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Monetary Policy, Accountability and Legitimacy: A Review of the Issues in Canada*

Published online by Cambridge University Press:  10 November 2009

William D. Coleman
William D. Coleman
Affiliation:
McMaster University
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Abstract

Monetary policy in Canada is formulated and implemented in a state-directed policy network dominated by the Bank of Canada. State-directed networks embody a tension between democratic accountability and legitimacy on the one side and maintaining support from the business community on the other. This article assesses this tension in Canadian monetary policy, focussing on the relationships between the Bank of Canada and other actors. As a central bank, the Bank of Canada possesses a unique constitutional status, being tied to the government through a directive power of the minister of finance. The Bank has also developed close working relationships with financial institutions for the implementation of monetary policy. In reviewing these relationships, the article identifies problems related to the Bank's political accountability and its ability to maintain legitimacy. The article then reviews some reforms that might address these problems: making the Bank more independent, subjecting it to closer control by the minister of finance and endowing it with a council-based internal governing system.

Résumé

La formulation et la mise en oeuvre de la politique monétaire au Canada se produisent au sein d'un réseau politique dirigiste dominé par la Banque du Canada. Les réseaux politiques, où l'État joue un rôle dirigiste, incorporent une tension entre la responsabilité démocratique et la légitimité d'une part et le maintien de l'appui du monde des affaires de l'autre. Cet article analyse cette tension dans la politique monétaire canadienne, en soulignant les rapports entre la Banque du Canada et divers autres acteurs. Comme banque centrale, la Banque du Canada possède un statut constitutionnel particulier; elle est autonome mais le ministre des Finances peut donner des instructions à suivre s'il y a des différences insurmontables entre le gouvernement et la Banque. La Banque cultive des rapports étroits avec les sociétés financières afin de mettre en oeuvre la politique monétaire. En analysant ces rapports, cet article décrit des problèmes qui relèvent de la responsabilité politique de la Banque et de sa légitimité. Enfin, l'article présente des réformes qui peuvent résoudre ces problèmes: rendre la Banque plus indépendante; la soumettre au contrôle plus serré du ministre des Finances; la doter d'un conseil représentatif comme autorité interne au lieu d'un gouverneur.

Type
Research Article
Information
Canadian Journal of Political Science/Revue canadienne de science politique , Volume 24 , Issue 4 , December 1991 , pp. 711 - 734
Copyright
Copyright © Canadian Political Science Association (l'Association canadienne de science politique) and/et la Société québécoise de science politique 1991

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References

1 This set of categories for the study of state-civil society relations is developed more extensively in Atkinson, M. M. and Coleman, W. D., “Strong States and Weak States: Sectoral Policy Networks in Advanced Capitalist Economies,” British Journal of Political Science 19 (1989), 47–67.CrossRefGoogle Scholar

2 Perhaps the most recent and most comprehensive examination of this kind is found in the set of studies edited by Toniolo, Gianini, Central Banks' Independence in Historical Perspective (New York: Walter de Gruyter, 1988Google Scholar). A widely cited quantitative study of independence is that by Banaian, K., Laney, O. and Willet, T., “Central Bank Independence: An International Comparison,” Federal Reserve Bank of Dallas Economic Review (1983), 1–13Google Scholar. This approach is criticized for abstracting central banks from their institutional context in Giangiacomo Nardozzi, “A Central Bank Between the Government and the Credit System: The Bank of Italy after World War II,” in Toniolo, ed., Central Banks' Independence, 161–96.

