Western Standard

The Shotgun Blog

« Polk Dance | Main | The Financial Crisis Redux »

Wednesday, December 02, 2009

Is Canada’s central bank independent? And does it matter?

The Bank of Canada, Canada’s central bank, is an independent body operating at arms-length from the government with a mandate to "promote the economic and financial well-being of Canada."

The Minister of Finance doesn’t have a seat on the Board of Directors, and while the Deputy Minister of Finance does, he or she doesn’t have a vote. Since the creation of the central bank in 1935, the Minister of Finance has never dismissed a central banker or been forced to redirect central bank policy.

That sounds like an independent central bank.

But is it?

Finance Minister Jim Flaherty is at the centre of discussions on the impact of Canada’s high dollar on Canadian manufacturers looking to export products at globally competitive prices. When the Canadian dollar is high, Canadian exports are more expensive.

In the Calgary Herald today, Flaherty said he has “options” for dealing with the high value of the Canadian dollar:

“There are options we have if we chose to use them, but there is no indication that we would do anything like that now.”

The option for dealing with a high Canadian dollar is to devalue the dollar by printing more money, which is the sole purview of Bank of Canada governor Mark Carney. (Is there another option for dealing with a high dollar?)

So, if the central bank is independent, why should we care what Finance Minister Jim Flaherty thinks of the Loonie? And why would Flaherty feel obliged to answer media questions on the subject with a statement other than “Monetary policy is responsibility of the central bank. Ask Mark Carney.”?

And one more question: Is central bank independence important?

These aren’t rhetorical questions. I’m hoping for answers from Western Standard readers more knowable than myself on this matter.

Posted by Matthew Johnston on December 2, 2009 | Permalink


I'd say it is essential that the central bank be independent, lest politicians be able to manipulate its policies for short-term gains. I need only point back to the Dark Ages of Pierre the Terrible for that - inflation, low currency etc. If it ain't broke, don't fix it.

Posted by: Zebulon Pike | 2009-12-02 2:12:55 PM

It is broke Pike. The central bank is not independent. Even if it was, there is no logical argument as to why interest rates cannot be determined by the market.

Posted by: Charles | 2009-12-02 5:03:09 PM


" the Minister of Finance has never dismissed a central banker or been forced to redirect central bank policy."

Sort of. Refer to the Coyne Affair: http://en.wikipedia.org/wiki/James_Coyne

Governor James Coyne was effectively dismissed by the Diefenbaker government, but this was blocked by the Liberal controlled Senate. Dief and his Minister of Finance Donald Fleming wanted a looser monetary policy, Coyne a tighter one. Coyne later resigned, somewhat in protest. He is still alive and his son is the columnist Andrew Coyne.

To your essential point, it sort of matters that the Bank is independent. As Zeb alludes, short-term political interference could be devastating. That said, in historical terms it has mattered little. The Bank of England was only made fully independent in the last decade i.e. similar provisions were introduced in the UK to those in existence in Canada for decades.

At the game of price stability, the UK has not faired much worse than Canada. However critical I am of PET, you can't blame Stagflation on him. It was a phenomenon seen across the western world, whose chief culprit was the US Federal Reserve. Having steadily inflated during the Vietnam War, the Fed then choose to "monetize" the 1973 oil shock (this was after the close of the gold window and the collapse of Bretton Woods). That was the triggering event. It took until the 1981-2 recession - so far the most severe since 1945, whatever the hyperbole of the MSM today - to beat inflation back to "normal" levels.

As Charles suggest, this is rather beside the point. Whether a Central Bank is "independent" or "tame" is a matter of degrees. It reminds me of the old debates over nationalized industries in Britain. Should the business be run as businesses? Or as ministries? It was splitting hairs really. Without a genuine market
the nationalized industries could not behave as true businesses.

The same issue applies to Central Banks. Trying to determine how large the money supply - however many Ms you care to use in figuring that out - is like trying to have the government figure out how many boots need to be produced next year. You can make a vague guess, say based on the number of boots in an economy, the average length of time before each pair has to be replaced due to wear and tear and factor in population growth. It would be a somewhat plausible number, but without the signalling mechanism of prices it would remain a groping in the dark guess.

The same applies to Central Banks. The genius of the gold standard - or whatever other commodity you might choose - is that it can adjust to the actual demands of the economy.

