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Questions and Answers
What primary role does the Bank of Canada play in managing the country's monetary policy?
What primary role does the Bank of Canada play in managing the country's monetary policy?
Which of the following is NOT a responsibility of the Bank of Canada?
Which of the following is NOT a responsibility of the Bank of Canada?
Which of the following tools is primarily used by the Bank of Canada to control the money supply?
Which of the following tools is primarily used by the Bank of Canada to control the money supply?
What is the significance of the Bank of Canada being a lender of last resort?
What is the significance of the Bank of Canada being a lender of last resort?
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What is a common objective of many central banks, including the Bank of Canada?
What is a common objective of many central banks, including the Bank of Canada?
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Which organization is primarily responsible for the operational functioning of the national payments system in Canada?
Which organization is primarily responsible for the operational functioning of the national payments system in Canada?
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Which statement best describes the independence of the Bank of Canada?
Which statement best describes the independence of the Bank of Canada?
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What strategy does the Bank of Canada use to influence exchange rates?
What strategy does the Bank of Canada use to influence exchange rates?
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What is a main characteristic of the Bank of Canada's independence?
What is a main characteristic of the Bank of Canada's independence?
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Which factor contributes to the dependency of the Bank of Canada?
Which factor contributes to the dependency of the Bank of Canada?
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What effect could political pressure have on the Bank of Canada's monetary policy?
What effect could political pressure have on the Bank of Canada's monetary policy?
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Which action has the Bank of Canada taken to enhance its accountability?
Which action has the Bank of Canada taken to enhance its accountability?
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What is one of the main arguments made for maintaining the Bank of Canada's independence?
What is one of the main arguments made for maintaining the Bank of Canada's independence?
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Why is it proposed that the Bank of Canada should avoid facilitating government financing?
Why is it proposed that the Bank of Canada should avoid facilitating government financing?
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What potential issue arises if politicians were to control the Bank's monetary policy?
What potential issue arises if politicians were to control the Bank's monetary policy?
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What is a primary role of the Bank of Canada's Governing Council?
What is a primary role of the Bank of Canada's Governing Council?
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What entities comprise the Federal Open Market Committee (FOMC)?
What entities comprise the Federal Open Market Committee (FOMC)?
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Which statement accurately describes the independence of the Federal Reserve?
Which statement accurately describes the independence of the Federal Reserve?
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What is one primary goal of the European Central Bank (ECB) as established by the Maastricht Treaty?
What is one primary goal of the European Central Bank (ECB) as established by the Maastricht Treaty?
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Which of the following best describes the structure of the ECB's Governing Council?
Which of the following best describes the structure of the ECB's Governing Council?
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Which characteristic makes the ECB the most independent central bank in the world?
Which characteristic makes the ECB the most independent central bank in the world?
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Why is the Federal Reserve's independence considered limited?
Why is the Federal Reserve's independence considered limited?
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What is one of the key features of the FOMC's meetings?
What is one of the key features of the FOMC's meetings?
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Study Notes
Chapter 14: Central Banks and the Bank of Canada
- The Bank of Canada was created by the Bank of Canada Act in 1934 and began operations in 1935.
- Initially, it was a private institution but was nationalized in 1938, becoming a national institution headquartered in Ottawa.
- Unlike a private bank driven by profit, the Bank of Canada is responsible for Canada's monetary policy and regulates Canada's deposit-based financial institutions.
Learning Objectives
- Recognize the Bank of Canada's historical development.
- Describe the Bank of Canada's key features and functions.
- Evaluate the Bank of Canada's degree of independence.
- Explain how bureaucratic behavior influences central bank actions.
- Assess the independence of major international central banks.
Structure of the Bank of Canada
- Responsibility rests with a 15-member Board of Directors.
- The Governor, also the chief executive officer and chairman, holds a renewable seven-year term.
- The Senior Deputy Governor and Deputy Minister of Finance are also part of the board.
- Twelve outside directors are appointed for three-year terms by the minister of finance (with cabinet approval).
- The Governing Council, chaired by the governor, includes the senior deputy governor and four deputy governors.
- The Board appoints the governor and senior deputy governor with government approval for renewable seven-year terms.
- Outside directors are appointed by the minister of finance with cabinet approval for three-year terms.
Functions of the Bank of Canada
- Currency management.
- Funds management (including debt management).
- Financial system supervision.
- Monetary policy execution.
- Retail payment supervision.
Currency
- Before the Bank's creation, the federal government and early banks issued notes.
- By 1945, the Bank of Canada held a monopoly over note issuance.
- The Bank conducts ongoing research to improve cost-effectiveness, increase note durability, and reduce counterfeiting.
Funds Management
- As the federal government's fiscal agent, the Bank provides debt-management services (advising on borrowings, managing new debt offerings, servicing outstanding debt).
- It manages foreign exchange reserves held by the Exchange Fund Account.
- It engages in international financial transactions to influence exchange rates.
Financial System/Retail Payments
- As Canada's central bank, the Bank of Canada acts as the lender of last resort, preventing bank runs and panics during liquidity crises.
