Chapter 14: Central Banks and the Bank of Canada PDF

Chapter 14 Central Banks and the Bank of Canada Copyright © 2020 Pearson Canada Inc. 14 - 1 Learning Objectives 1. Recognize the historical context of the development of the Bank of Canada 2. Describe the key features and functions of the Bank of Canada. 3. Assess the degree of in...

Chapter 14 Central Banks and the Bank of Canada Copyright © 2020 Pearson Canada Inc. 14 - 1 Learning Objectives 1. Recognize the historical context of the development of the Bank of Canada 2. Describe the key features and functions of the Bank of Canada. 3. Assess the degree of independence of the Bank of Canada. 4. Identify the ways in which the theory of bureaucratic behavior can help explain central bank actions. 5. Assess the degree of independence of other major central banks around the world. Copyright © 2020 Pearson Canada Inc. 14 - 2 Origins of the Bank of Canada 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 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 © 2020 Pearson Canada Inc. 14 - 3 Structure of the Bank of Canada (1 of 2) Responsibility for the operation of the Bank rests with a Board of Directors, which consists of fifteen members: – The Governor (who is also the chief executive officer and chairman of the Board of Directors) – The Senior Deputy Governor – The Deputy Minister of Finance – Twelve outside Directors Copyright © 2020 Pearson Canada Inc. 14 - 4 Structure of the Bank of Canada (2 of 2) 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 The Governing Council is chaired by the governor and is composed of the senior deputy governor and four deputy governors Copyright © 2020 Pearson Canada Inc. 14 - 5 Functions of the Bank of Canada The functions of the Bank of Canada are: – Currency – Funds Management – Financial System – Monetary Policy – Retail Payment Supervision Copyright © 2020 Pearson Canada Inc. 14 - 6 Currency Before the creation of the Bank, the federal government and the early banks issued notes By 1945 the Bank had a monopoly over note issue in the country The Bank also conducts ongoing research – To improve cost-effectiveness – Increase the durability of bank notes – Reduce counterfeiting Copyright © 2020 Pearson Canada Inc. 14 - 7 Funds Management 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  servicing outstanding debt – Manages the government’s foreign exchange reserves held by the Exchange Fund Account – Engages in international financial transactions to influence exchange rates Copyright © 2020 Pearson Canada Inc. 14 - 8 Financial System/Retail Payments 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 power to create base money – Has explicit responsibility for the regulatory oversight of the national payments system, operated by the Payments Canada – Acts as the holder of deposit accounts for:  the federal government  the directly clearing members of the Payments Canada  international organizations such as the IMF  other central banks Copyright © 2020 Pearson Canada Inc. 14 - 9 Monetary Policy The Bank employs such tools as: – Open market operations – Shifting of government balances between it and the direct clearing members of the Payments Canada 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 © 2020 Pearson Canada Inc. 14 - 10 How Independent Is the Bank of Canada? Instrument but not goal independence Two main principles reflecting Louis Rasminsky’s view of Bank of Canada independence – “.. 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 © 2020 Pearson Canada Inc. 14 - 11 Factors Making Bank of Canada Dependent Joint responsibility system 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 © 2020 Pearson Canada Inc. 14 - 12 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 the Monetary Policy Report 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 Copyright © 2020 Pearson Canada Inc. 14 - 13 Should the Bank of Canada Be Independent? The Bank of Canada is probably the most independent government agency in Canada The question arises whether the independence given to the Bank of Canada should be curtailed Politicians who strongly oppose a Bank policy often want to bring it under their supervision in order to impose a policy more to their liking Copyright © 2020 Pearson Canada Inc. 14 - 14 The Case for Independence Political pressure would impart an inflationary bias to monetary policy Should avoid political business cycles, where before elections expansionary policies are pursued Avoids using the Bank to facilitate government financing of large budget deficits: accommodation Monetary policy is too important to leave to politicians — the principal-agent problem is worse for politicians Copyright © 2020 Pearson Canada Inc. 14 - 15 The Case Against Independence Undemocratic