Board have long terms2. Fed is financially independent: This is most

important

Factors making Fed dependent1. Congress can amend Fed legislation2. President appoints Chairmen and Board members

and can influence legislation

Overall: Fed is one of the most independent central banks in the world


Central Bank Independence

Other Central Banks1. European Central Bank: highly independent2. Bank of England: similar to Bank of Canada since

19973. Japan: increased formal independence since

1998 4. Trend to greater independence: New Zealand,

European nations

15 - 19

Explaining Central Bank Behaviour

Theory of bureaucratic behaviour

1.Is an example of principal-agent problem2.Bureaucracy often acts in own interest

Implications for Central Banks:

1.Act to preserve independence2.Try to avoid controversy3.Seek additional power over banks

© 2005 Pearson Education Canada Inc.

15 - 20

The Case for Independence I

Case For:

1. Independent Bank likely has longer-run objectives, politicians may not

2. Avoids political business cycle3. Less likely deficits will be inflationary

Case Against:

1. Bank may not be accountable2. Hinders coordination of monetary and fiscal policy


15 - 21

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


Copyright 2011 Pearson Canada Inc. 15 - 1 Chapter 15 The Structure of Central Banking and the Bank of Canada.

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