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CHAPTER 15
Central Banks and the Bank of Canada
399
SHO UL D THE BAN K OF CA NA DA BE IN DE PE N DE NT ?
As we have seen, the Bank of Canada is probably the most independent government agency in Canada. Every few years, 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. Should the Bank of Canada be independent,
or would we be better off with a central bank under the control of the government?
The Case for
Independence
The strongest argument for an independent Bank of Canada rests on the view that
subjecting the Bank to more political pressures would impart an inflationary bias to
monetary policy. In the view of many observers, politicians in a democratic society
are shortsighted because they are driven by the need to win their next election. With
this as the primary goal, they are unlikely to focus on long-run objectives, such as promoting a stable price level. Instead, they will seek short-run solutions to problems, like
high unemployment and high interest rates, even if the short-run solutions have undesirable long-run consequences. For example, we saw in Chapter 5 that high money
growth might lead initially to a drop in interest rates but might cause an increase later
as inflation heats up. Would a Bank of Canada under the control of the government
be more likely to pursue a policy of excessive money growth when interest rates are
high, even though it would eventually lead to inflation and even higher interest rates
in the future? The advocates of an independent central bank say yes. They believe that
a politically insulated central bank is more likely to be concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.
A variation on the preceding argument is that the political process in Canada
could lead to a political business cycle, in which just before an election, expansionary policies are pursued to lower unemployment and interest rates. After the
election, the bad effects of these policies high inflation and high interest rates
come home to roost, requiring contractionary policies that politicians hope the