Unaccountable Difficult to coordinate fiscal and monetary policy Some may feel the Bank has not used its independence successfully Internationally, while countries with independent central banks have lower inflation, they don’t have very different unemployment rates or output fluctuations Copyright © 2020 Pearson Canada Inc. 14 - 16 Explaining Central Bank Behaviour (1 of 2) Theory of bureaucratic behaviour – Is an example of principal-agent problem – Bureaucracy often acts in own interest Implications for Central Banks: – Act to preserve independence – Try to avoid controversy – Seek additional power over banks Copyright © 2020 Pearson Canada Inc. 14 - 17 Explaining Central Bank Behaviour (2 of 2) Theory of bureaucratic behaviour: objective is to maximize its own welfare which is related to power and prestige – Fight vigorously to preserve autonomy – Avoid conflict with more powerful groups Does not rule out altruism Copyright © 2020 Pearson Canada Inc. 14 - 18 Federal Reserve System U.S. central bank, the Federal Reserve System – “the Fed” Includes: – Board of Governors of the Federal Reserve System – Federal Reserve Banks – Federal Open Market Committee (FOMC) – Federal Advisory Council – 2500 member commercial banks Copyright © 2020 Pearson Canada Inc. 14 - 19 Board of Governors of the Federal Reserve System Seven members headquartered in Washington, D.C. Governors are appointed by the president and confirmed by the Senate Serve 14-year non-renewable term Required to come from different districts Chairman is chosen from the governors and serves four-year term Copyright © 2020 Pearson Canada Inc. 14 - 20 Federal Reserve Banks Each of the twelve Federal Reserve districts has one main Federal Reserve bank The three largest Federal Reserve banks in terms of assets are those of New York, Chicago, and San Francisco – They hold more than 50% of the assets of the Federal Reserve System – The New York bank, with around one-quarter of the assets, is the most important of the Federal Reserve banks Copyright © 2020 Pearson Canada Inc. 14 - 21 Federal Open Market Committee (FOMC) Meets eight times a year Consists of 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 Chairman of the Board is also chair of FOMC Makes decisions regarding: – The conduct of monetary policy – The setting of the policy interest rate Copyright © 2020 Pearson Canada Inc. 14 - 22 How Independent Is the Fed? The Federal Reserve appears to be remarkably free of the political pressures that influence other agencies The power of the U.S. President in appointing members to the Board is limited – The term of the Chairman of the Board is not necessarily concurrent with that of the president Not entirely free of political pressures – To understand the Fed’s behaviour, we must recognize that public support for the actions of the Federal Reserve plays a very important role in its decisions Copyright © 2020 Pearson Canada Inc. 14 - 23 The European Central Bank European Central Bank (ECB) – The central bank of the euro area countries – Conducts monetary policy for countries that are members of the European Monetary Union – Monetary operations of the Eurosystem are conducted by all the National Central Banks in each country – The ECB is the most independent central bank in the world Maastricht Treaty – Established Eurosystem – Makes the ECB instrument-independent – Specifies that the goal of the ECB is price stability Copyright © 2020 Pearson Canada Inc. 14 - 24 ECB Governing Council Monthly meetings at ECB in Frankfurt, Germany Twelve National Central Bank heads and six Executive Board members Operates by consensus ECB announces the target rate and takes questions from the media To stay at a manageable size as new countries join, the Governing Council will be on a system of rotation Copyright © 2020 Pearson Canada Inc. 14 - 25 How Independent Is the ECB? Most independent in the world Members of the Executive Board have long terms Determines own budget Less goal independent Charter cannot by changed by legislation; only by revision of the Maastricht Treaty Copyright © 2020 Pearson Canada Inc. 14 - 26 Structure and Independence of Other Foreign Central Banks Bank of England – Has some instrument independence – Government can overrule the Bank and set interest rates Bank of Japan (Nippon Ginko) – Has some degree of instrument and goal independence – The objective of monetary policy is to attain price stability – Government can request delays in monetary policy decisions Growing international trend towards greater Central Bank independence Copyright © 2020 Pearson Canada Inc. 14 - 27  Exercise How different is US central banking system from Canadian? Discuss in group of two and share with class. Copyright © 2020 Pearson Canada Inc. 14 - 28