3 With the partial exception of Richard Phidd and G. Bruce Doern, Canadian political scientists have not reflected on the peculiarities of the institutional arrangements for monetary policy in Canada. Phidd and Doern discuss the Bank of Canada in their study of Canadian economic policy. See Phidd, Richard W. and Doern, G. Bruce, The Politics and Management of Canadian Economic Policy (Toronto: Macmillan Canada, 1978Google Scholar), esp. 245ff. By contrast, political scientists in the United States have examined many aspects of the Federal Reserve System. See in particular the excellent studies by Woolley, John, Monetary Politics: The Federal Reserve and the Politics of Monetary Policy (Cambridge: Cambridge University Press, 1984CrossRefGoogle Scholar), and “Central Banks and Inflation,” in Lindberg, Leon N. and Maier, C. S., eds., The Politics of Inflation and Economic Stagnation (Washington: Brookings, 1985), 318–348Google Scholar. A more recent work on international monetary politics by political scientists is Destler, I. M. and Henning, C. Randall, Dollar Politics: Exchange Rate Policymaking in the United States (Washington: Institute for International Economics, 1989Google Scholar).

4 Dyson describes such state action as a last resort. See Dyson, Kenneth, “West Germany: The Search for a Rationalist Consensus,” in Richardson, Jeremy, ed., Policy Styles in Western Europe (London: George Allen and Unwin, 1982Google Scholar).

5 Particularly revealing here have been several studies of France and Japan. See Hall, Peter A., Governing the Economy: The Politics of State Intervention in Britain and France (Oxford: Oxford University Press, 1986Google Scholar); Green, Diane, “Strategic Management and the State: France,” in Dyson, Kenneth and Wilks, Stephen, eds., Industrial Crisis: A Comparative Study of State and Industry (Oxford: Basil Blackwell, 1983), 161–192Google Scholar; Samuels, Richard J., The Business of the Japanese State: Energy Markets in Comparative and Historical Perspective (Ithaca: Cornell University Press, 1987Google Scholar); and Boyd, Richard, “Government-Industry Relations in Japan: Access, Communication, and Competitive Collaboration,” in Wilks, Stephen and Wright, Maurice, eds., Comparative Government-Industry Relations (Oxford: Clarendon Press, 1987), 61–90.Google Scholar

6 Direct clearers are those financial institutions that belong to the Canadian Payments Association, participate directly in the national payments and settlement system and maintain a settlement account with a line of credit feature at the Bank of Canada. In contrast, indirect clearers must arrange their clearing and settlement through one of the direct clearers.

7 An extensive textbook discussion of monetary policy implementation is available in Boreham, Gordon, Money, Banking and Finance: The Canadian Context (Toronto: Holt, Rinehart and Winston, 1988Google Scholar).

8 Moral suasion refers to attempts by the Bank to influence the availability of credit through informal advice to, and special arrangements with, chartered banks and, occasionally, other lenders. The last recorded use of moral suasion occurred in July 1981 when both the minister of finance and the Governor asked the major chartered banks to limit their financing of takeovers by Canadians of businesses in Canada owned by non-residents. (See Boreham, Money, 250–51.) The use of moral suasion spurred some analysis of the Bank of Canada from a public choice perspective in the early 1970s. (See Chant, John F. and Acheson, Keith, “Mythology and Central Banking,“ Kyklos 26, 2 [1973], 362–379CrossRefGoogle Scholar; “The Choice of Monetary Instruments and the Theory of Bureaucracy,” Public Choice 12 [1972], 13–33CrossRefGoogle Scholar; and “Bureaucracy and the Choice of Central Bank Goals,” Journal of Money, Credit and Banking 5 [1973], 637–755CrossRefGoogle Scholar.)

9 Confidential interview, April 26, 1989.

10 Interviews were conducted with the six largest domestic chartered banks, the Laurentian Bank of Canada, two Schedule II foreign controlled banks, three large trust companies, the Conféderation des Caisses Populaires Desjardins and nine interest associations representing financial sector firms.

11 The debate is reviewed and an extensive bibliography is provided in Dufour, Jean Marie and Racette, Daniel, “Monetary Control in Canada,” in Sargent, John, ed., Fiscal and Monetary Policy, Studies of the Royal Commission on the Economic Union and Development Prospects for Canada, Vol. 21 (Toronto: University of Toronto Press for Supply and Services Canada, 1986Google Scholar).

