1. chapter 14 Structure of Central Banks and the Bank of Canada

2. Copyright © 2002 Pearson Education Canada Inc. 14- 2 The Bank of Canada (The Bank) The Bank was created by the Bank of Canada Act in 1934 and started operations on March 11, 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.

3. Copyright © 2002 Pearson Education Canada Inc. 14- 3 Establishment of Selected Central Banks CountryYear central bank was established Sweden 1656 United Kingdom1694 France1800 Belgium1850 Germany1875 Japan1882 Italy1893 Switzerland1905 United States1913 Canada 1935

4. Copyright © 2002 Pearson Education Canada Inc. 14- 4 Formal Structure of the Bank of Canada Responsibility for the operation of the Bank rests with a Board of Directors, which consists of fifteen members the governor (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 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.

5. Copyright © 2002 Pearson Education Canada Inc. 14- 5 The Political Environment and the Bank of Canada Since the inception of the Bank of Canada, there have been seven governors: 1935-1954, Graham Towers 1955-1961, James Coyne 1961-1973, Louis Rasminski 1973-1987, Gerald Bouey 1987-1994, John Crow 1994-2000, Gordon Thiessen 2001-, David Dodge

6. Copyright © 2002 Pearson Education Canada Inc. 14- 6 The Functions of the Bank of Canada The functions of the Bank of Canada are bank note issue government debt and asset management services central banking services, and monetary policy management.

7. Copyright © 2002 Pearson Education Canada Inc. 14- 7 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.

8. Copyright © 2002 Pearson Education Canada Inc. 14- 8 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

9. Copyright © 2002 Pearson Education Canada Inc. 14- 9 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. This lending is closely coordinated with the two federal regulatory agencies that are set up specifically to regulate financial institutions — OSFI and CDIC 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.

10. Copyright © 2002 Pearson Education Canada Inc. 14- 10 Monetary Policy Although in Canada the ultimate responsibility for monetary policy rests with the government, the Bank employs such tools as open market operations and, to a lesser extent, the shifting of government balances between it and the directly clearing members of the CPA to implement changes in the M. The Bank’s ultimate objective is to keep  low. Low  is closely related to the goal of steady economic growth, because businesses are more likely to invest to increase productivity and economic growth when  is low. Low  is also desirable because it protects the purchasing power of pensioners and those on fixed incomes.

11. Copyright © 2002 Pearson Education Canada Inc. 14- 11 Bank of Canada Independence Factors making Bank of Canada independent 1.Bank has ‘operational’ (or ‘instrument’) independence 2.Bank has moved towards greater ‘transparency’ in its operations. The Bank’s Governing Council publishes the Monetary Policy Report (every May and November), since 1999 the Update to the Monetary Policy Report (every February and August), the Bank of Canada Review, and the Bank of Canada Banking and Financial Statistics. 3.Bank increased the number of press conferences, press releases, and speeches, and also reorganized its regional offices, with the objective of improving communication and its assessment of economic conditions across Canada.

12. Copyright © 2002 Pearson Education Canada Inc. 14- 12 Bank of Canada Independence 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. The directive, however, must be published indicating not only the new policy that the Bank is supposed to undertake but also the period during which it is to apply. Overall: Bank of Canada is quite independent but not on paper

13. Copyright © 2002 Pearson Education Canada Inc. 14- 13 Formal Structure of the Fed

14. Copyright © 2002 Pearson Education Canada Inc. 14- 14 Informal Structure of the Fed

15. Copyright © 2002 Pearson Education Canada Inc. 14- 15 Central Bank 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 quite independent Other Central Banks 1.Bank of England least independent: Govt. makes policy decisions 2.European Central Bank: most independent—price stability primary goal 3.Bank of Japan: fair degree of independence, but not all on paper 4.Trend to greater independence: New Zealand, European nations

16. Copyright © 2002 Pearson Education Canada Inc. 14- 16 Explaining Central Bank Behaviour Theory of bureaucratic behaviour suggests that the objective of a bureaucracy is to maximize its own welfare, in the same way that a consumer is motivated to maximize utility and a firm is motivated to maximize profits. 1.Is an example of principal-agent problem 2.Bureaucracy often acts in own interest Implications for Central Banks: 1.Act to preserve autonomy and independence 2.Try to avoid controversy with powerful groups that may threaten to curtail its power and autonomy: often plays games 3.Seek additional power over banks

17. Copyright © 2002 Pearson Education Canada Inc. 14- 17 Should the Bank of Canada Be Independent? Case For: 1.Independent Bank likely has longer-run objectives, politicians don’t: evidence is better policy outcomes (see Figure 14-1) 2.Avoids political business cycle. (By taking the long view, an independent Bank will not respond to short-run problems that will result in expansionary policy and a political business cycle) 3.Less likely deficits will be inflationary Case Against: 1.The Bank may not be accountable 2.Makes the coordination of monetary and fiscal policy difficult 3.The Bank of Canada has often performed badly

18. Copyright © 2002 Pearson Education Canada Inc. 14- 18 Central Bank Independence and Macro Performance in 17 Countries Figure 14-1