Let us say you peg the price of gold at $100.00 an once - for simplicity imagine the Bank of Canada is fixing the price of gold as the US Treasury used to in the 19th century [historically the price was $20.67 for much of the period]. If the market price rises above $100.00, because of an increased demand for money, the B of C would sell its gold reserves to lower the price. This would expand the money supply to meet the increased demand. Now repeat in the opposite direction. The market price falls below $100.00, that would require the B of C to buy gold to bring up the price. That would reduce the money supply, to reflect a fall in demand. On a point of historical accuracy, the B of C never did this as it was created in 1935, after gold was largely abandoned.

That's roughly how the gold standard worked in the 19th century. The government played a minor role in setting and helping to maintain the price. The price however was known to all and did not fluctuate on the basis of bureaucratic or political whim. That same role - of price fixing - could easily be played by private banks.

Posted by: Publius | 2009-12-02 7:53:14 PM

If the role of the Central Bank is:"promote the economic and financial well-being of Canada." Why do we bother electing politicians?
By the way a number of countries central bankers are former Alumni of Goldman Sachs.
And the Bank for International Settlements(BIS) has Central Banks as its "customers."

Posted by: Stephen J. Gray | 2009-12-02 8:28:17 PM

okay, i'll state the obvious...

independent or not, it absolutely doesn't matter, because free markets can't control what the Central Bank does.

the question might be: "should there be a central bank?"

Posted by: shel | 2009-12-02 9:22:07 PM

The best interests of a totally independent bank and the whims of politicians can converge.

Posted by: Agha Ali Arkhan | 2009-12-02 9:52:04 PM

Central bank independence is indeed important. There is strong empirical data to show that the more independent a central bank is of its legislature, the lower inflation is, this is because independent central banks look towards long-term goals, while politicians concentrate on short-term goals and create even higher inflation.

With this being said, I think the free-market alternatives of the pure gold standard, and free banking are the least inflationary and the best for true long term economic growth and freedom.

The Bank of Canada is actually more transparent and less independent than the Federal Reserve in the United States. If I recall there were actually threats, I believe, by a former Prime Minister or Finance Minister of removing a governor of the Bank of Canada once.

There was an interview in the Council on Foreign Relations last month actually which stated that if these "regional currency blocs" spread and the dollar is removed as the world's reserve currency there could be a return to the global gold standard via new means such as international gold-based debit cards. Specifically he stated:

The only other viable alternative I see is privately produced gold-backed money. There are already many "gold banks" in operation, which allow account holders to store, receive, and transfer digital shares of gold. If the phenomenon grows, it will naturally lead to the issuance of gold debit cards. This would allow you, for example, to walk into a café in Sao Paolo and pay for your cappuccino with a swipe of your card for a tenth of a gram of gold.

You can read about it here:

Posted by: Omar Abu Hatem | 2009-12-03 2:27:09 AM

The B o C is LESS independent than the US FED.

The FED, for better or worse, is a private organization, which arguably dictates policy to government, AFTER taking a political hint.

The B o C is a more purely state entity, and far more responsive to political hints.

Even as the FED was mouthing alleged concern for burst bubbles, the Tories made it abundantly clear they wanted to reflate Canada's housing bubble as part of its "stimulus" strategy.

Given that Canada's federal balance sheet was stronger than that of the US, and that our housing bubble had not eaten up as much seed capital as did the one south of the border, it is arguable that no independent central bank would have cranked up the printing presses the way the B o C so unnecessarily did.

Note too the parallel policy of the Harper Tories to lift $75-odd-Billion in mortgage liabilities from the private banks -- theoretically as an incentive to get them lending at the B o C's ridiculously low rates.

Throw in the sop to homebuilders that is the renovation tax credit, and Harper's policy is very clear. The B o C can not be viewed in the big picture as acting independently but rather in concert with fiscal policy.

The B o C needs to go the way Ron Paul has in mind for the FED. Start with an audit.

Posted by: JC | 2009-12-03 9:30:43 PM

The only other viable alternative I see is privately produced gold-backed money.
Posted by: Omar Abu Hatem | 2009-12-03 2:27:09 AM

As the total amount of gold that has ever been produced, even at $1100 an ounce, doesn't even come close to just the US economy your only option to have a gold backed currency is to issue the money against gold certificates. Which means you are really backing your currency with paper which is exactly what governments are doing today. So please detail why you system is better.

Posted by: The Stig | 2009-12-04 10:24:54 AM

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make it's holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank holdings as silver or copper or any other good and thereafter decline to accept checks as payments for goods, bank deposits would lose their purchasing power and government-credited bank credit would be worthless as claims on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. if one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."
-Taken from an article written in 1966 by Alan Greenspan entitled "Gold and Economic Freedom"

Having a commodity-backed currency protects against the confiscation of wealth. When people can trade their dollars for gold they can save themselves from the effects of inflation. It doesn't have to be only gold. Gold is favored because it has a high value even in small quantities and is easily denominated. It is also important to distinguish between the value of gold and the price of gold in dollars. Gold prices are going up because of the drop in value of the dollar. (It now takes more dollars to equal the value of an ounce of gold).
Value of currency has been judged against gold for 6000 years and was given this role by market forces.

