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Chapter 14Structure of Central Banks and the Bank of Canada

© 2005 Pearson Education Canada Inc.

© 2005 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.


Establishment of Selected Central BanksCountry Year central bank was establishedSweden 1656United Kingdom 1694France 1800Belgium 1850Germany 1875Japan 1882Italy 1893Switzerland 1905United States 1913Canada 1935


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


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 (currently David Dodge, 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.


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, and • monetary policy management.


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.


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


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.


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.


Bank of Canada Independence

Factors making Bank of Canada independent1. Bank has ‘operational’ (or ‘instrument’) independence2. 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 January and July), 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.


Bank of Canada Independence

Factors making Bank of Canada dependent1. 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


Formal Structure of the Fed


Federal Reserve Districts


Informal Structure of the Fed


Fed IndependenceFactors making Fed independent1. Members of Board have long terms2. Fed is financially independent: This is most important

Factors making Fed dependent1. Congress can amend Fed legislation2. President appoints Chairmen and Board members and can influence legislation

Overall: Fed is quite independentOther Central Banks1. Bank of England least independent: Govt. makes policy decisions2. European Central Bank: most independent—price stability primary goal3. Bank of Canada and Japan: fair degree of independence, but not all on paper4. Trend to greater independence: New Zealand, European nations

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Explaining Central Bank BehaviorTheory of bureaucratic behavior1. Is an example of principal-agent problem2. Bureaucracy often acts in own interestImplications for Central Banks:1. Act to preserve independence2. Try to avoid controversy: often plays games3. Seek additional power over banksShould the Bank of Canada be Independent?Case For:1. Independent Bank likely has longer-run objectives, politicians don't: evidence is

independence produces better policy outcomes throughout the whole2. Avoids political business cycle3. Less likely deficits will be inflationaryCase Against:1. Bank may not be accountable2. Hinders coordination of monetary and fiscal policy3. Bank has often performed badly

© 2005 Pearson Education Canada Inc.

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