12 Ml refers essentially to the amount of currency in circulation plus demand deposits.

13 For the perspective of two senior Bank officials, see Thiessen, Gordon G., “The Canadian Experience with Monetary Targeting,” in Meek, Paul, ed., Central Bank Views on Monetary Targeting (New York: Federal Reserve Bank of New York, 1983Google Scholar); Freedman, Charles, “Changes in the Canadian Financial Structure Over the Last Decade.” in Bank for International Settlements, Financial Innovation and Monetary Policy (Basel: BIS, 1986), 42–53Google Scholar. Courchene, T. J. provides a different kind of assessment in No Place to Stand? Abandoning Monetary Targets: An Evaluation (Montreal: C. D. Howe Institute, 1983Google Scholar).

14 Kane, Edward J., “External Pressures and the Operations of the Fed,” in Lombra, Raymond E. and Witte, Willard E., eds., Political Economy of International and Domestic Monetary Operations (Ames, Iowa: Iowa State University Press, 1982), 223.Google Scholar

15 See Chant and Acheson, “Mythology and Central Banking,” and Goodfriend, Marvin, “Monetary Mystique: Secrecy and Central Banking,” Journal of Monetary Economics 17 (1986), 63–92.CrossRefGoogle Scholar

16 Woolley, “Central Banks and Inflation,” 338–39.

17 Crow, John W., “The Bank of Canada and Its Objectives,” Bank of Canada Review (BCR), April 1987, 21–22.Google Scholar

18 See his speech, “Grundzüge einer europäischen Geldordnung,” given in Paris on January 16. 1990, and reprinted in Deutsche Bundesbank, Auszüge aits Presseartikeln, Frankfurt, January 16, 1990. The preliminary statutes for a new European central bank presented in Rome in December 1990 define price stability as the central and sole objective of the new bank.

19 Alan Greenspan, Statement before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, October 25, 1989, reprinted in Federal Reserve Bulletin 75 (1989), 795–803. Needless to say, adoption of zero inflation as a primary objective has not been universally welcomed. For a Canadian critique, see Lucas, R. F., “The Bank of Canada and Zero Inflation: A New Cross of Gold?” Canadian Public Policy 15 (1989), 84–93CrossRefGoogle Scholar. For an endorsement of the Bank's position, see the essays in Lipsey, Richard G., eds., Zero Inflation: The Goal of Price Stability (Toronto: C. D. Howe Institute, 1990Google Scholar).

20 “The Bank of Canada and the Money Market,” BCR, May 1989, 21.

21 For a comprehensive review of this literature, see Blackburn, Keith and Christensen, Michael, “Monetary Policy and Policy Credibility: Theories and Evidence,” Journal of Economic Literature 27 (1989), 1–45Google Scholar. Also see Freedman, Charles, “Monetary Policy in the 1990s: Lessons and Challenges,”paper prepared for the Economic Policy Symposium,Federal Reserve Bank of Kansas City, 1989, 6–8Google Scholar

22 George S. Watts, “The Origins and Background of Central Banking in Canada,” BCR, May 1972, 22. In addition to Macmillan, the Commission included Sir Charles S. Addis (also British and a former director of the Bank of England), Sir W. Thomas White (a banker and former finance minister), John Brownlee (Alberta premier) and Beaudry Leman (a banker).

23 Royal Commission on Banking and Currency in Canada, Report (Ottawa: King's Printer. 1933). 65.Google Scholar

24 For a detailed discussion of the early years of the Bank, see Watts, George S., “The Legislative Birth of the Bank of Canada,” BCR, August 1972, 13–26Google Scholar, “The First Phase of the Bank of Canada's Operations, 1935–39,” BCR, November 1972, 7–21, and Stokes, Milton L., The Bank of Canada: The Development and Present Position of Central Banking in Canada (Toronto: Macmillan, 1939)Google Scholar.