- It has the power to create base money.
- It's responsible for regulating the national payments system (operated by Payments Canada).
- It holds deposit accounts for the federal government, directly clearing members of Payments Canada, and international organizations like the IMF.
Monetary Policy
- The Bank employs open market operations (shifting government balances between itself and direct clearing members of Payments Canada) to implement changes in the money supply.
- The Bank's ultimate objective is to keep inflation low.
- Low inflation supports steady economic growth and protects the purchasing power of those on fixed incomes (e.g., pensioners).
How Independent Is the Bank of Canada?
- The Bank has an instrument but not complete goal independence.
- Two key principles, per Louis Rasminsky (1961), are: (1) the Bank is responsible for monetary policy and (2) the government can direct the Bank if it disagrees with its policies.
Factors Making the Bank of Canada Dependent
- The joint responsibility system allows the Minister of Finance to issue directives.
- Directives include policy changes for the Bank to follow, outlining the new policy, and the period the policy will be in effect.
- While the ultimate authority rests with the government, the Bank of Canada retains significant independence.
The Changing Face of the Bank of Canada
- The Bank is striving for greater transparency and accountability in its operations.
- The Monetary Policy Report is published by the Governing Council.
- Increased press conferences, releases, and speeches are part of the communication strategy.
- The Bank has a comprehensive website (www.bankofcanada.ca)
Should the Bank of Canada Be Independent?
- The Bank of Canada is likely the most independent government agency in Canada.
- There are arguments for and against maintaining this independence.
- Concerns about the independence of the Bank may arise when politicians disagree with its policies.
The Case for Independence
- Political pressure would imbue monetary policy with an inflationary bias.
- It should avoid political business cycles (expansionary policies are pursued before elections).
- It should not be used to finance government budget deficits.
The Case Against Independence
- Critics argue that independence is undemocratic and unaccountable.
- Coordinating fiscal and monetary policies can be difficult.
- Some might feel that the Bank hasn't used its independence effectively.
Explaining Central Bank Behavior
- The theory of bureaucratic behavior helps explain central bank actions.
- It suggests that central banks act in their self-interest to preserve independence, avoid controversy, and seek additional power.
- Central banks strive to maintain autonomy, avoid disputes with powerful groups, and don't rule out altruistic motivations.
Federal Reserve System
- The Federal Reserve is the U.S. central bank ("the Fed").
- The Fed includes the Board of Governors, Federal Reserve Banks, the Federal Open Market Committee (FOMC), the Federal Advisory Council, and 2,500 member commercial banks.
Board of Governors of the Federal Reserve System
- The Board has seven members headquartered in Washington, D.C.
- Governors are appointed by the president and confirmed by the Senate for 14-year non-renewable terms.
- Governors must come from different districts.
- The Chairman is chosen from amongst the governors for a four-year term.
Federal Reserve Banks
- Each of the 12 Federal Reserve districts has its Federal Reserve bank.
- The largest Federal Reserve Banks are located in New York, Chicago, and San Francisco.
- These banks hold a significant portion of the Federal Reserve System's assets.
- The New York Federal Reserve Bank is the most important.
Federal Open Market Committee (FOMC)
- The FOMC meets eight times a year.
- It comprises seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve banks.
- The Chairman of the Board is the chairman of the FOMC.
- The FOMC makes decisions about monetary policy and sets the policy interest rate.
How Independent Is the Fed?
- The Federal Reserve seems remarkably free from political pressures that affect other agencies.
- The U.S. President's power in appointing Board members is limited.
- The Chairman's term isn't always concurrent with the president's.
- The Fed isn't entirely free from political pressure but public support plays a significant role for the Fed.
The European Central Bank (ECB)
- The ECB is the central bank for the euro area countries.
- It conducts monetary policy for countries in the European Monetary Union.
- Monetary operations are conducted by the National Central Banks of each country.
- The ECB is considered the most independent central bank internationally.
- The Maastricht Treaty established the Eurosystem and the ECB, making the ECB instrument-independent.
- The Treaty specifies that the ECB's primary goal is price stability.
ECB Governing Council
- Monthly meetings are held at the ECB in Frankfurt, Germany.
- Twelve National Central Bank heads and six Executive Board members participate.
- The ECB operates by consensus, announcing target interest rates and answering media questions.
- To maintain a manageable size, there's a rotation system when new countries join.
How Independent Is the ECB?
- The ECB is considered the most independent central bank globally.
- Members of the Executive Board have long terms.
- The ECB determines its own budget.
- The ECB's charter can only be changed by revising the Maastricht Treaty.
Structure and Independence of Other Foreign Central Banks
- Bank of England has some instrument independence.
- The Bank of England's independence is subject to government intervention to set interest rates.
- The Bank of Japan has some degree of instrument and goal independence.
- The Bank of Japan's goal is price stability.
- Governments may request delays in monetary policy decisions.
- A global trend exists toward greater central bank independence.
Exercise
- Discuss the differences between the U.S. and Canadian central banking systems.
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