the structure of central banking and the bank of canada

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Pearson Canada Inc.
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Chapter 15
The Structure of Central Banking
and the Bank of Canada
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Origins of the Bank of Canada I
•

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
•
The Bank also has regional offices in Toronto, Vancouver,
Calgary, Montreal, and Halifax
•
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.
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Origins of The Bank of Canada II
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Formal Structure of the Bank of Canada I

•
Responsibility for the operation of the Bank rests with a
Board of Directors, which consists of fifteen members:
•
the governor (currently Mark Carney, who is the chief
executive officer and chairman of the Board of
Directors)
•
the senior deputy governor,
•
the deputy minister of finance, and
•

twelve outside directors

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Formal Structure of the Bank of Canada II
•
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.
•
In 1994 the Board of directors established a new senior
decision making authority called the Governing Council
•
The Council is chaired by the governor and is composed of
the senior deputy governor and four deputy governors
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The Functions of the Bank
The functions of the Bank of Canada are:
•
Bank Note Issue
•
Government Debt and Asset Management Services
•
Central Banking Services
•
Monetary Policy
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Bank Note Issue
•
Before the creation of the Bank, the federal government
and the early banks issued notes designed to circulate as
currency.
•
By 1945, however, the Bank had a monopoly over note
issue in the country.
•
The Bank also conducts ongoing research, working

closely with private sector partnerships and note-issuing
authorities in other countries, in order to improve cost-
effectiveness, increase the durability of bank notes, and
reduce counterfeiting.
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Government Debt and Asset Management
Services
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, and servicing outstanding debt
•
manages the government’s foreign exchange reserves held
by the Exchange Fund Account of the Department of Finance
•
engages in international financial transactions, on behalf of
the government, in order to influence exchange rates
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Central Banking Services
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 explicit responsibility for the regulatory oversight of
the national payments system, operated by the CPA
•
acts as the holder of deposit accounts of the federal
government, the directly clearing members of the CPA,

international organizations such as the IMF, and other
central banks.
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Monetary Policy
The Bank employs such tools as:
•
open market operations (purchase/sale of Gov bonds)
•
shifting of government balances between it and the

direct clearing members of the CPA 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.
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Bank of Canada Independence I
•
Bank has instrument (operational) independence but
not goal independence (ability to set the goals of policy)
•
“ 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)
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Bank of Canada Independence II
Factors making Bank of Canada dependent
1. Joint responsibility system (since 1967 when the Bank
of Canada Act was amended)
2. 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
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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 (twice a year)
the Monetary Policy Report and the Update to the
Monetary Policy Report
•
Has 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
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U.S. Federal Reserve System
•
U.S. central bank, the Federal Reserve System
(“The Fed”)

•
Board of Governors of the Federal Reserve
System
•
Federal Reserve Banks
•
Federal Open Market Committee (FOMC)
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Structure and Independence of Foreign

Central Banks
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The Federal Reserve System
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Federal Reserve Independence
Factors making Fed independent

1. Members of Board have long terms
2. Fed is financially independent: This is most
important
Factors making Fed dependent
1. Congress can amend Fed legislation
2. President appoints Chairmen and Board members
and can influence legislation
Overall: Fed is one of the most independent
central banks in the world
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Central Bank Independence
Other Central Banks
1. European Central Bank: highly independent
2. Bank of England: similar to Bank of Canada since
1997
3. Japan: increased formal independence since 1998
4. Trend to greater independence: New Zealand,
European nations
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Explaining Central Bank Behaviour

Theory of bureaucratic behaviour
1.Is an example of principal-agent problem
2.Bureaucracy often acts in own interest
Implications for Central Banks:
1.Act to preserve independence
2.Try to avoid controversy
3.Seek additional power over banks
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The Case for Independence I
Case For:

1. Independent Bank likely has longer-run objectives,
politicians may not
2. Avoids political business cycle
3. Less likely deficits will be inflationary
Case Against:
1. Bank may not be accountable
2. Hinders coordination of monetary and fiscal policy
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The Case for Independence II
•

Recent research shows that more independent
central banks are better able to contain
inflation and not at the expense of output
fluctuations and high unemployment
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