25 The concept of a subgovernment is borrowed from Pross, A. Paul, Group Politics and Public Policy (Toronto: Oxford University Press, 1986Google Scholar). For its linkage to the concept of policy network, see Coleman, W. D. and Skogstad, Grace, “Policy Communities and Policy Networks: A Structural Approach,” in Coleman, and Skogstad, , eds., Policy Communities and Policy-Making in Canada: A Structural Approach (Toronto: Copp Clark Pitman, 1990), 25–29.Google Scholar

26 Cited in Neufeld, E. P., Bank of Canada Operations and Policy (Toronto: University of Toronto Press, 1958), 13Google Scholar. All evidence suggests that Towers, the first Governor, shared this view. See the report on his testimony before the House of Commons Committee on Banking and Commerce, March 18, 1954, in Fullerton, Douglas H., Graham Towers and His Times (Toronto: McClelland and Stewart, 1986), 51.Google Scholar

27 Professional economists played an important role in this attack and perhaps the most useful account of the issues in the debate comes from one of these protagonists. (See Gordon, H. Scott, The Economists versus the Bank of Canada [Toronto: Ryerson Press, 1961].Google Scholar)

28 Bank of Canada, “Submissions to the Royal Commission on Banking and Finance,” Ottawa, May 31, 1962.

29 Confidential interview, April 1989.

30 Members of the Board cannot be a director, officer or shareholder of a chartered bank or any other member of the Canadian Payments Association that maintains a deposit with the Bank, or an investment dealer that acts as a primary distributor for new Government of Canada securities (Bank of Canada, Bank of Canada: Management anil Accountability [Ottawa: Bank of Canada, 1987], 9Google Scholar). Generally, they are lay persons in the sense that they are normally neither economists nor persons with any specific expertise in monetary policy.

31 Their choice is then approved by Governor-in-Council, that is, by the cabinet.

32 BOC, Management, 6.

33 Pross, Group Politics, chap. 5.

34 This policy is set out in Canada, Department of Finance, “Foreign Exchange Market Intervention in Canada,” a report submitted to the Working Group on Exchange Market Intervention of the Economic Summit, September 1982.

35 Longworth, David and Murray, John, “Canadian Exchange Market Management and Monetary Policy,” in BIS, Exchange Market Intervention and Monetary Policyc (Basel: BIS, 1988), 32.Google Scholar

36 This point is made by Freedman, “Monetary Policy in the 1990s,” 21ff.

37 This example is discussed in Freedman, C. and Dingle, J. F., “Monetary Policy Implementation in Canada: Traditional Structure and Recent Developments,” in Bank for International Settlements (BIS), Changes in Money-Market Instruments and Procedures: Objectives and Implications (Basel: BIS, 1986), 36–37.Google Scholar

38 Louis Rasminsky, “The Role of the Central Banker Today,” 1966 Per Jacobsson Lecture reprinted in Cairns, James P., Binhammer, H. H. and Boadway, Robin W., Canadian Banking and Monetary Policy (2nd ed.; Toronto: McGraw-Hill Ryerson, 1972), 184Google Scholar. The recognition of the importance of co-ordination also had a central place in the report of the Porter Commission, which had a major effect on banking and monetary policy in the 1960s. (See Canada, Royal Commission on Banking and Finance, Report [Ottawa: Queen's Printer, 1964], esp. chap. 25.Google Scholar)

39 For some elaboration of this point, see Thomas J. Courchene, “Rethinking the Macro Mix: The Case for Provincial Stabilization Policy,” School of Policy Studies Working Paper No. 90–01, Queen's University, 1990.

40 See Freedman, “Monetary Policy in the 1990s,” 10–11, and Blackburn and Christensen, “Policy Credibility,” 27–29. For perhaps an overstated attack on the US policy, see Destler and Henning, Dollar Politics.

41 See Funabashi, Yoichi, Managing the Dollar: From the Plaza to the Louvre (Washington: Institute for International Economics, 1988Google Scholar).

42 See Courchene, “Rethinking the Macro Mix,” 31–37.

43 Sparks, Gordon R., “The Theory and Practice of Monetary Policy in Canada: 1945–83,” in Sargent, , ed., Fiscal and Monetary Policy, 125Google Scholar, and Courchene. “Rethinking the Macro Mix,” 33–37.

