Bank of Canada: Origins and Structure

Origins of the Bank of Canada

• The Bank of Canada (BoC), also known as "the Bank," was established through the Bank of Canada Act in 1934
• Operations commenced in 1935
• Initially a private institution, it was nationalized in 1938
• It serves as a federal agency responsible for the country’s monetary policy and other tasks

Structure of the Bank of Canada

• The Governor is the Chief Executive Officer, role currently held by Tiff Macklem
  • The Governor leads bank operations, the Governing Council, and chairs the Board of Directors
• The Governing Council is the policy-making body
  • Is responsible for monetary policy
  • Promotes a safe and efficient financial system
• The Board of Directors oversees the bank’s management and administration
  • Appoints the governor and senior deputy governor with government approval
  • Appointments are for renewable terms of 7 years
• The Board of Directors has fifteen members including:
  • The Governor
  • Senior Deputy Governor
  • Deputy Minister of Finance (non-voting)
  • Twelve Outside Directors
• Outside directors are appointed by the Minister of Finance for 3-year terms
• The Governing Council is composed of:
  • The senior deputy governor
  • Four deputy governors
• The Governing Council is chaired by the governor

Functions of the Bank of Canada

• The Bank of Canada Act mandates regulating credit and currency in the best interests of the economic life of the nation
• The Bank's mandate involves:
  • Currency management
  • Funds management
  • Financial system oversight
  • Monetary policy implementation

Currency

• Since 1945, the BoC has been the only institution in Canada authorized to issue bank notes
• Before 1976, the BoC was required to offer gold in exchange for bank notes
• In 1976, the Bank of Canada Act was revised, and Canada adopted the paper standard

Funds Management

• As the federal government’s fiscal agent, the Bank provides debt-management services, including advising on borrowings and managing new debt offerings
• The Bank services outstanding debt, manages foreign exchange reserves in the Exchange Fund Account, and engages in international financial transactions to influence exchange rates

Financial System

• As Canada’s central bank, the Bank of Canada serves as the lender of last resort to prevent bank runs and panics by addressing liquidity crises
  • It can always create base money
• The Bank oversees the national payments system, run by Payments Canada
• The Bank acts as the holder of deposit accounts for:
  • The federal government
  • Directly clearing members of Payments Canada
  • International organizations like the IMF
  • Other central banks

Monetary Policy

• The Bank's goal is to maintain low inflation, which is closely related to steady economic growth and protects the purchasing power of pensioners and workers on fixed incomes
• The Bank uses tools such as:
  • Open market operations
  • Shifting government balances between it and direct clearing members of the CPA to change the money supply

Independence of the Bank of Canada

• Central bank independence refers to the extent to which the central bank is insulated from bureaucratic and political pressure
• Stanley Fischer identified two types of independence:
  • Goal independence
  • Instrument independence
• The Bank of Canada has a high degree of instrument independence, while its goal independence has evolved
• The 1961 Coyne affair highlighted initial uncertainties regarding the degree of independence
• Since 1961, the BoC's independence reflects Louis Rasminsky’s view of a joint responsibility system
  • The Bank is responsible for monetary policy in the ordinary course of events
  • If the government disapproves, it has the right to direct the bank on policy

The Changing Face of the Bank of Canada

• The Bank aims to explain and build confidence in its actions through increased transparency and accountability
• The Bank’s Governing Council publishes the Monetary Policy Report
• Efforts to improve communication involve increased press conferences/releases, speeches, and reorganized regional offices
• The Bank has a comprehensive website: www.bankofcanada.ca

Should the Bank of Canada be Independent?

• The BoC is considered the most independent government agency in Canada
• Politicians who oppose bank policy may prefer to supervise it to implement policies they prefer

The Case for Independence

• Independence allows a focus on long-run objectives, including a stable price level
• Political pressure may shorten the planning horizon and impart an inflationary bias
• Independence avoids political business cycles where expansionary policies before elections can lead to inflation
• Independence avoids accommodation, where the Bank finances large budgetary deficits
• Monetary policy is a technical area that requires experience

The Case Against Independence

• The Bank is undemocratic and unaccountable
• Independence complicates coordination of fiscal and monetary policy
• Some feel the Bank has not used its independence successfully
• While independent central banks correlate with lower inflation internationally, they do not significantly affect unemployment or output fluctuations

Explaining Central Bank Behaviour

• The behaviour of central banks can be attributed to:
  • Public interest view, where actions reflect public interest
  • Theory of bureaucratic behaviour
• Theory of bureaucratic behavior (TBB) posits that bureaucracies maximize their own welfare through survival, size, power, and prestige

Implications of TBB for BoC

• The TBB results in the BoC acting to preserve autonomy and independence
• The BoC avoids controversy with powerful actors, such as the federal government Ex: raising interest rates slowly
• The BoC carries out its mission of serving its mandate and hence the public interest
  • Carrying out its mission can help maximize its own welfare

Federal Reserve System

• The Federal Reserve System, or "the Fed," is the central bank of the U.S.
• Its complex structure includes:
  • Board of Governors of the Federal Reserve System
  • Federal Reserve Banks
  • Federal Open Market Committee (FOMC)
  • Federal Advisory Council
  • 3,000 member commercial banks

Board of Governors of the Federal Reserve System

• HQ is Washington, D.C.
• Head of the Federal Reserve System
• Consists of seven members serving 14-year non-renewable terms
  • Members are appointed by the President and confirmed by the Senate
  • Members must come from different districts
• The Chairperson is chosen from the governors and serves a four-year term
  • After their term ends, the chair retires from Board

Federal Reserve Banks

• Each of the twelve Federal Reserve districts has one main Federal Reserve Bank
• The Federal Reserve Bank of New York:
  • Is the largest, holding over 25% of the total assets of the Federal Reserve System
  • A special role for several reasons; NY hosts the head offices of major banks as the financial center of the US

Federal Open Market Committee (FOMC)

• The FOMC, often called "the Fed," meets eight times a year to make two key monetary policy decisions:
  • Open-market operations
  • Setting the policy interest rate, the federal funds rate in the U.S.
• Consists of the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and the presidents of four other Federal Reserve banks
• The Chair of the Board also chairs the FOMC

How Independent Is the Fed?

• The Federal Reserve is a very independent government agency
  • The U.S. President's power to influence who will be Chair of the Board is limited
    • The Chair is often an experienced Board member appointed by previous U.S. Presidents
• The Fed is not entirely independent of political pressure
  • Public support plays an important role in its decisions

The European Central Bank (ECB)

• The Maastricht Treaty (1992) established the European Monetary Union (“the euro”), including the ECB and the Eurosystem
  • The treaty made the ECB about 100% instrument-independent and specified that the primary goal of the ECB is price stability
• The European Central Bank (ECB):
  • Conducts monetary policy since the adoption of the euro in January 1999 for countries in the Euro Area (currently 19 of the 27 countries in the European Union)
  • Monetary operations of the Eurosystem are conducted by all the National Central Banks in each country

How Independent Is the ECB?

• The ECB is the most independent central bank in the world, but not goal independent and has to follow its charter
  • The Charter can only be changed by revision of the Maastricht Treaty, which requires unanimity among the 27 EU countries
• Members of the Executive Board have long terms
• The ECB determines its own budget

Structure and Independence of Other Foreign Central Banks

• The Bank of England has some instrument independence, but the Government can overrule the Bank and set interest rates
• The Bank of Japan (Nippon Ginko) has some degree of instrument and goal independence -Objective of monetary policy is to attain price stability
  • Government can request delays in monetary policy decisions
• There is a growing international trend towards greater Central Bank independence