Bank of Canada

The Bank of Canada has received many accolades in recent years because of its handling of the financial crisis, especially owing to the popularity of its governor at the time, Mark Carney, who was also appointed chairman of the G20's Financial Stability Board in 2011 and then, in 2013, he became Governor of the Bank of England. As far as central banking internationally is concerned, the Bank of Canada exerts much more prominence among central banks than it would otherwise do when measured simply by the size and importance of the macroeconomy that the Bank oversees through its activities. The Bank of Canada has acquired high credibility also because it has managed a solid and sophisticated banking system, which did not face the same difficulties that plagued the US banking sector during the financial crisis that erupted in 2008.

Much like the US Federal Reserve (Fed), this central bank was founded following major financial crises on the North American continent during the early decades of the twentieth century, namely after the crisis of 1907 for the US Fed and the Great Crash of 1929 for the Bank of Canada (see Lavoie and Seccareccia, 2013). In stark contrast to the Fed, which established a "decentralized" central banking system in 1913 with 12 separate reserve districts, the institutional structure of the Bank of Canada was modelled on the more centralized organization of the Bank of England, with this structure being adapted to the Canadian context following its founding in 1934, for instance in terms of its regional and linguistic representation on its board of directors and governing council. Hence, while first a private institution, the Bank of Canada was quickly nationalized by the federal government within a few years of its creation in 1938 (see Plumptre, 1940; Bank of Canada, 2014).

Unlike the Bank of England, the US Fed, and the European Central Bank, the Bank of Canada does not hold the official status of an "independent" central bank. Though being an arm's-length public institution, with the appointment of the governor of the Bank of Canada exceeding the normal duration of parliament, decisions regarding the direction of monetary policy cannot be pursued at variance with the views of the demo- cratically elected government in power. To assure this communication link between the government and the Bank of Canada, the Deputy Minister of Finance sits as ex officio member of the board of directors of the Bank of Canada. Often referred to as the Coyne affair, this political "dependence" of the Bank of Canada was once put to the test in 1961, when a conflict had erupted between the Minister of Finance and the Governor, with the latter being eventually pressured to resign. This ultimate power over Bank policy was (and must still be) exercised, however, within the broad framework of its mandate as set out in the preamble to the Bank of Canada Act of 1934, which, for instance, despite the Bank's official commitment to inflation targeting since February 1991, actually remains a multi-faceted mandate, namely "to regulate credit and currency [. . .] and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment" (Government of Canada, 2014, p. 1), which is a mandate that has remained unchanged over the past 80 years.

Much like other national central banks, the Bank of Canada is the sovereign issuer of Canada's currency. It is the ultimate dispenser of liquidity to the commercial banks, and it manages the interbank market for funds through its targeting of the overnight rate of interest, the key lending rate in the economy, via a corridor system of interest rate setting.

At the same time, it is the fiscal agent of the federal government, by managing the market for federal government securities. Historically, it has also intervened in foreign exchange markets in order to influence the exchange rate of the Canadian dollar, even though it has not officially intervened since 1998, thereby making the Canadian dollar exchange rate a pure float.

The Bank of Canada's interventions throughout its history took place within policy frameworks that varied as successive competing schools of thought in monetary theory became fashionable. For instance, during the Second World War and during the early post-war years, the Bank of Canada pegged interest rates at very low levels that sup- ported the war effort and post-war growth by accommodating public spending largely within a Keynesian frame of reference. However, once central banks internationally began to free up interest rates by engaging in discretionary interest rate policy, the Bank of Canada began to focus on combating inflation as its principal goal. The most impor- tant change in policy direction took place in the mid 1970s immediately after the first oil price shock, when the Bank of Canada adopted a hybrid monetarist framework dubbed "monetary gradualism" by targeting the growth of a narrow monetary aggregate, namely M1. The Bank's incapacity to meet its M1 target by the early 1980s brought the monetary authorities to abandon altogether the monetarist framework in 1982 (see Lavoie and Seccareccia, 2006).

After a short interlude of policy drift in the 1980s, by the early 1990s the Bank of Canada had adopted a new monetary policy framework along Wicksellian lines. This entailed a precise institutional structure whereby the operating target would be the overnight rate of interest and where the goal would be an officially-approved inflation target, which the government would renew every five years. Similar to other inflation- targeting central banks, until the global financial crisis of 2008-09 the Bank of Canada targeted a 2 per cent core inflation rate compatible with a positive real overnight rate of interest.

During the financial crisis that burst in 2008, it can be said that, although never abandoning officially its inflation target, the Bank of Canada pegged its administered interest rate at practically zero level, which engendered a negative overnight rate of inter- est, in the hope that the latter would provide sufficient boost and would complement the fiscal stimulus that had been introduced by the federal government to combat the recession. It also introduced quantitative easing in what has been argued by some as a futile attempt to encourage banks to lend via a supply-side policy measure (see Lavoie and Seccareccia, 2013). Towards the end of 2010, the Bank of Canada reverted back to a semblance of discretionary interest rate policy, but with the persistence of a negative real overnight rate of interest, which, since then, has attested to the fears and reality of secular stagnation.

See also:

Bank of England; Carney, Mark; Central bank as fiscal agent of the Treasury; Central bank credibility; Corridor and floor systems; Credibility and reputation; Federal Reserve System; Financial crisis; Inflation targeting; Interest rates setting; Monetary aggregates; Monetary targeting; Negative rate of interest; Quantitative easing; Wicksell, Knut; Zero interest-rate policy.