THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 413

CHAPTER 15

Central Banks and the Bank of Canada

LE A RNI NG OB JE CTI VE S
After studying this chapter you should be able to
1. classify the institutional structure of the Bank of Canada as well as four of the most
important foreign central banks
2. identify the Bank of Canada s functions and degree of independence and
specify the arguments for and against an independent central bank
3. describe the relationship between central bank independence and macroeconomic performance

PRE VI EW

Among the most important players in financial markets throughout the world are
central banks, the government authorities in charge of monetary policy. Central
banks actions affect interest rates, the amount of credit, and the money supply, all
of which have direct impacts not only on financial markets but also on aggregate
output and inflation. To understand the role that central banks play in financial
markets and the overall economy, we need to understand how these organizations
work. Who controls central banks and determines their actions? What motivates
their behaviour? Who holds the reins of power?
In this chapter, we look at the goals and institutional structure of major central
banks, and focus particularly on the Bank of Canada, Canada s central bank, often
just called the Bank. We start by examining what central banks are trying to do,
and then focus on the elements of the Bank of Canada s institutional structure that
determine where the true power within the Bank of Canada lies. By understanding who makes the decisions, we will have a better idea of how they are made.
We then look at several other major central banks, particularly the Federal Reserve
System in the United States the most important central bank in the world and
the European Central Bank, and see how they are organized. Finally, we examine
what explains central bank behaviour and whether it is a good idea to make central banks independent by insulating them from politicians. With this context in

place, we will be prepared to comprehend the actual conduct of monetary policy
described in the following chapters.

ORI G IN S OF THE BAN K OF CA NA DA
The devastation of the Great Depression was of fundamental importance in the
creation of the Bank of Canada. From 1929 to 1933, Canadian real GDP fell by
almost 30% and the unemployment rate increased sevenfold from less than 3% to
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