Posted by: EndtheFed | 2009-12-06 12:16:34 PM

The argument for central bank independance is ambiguous because the central bank is highly politicized by deficit spending. The reason politicians favor a central bank is because they can fund things that the public would not tolerate being taxed for. This is why inflation is referred to as the "hidden tax". One major argument against inflationary policy is that people are affected unproportionately with the poor and middle class taking the hit.

Posted by: EndtheFed | 2009-12-06 12:27:26 PM

-Taken from an article written in 1966 by Alan Greenspan entitled "Gold and Economic Freedom"
Posted by: EndtheFed | 2009-12-06 12:16:34 PM

October 23, 2008

Rep. Henry Waxman -“In other words, you found that your view of the world, your ideology, was not right, it was not working,

Alan Greenspan - “Absolutely, precisely,”

Greenspan has been discredited. His theory on the gold standard is merely academic mumbo-jumbo that is impractical in a modern economy.

It doesn't have to be only gold.
Posted by: EndtheFed | 2009-12-06 12:16:34 PM

It could be cows or chickens I suppose if you wish to revert to a barter economy.

Posted by: The Stig | 2009-12-06 12:48:11 PM

Why does Matthew Johnstons reponse get funnier each time he post it?

Posted by: Un-published-er | 2009-12-06 1:18:49 PM

the stig said:
"Rep. Henry Waxman -“In other words, you found that your view of the world, your ideology, was not right, it was not working,
Alan Greenspan - “Absolutely"

Interestingly, when asked by Ron Paul if he would like to add a disclaimer to his article "Gold and Economic Freedom", Greenspan claimed he had just recently re-read it, and that he would not change a word of it. This was after he became chairman of the Fed.
I'm not sure what context Waxman's question was in, but the answer given by Greenspan isn't consistent with what he told Ron Paul. Greenspan believed that the benefits of the gold-standard could be acheived without it's limitations by manipulating the money supply and the interest rates. He was seduced by Keynesian economics and he thought that people had become smart enough to successfully control monetary policy and interest rates in order to avoid downturns. That's what he was wrong about.
Are you a fan of keynesian economics?

the stig said:

"His theory on the gold standard is merely academic mumbo-jumbo that is impractical in a modern economy."

How so?

Posted by: EndtheFed | 2009-12-06 1:53:51 PM

the stig said:
"His theory on the gold standard is merely academic mumbo-jumbo that is impractical in a modern economy."
How so?
Posted by: EndtheFed | 2009-12-06 1:53:51 PM

Gold and any other commodity that you wish to use to value your currency, has a multitude of uses other than backing a currency. You cannot accurately predict the amount of gold that will be produced. Therefore you run into the main problem of using gold which is that unless the amount of new gold produced equals the rate of growth in an economy you either will have large swings of inflation or deflation.The price of gold on Nov. 30-06 was $645 an ounce, by Nov 30.-09 the price was $1180. The value of your currency would have appreciated by 80% over three years, it could just as easily go the other way. The other problem of using gold is there simply isn't enough real gold in the world to cover just the US economy. You then would have to use gold certificates which means you are simply doing what is done today.

Posted by: The Stig | 2009-12-06 4:51:56 PM

the stig said:
"The price of gold on Nov. 30-06 was $645 an ounce, by Nov 30.-09 the price was $1180."

You are looking at the price of gold in dollars. This means that the dollar was inflated drastically during that time. The amount of gold the dollar buys is a measuring stick for how much it is actually worth.

the stig said:
"The other problem of using gold is there simply isn't enough real gold in the world to cover just the US economy"

You are still thinking in terms of dollars. It's the purchasing power that matters, not the amount of units of dollars in the economy. It is this limitation that is desired from a commodity-backed currency so that it cannot be instantly diluted. The tie to a commodity keeps the currency grounded close to the same purchasing power, which keeps people safe from the deterioration of wealth which results from inflating a fiat currency.