44 An important step was the introduction of the Bank of Canada Review in 1971. More recently, the BCR has begun to publish the Governor's comments to the Board of Directors, given at each of the Board's eight meetings per year.

45 For example, of the 59 speeches or statements of Gerald Bouey, the preceding Governor of the Bank, that were published in the BCR, 14 were delivered6 to financial sector audiences, 24 to more general groups of business persons, 14 to parliamentary committees, only 7 to non-business audiences.

46 “Editorial: Pöhl Throws a Gauntlet,” Financial Times, January 23, 1990.

47 Both the French and the British central banks are extensively involved in the supervision of financial institutions. The Bank of Canada is involved only at the margins, a level of activity perhaps inconsistent with its role as lender of last resort in the financial system. The subject of central banks and financial system regulation is a complex one which cannot be addressed adequately here.

48 For a useful and not at all dated review of the arguments for this position, see Harry G. Johnson, “Should There Be an Independent Monetary Authority?” testimony before the US Congress in 1964 and reprinted in J. P. Cairns, etal., Canadian Banking, 173–76.

49 Watt, “The Origins,” 22. In this respect, the formation of the Canadian central bank was consistent with a broader plan developed by Montagu Norman, the long-standing Bank of England Governor. The Adviser was Norman's special emissary as the Governor sought to strengthen the emergent Commonwealth with “the necessary local machinery which would protect and strengthen sterling, still the chief trading currency of a world in depression.” (See Boyle, Andrew, Montagu Norman: A Biography [London: Cassell, 1967], 284.Google Scholar)

50 Leman, who was president and managing director of the Banque canadienne nationale, filed a memorandum of dissent to the report of the Commission. Leman wrote, “Regardless of the constitutional aspects of the question, if a central bank is to be a co-ordinating agency in this country it would seem indispensable to ascertain beforehand that such an institution would be assured of the goodwill and co-operation of each and every one of the Provinces of Canada. Before a central bank can hope to speak with one voice on behalf of Canada, it would seem desirable that it should have authority to express the views not only of the Dominion Government but also those of all the Provinces” (Royal Commission on Banking and Currency in Canada, Report, 95–96).

51 For the structure of the Federal Open Market Committee of the US, see Woolley, Monetary Politics. The structure and operations of the Deutsche Bundesbank are reviewed in Sturm, Roland, “Die Politik der Deutschen Bundesbank,” in von Beyme, Klaus and Schmidt, Manfred, eds., Politik in der Bundesrepublik Deutschland (Opladen: Westdeutschen Verlag, 1990), 255–282CrossRefGoogle Scholar. The Swiss National Bank is run by a Bank Council, a Bank Committee, and a Directorate with the latter having the most immediate responsibility for monetary policy. The Council and the Committee have explicit requirements for regional representation; the three-person Directorate is appointed by the Federal Council on the recommendation of the Bank Council. (See BIS, Eight European Central Banks [London: Allen and Unwin, 1963], 268–277Google Scholar, and Aufricht, Hans, Central Banking Legislation: A Collection of Central Bank, Monetary, and Banking Laws, Vol. 2 [Washington: International Monetary Fund, 1967], 705–723.Google Scholar)

52 It proposed five: Atlantic, Quebec, Ontario, Prairies and British Columbia. “Such committees might help to increase the Bank's knowledge of general developments and public reactions in different parts of the economy, would encourage senior officers of the Bank to travel outside Ottawa more frequently, and could assist in the creation of an informed public opinion on monetary matters” (Royal Commission on Banking and Finance, Report, 549).

53 For a more detailed comparison of the US and Canadian arrangements, see Coleman, W. D., “Fencing Off: Central Banks and Networks in Canada and the United States,” in Marin, Bernd and Mayntz, Renate, eds., Policy Networks: Empirical Evidence and Theoretical Considerations (Frankfurt: Campus Verlag; Boulder, Col.: Westview, 1991Google Scholar).

54 For example, the Chambre de Commerce of Quebec in its brief to the Bélanger-Campeau Commission called for significant changes in the structure of the Bank of Canada. (See Le Devoir, November 8, 1990.)