Central Bank Independence: A Canadian Contrast

Published by the R Street Institute.

Whether central banks are or should be or could be “independent” of the rest of the government is a key question in political economics and political finance.  Given the great power of the unelected managers of central banks in a fiat currency system, the potentially huge costs of their mistakes, and their obvious ability to move markets, it is a question of substantial magnitude.

Unsurprisingly, the Federal Reserve itself is a big proponent of its own independence.  Former Fed chairmen Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen took to the Wall Street Journal on August 6 to make the independence case.

An interesting, perhaps more balanced, approach is taken by Canada, another economically advanced, democratic country with a sophisticated financial system, for its central bank, the Bank of Canada.  The Bank of Canada Act strikingly contrasts with the theory of independence in this respect.

Specifically, the Bank of Canada Act has a section entitled “Government Directive.”  This section provides for the explicit coordination between the central bank and the executive, and the ultimate superior authority of the Parliamentary government in monetary actions.  To understand the provisions I am about to quote, “Minister” means the Minister of Finance, equivalent to the Secretary of the Treasury in the U.S. government.  “Governor” means the head of the Bank of Canada, equivalent to the Chairman of the Federal Reserve System. “Governor in Council” means quite a different Governor, namely the Governor General of Canada, acting on advice of the Prime Minister and the Cabinet, formally representing the authority of the Crown.

Says this section of the Bank of Canada Act (with italics added):

“Consultations

14 (1) The Minister [of Finance] and the Governor [of the Bank of Canada] shall consult regularly on monetary policy and on its relation to general economic policy.

Minister’s Directive

(2) If, notwithstanding the consultations provided for in subsection (1), there should emerge a difference of opinion between the Minister and the Bank concerning the monetary policy to be followed, the Minister may, after consultation with the Governor and with the approval of the Governor [General] in Council, give to the Governor [of the Bank] a written directive concerning monetary policy, in specific terms and applicable for a specified period, and the Bank shall comply with that directive.”

That’s pretty clear.  Although such a directive to the central bank has never been issued, every Governor of the Bank has the strongest incentives never to have one issued.  The possibility is there, in the framework for the required consultations.

Other democracies with statutory provisions for the government to issue directions to the central bank include Australia, England, India and New Zealand (all, like Canada and the U.S., formerly parts of the British Empire).  Thus:

The Australian Reserve Bank Act: “The Treasurer may then submit a recommendation to the Governor-General, and the Governor-General, acting with the advice of the Federal Executive Council, may, by order, determine the policy to be adopted by the Bank.”

Bank of England Act: “The Treasury, after consultation with the Governor of the Bank, may by order give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances.”

The Reserve Bank of India Act: “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.”

Reserve Bank of New Zealand Act: “The Governor-General may, by Order in Council, on the advice of the Minister, direct the MPC [Monetary Policy Committee] to formulate, and the Bank to implement, monetary policy [objectives] specified in the order.”

Do these Canadian and other countries’ related provisions give too much power to the politicians?  Does the U.S. structure give too much power to the unelected managers of the central bank?  Where is the right balance?  Here we find ourselves in the domain of political philosophy, so the debates will surely continue.  These debates will benefit if better informed of the ideas of other important democracies.