Posted by: EndtheFed | 2009-12-07 9:32:01 AM

If the supply of dollars was doubled overnight and handed out, everyone would have extra cash on hand and would start buying things and services. Very soon after, the businesses would run into shortages due to the sudden increase in demand. It appears like everything is going great at first; stores are selling out their inventories, and people still want more. So what does a rational person do? Raise prices. This curtails some of the purchasers because some are not willing to pay a higher price, and the result is that the businesses sell fewer items at a higher price. They make more profits. Everything is still looking good. One day you wake up and you go to buy a loaf of bread for your sandwhich at lunchtime, and it dawns on you that a loaf of bread is now costing you 4 or 5 dollars. Milk is close to 10. It's a good thing the government doubled your money then, right? Wrong. The fact is that when the central bank increases the money supply, it is not handed out evenly. A few people and businesses get the advantage while other people are forced to pay more for their bread. Wages do not increase at the same rate. There is a lag before people begin to demand increased compensation for costs of living. This is robbery. And it hits the poor the hardest. Imagine making under 10 dollars an hour and trying to afford breakfast, lunch and dinner for you and your family when bread costs 5 dollars.

You cannot create wealth with a printing press. It is the purchasing power of the dollar that is important, not the amount of dollars you hold.

Posted by: EndtheFed | 2009-12-07 9:47:14 AM

You are looking at the price of gold in dollars.
Posted by: EndtheFed | 2009-12-07 9:32:01 AM

You are still thinking in terms of dollars.
Posted by: EndtheFed | 2009-12-07 9:32:01 AM

Then what you want is a barter system.

Posted by: The Stig | 2009-12-07 11:57:36 AM

the stig said:
"Then what you want is a barter system."

Gold is a currency.
In fact, if you check the US constitution (not sure about Canada's), it still says only gold and silver are permitted to be legal tender. The dollar is unconstitutional. And so is the Fed. Why is it that more people are not aghast that the constitution is being ignored. No wonder the list of rights keeps getting smaller, and smaller.

The system we have now with the dollar could also be described as a barter system. How can you expect to have a stable economy if the value of the dollar (your measuring stick for the economy) changes every day? This is not a rhetorical question, I'm quite curious to hear an answer.

Posted by: EndtheFed | 2009-12-07 12:24:32 PM

Keynesians have this idea that we can just inflate currency to stimulate economic growth and sustain bubbles by pegging interest rates, but it's ridiculous. Even when you ignore the effects of wealth re-distribution of inflationary monetary policy, it's still ridiculous. It's kids stuff; I used to wonder as a kid why we didn't just print more money when we needed it. We can't have unlimited money because we don't have unlimited resources. What's the real value of something that's unlimited?

It's that type of thinking that got us into this recession. Easy money from the fed causes malinvestment and allows people to be in business despite the fact that they aren't creating value. It's a mis-allocation of funds that hurts our economic potential. We have all heard the term "bubble" by now. When funds are allocated to unproductive investments, there should be no surprise that the investments fail. That's why these bubbles deflate. But instead of stimulating a period of saving by allowing a higher, proper level of interest rates to pay for the malinvestments, keynesians think it's time for extra government spending to kick in, combined with easier money from the fed.

To remain consistent with the bubble analogy, keynesians think the solution for a more stable economy is to re-inflate the deflating bubble (or create a new bubble to replace it). Wall-street adds to the problem because a publicly traded company need not be profittable to remain alive as long as it's share price is bid up. When these bubbles burst, we feel all of the effects of the bankruptcies and failed investments all at one time instead of in a more natural, spread-out, manageable manner. Under keynesian economics, we get all of the postponed market corrections of a period combined into one big one.

How can you solve the problem by doing more of the things that caused the problem in the first place? How can one expect limitless and secretive expansion of our money supply to be a sustainable process? How can we borrow money to waste on extravagent consumption, and expect to be able to continue forever paying it back with more borrowed money? How can we trust advocates of keynesian economics to be "smart enough to manipulate money supply and interest rates successfully" if they are producing results like these?

Someday we are going to need a market correction, and the longer we postpone it, the worse it will be (because the more propped up it will be).

A worldwide economy based on the unstable faith in a limitless fiat currency is a silly notion.

We (and more importantly the US) need to more efficiently allocate our resources to ensure real economic growth and stability. One way to do this is to allow market forces to determine interest rates.
We need to allow corrections indicated by market forces. A way to accomplish this is to limit the ability of government to inflate to pay for spending.
Both of these things can be accomplished by reducing the role of a central bank. More secrecy, or "independance", is the last thing we need for the central bank.

Posted by: EndtheFed | 2009-12-08 3:11:09 PM

Typepad has this clever feature that publishes my auto-reply every time someone posts a comment.

Posted by: Matthew Johnston | 2009-12-08 3:47:41 PM

The comments to this entry are closed.