The Bank of Canada: Not Your Average Bank, Essay Example

The concept of a central bank is a relatively recent innovation, and goes hand in hand with the development of the system of nation states from 1848, which still characterizes the contemporary modern world. The key function of a central bank is carrying out a country’s monetary policy. This involves controlling the rate of interest and the amount of money circulating in the economy. In addition to this and its other core function of printing and issuing bank notes, a central bank also acts as the banker for both the government and the other banks.[1] It is in this respect that the Canadian central bank acts as the banker’s bank. It is essentially a lender of last resort, which provides funding to banks that are experiencing a short term liquidity problem, and are unable to meet the cash withdrawal demands of their customers.

The Canadian central bank plays a key role in monetary policy, regulation of the financial institutions, and other processes that are important for the Canadian economy. The Canadian central bank is not a commercial bank and does not offer banking services to the public. Their job is to “promote the financial welfare of Canada.” [2]

The control of the money supply in the economy is of importance as too much money circulating in the economy can lead to inflation. With inflation comes a reduction in the value of and purchasing power of money. The Canadian central bank, in keeping with its core function of controlling the country’s monetary policy, will also be actively involved in controlling inflation. It will attempt to accomplish this by, controlling the interest rates charged by commercial banks, involving itself in open market operations such as the purchase and sale of government securities, and regulating banking reserve requirements.

According to the Bank of Canada, one of its main aims is to “keep inflation near two percent which is the midpoint of a 1 to 3 percent target range.”[3] According to the Bank, it carries out monetary policy by influencing short-term interest rates. It does this by raising and lowering the target for the overnight rate. (The “overnight rate” is the interest rate at which major financial institution, banks, credit unions and similar credit-granting organisations borrow and lend one-day (or overnight) funds among themselves.)[4]

Demand in the right quantities can be a prime motivator for economic growth and the control of unemployment. The great 20^th century economist John Maynard Keynes made the control of demand the core of his theory for dealing with the devastation of the Great Depression of the 1930s. His theory of demand management was largely responsible for the era of economic growth and near full employment in the post World War II years known as the long boom. However an excess as well as an insufficient amount of demand in the economy can both cause economic problems.

An increase in demand can be triggered by certain factors such as a rise in consumer incomes. The extra disposable income, all other things being equal, will trigger an increase in demand for goods. A simple demand/supply graph would show that this increase in demand would lead to a rise in prices. This is due to too many buyers chasing too few goods. If left unchecked this could lead to what is termed ‘demand pull inflation. A reduction in demand on the other hand would lead to a contraction of supply that could ultimately lead to higher levels of unemployment.

Factors causing a reduction in demand could include a reduction in incomes which adversely affects consumption. This will inevitably lead to a fall in demand, which will lead to producers lowering prices and reducing their supply of goods. Another potential cause could be an increase in taxation which causes a reduction of disposable income.[5]

In the case of excess demand leading to inflation, the Canadian central bank could limit demand by increasing taxation. Less disposable income would reduce consumption rates and therefore demand. A consistent monetary policy approach would also include measures to strengthen the currency while lowering interest rates.

Dealing with the reverse of too little demand would require the bank to take active measures to stimulate demand. This could include drastic action such as the government becoming an employer of last resort through the nationalization of key industries. A Keynesian approach would also involve the government running a budget deficit by increasing government expenditures in excess of current tax receipts. The increase in government expenditures should be sufficient to cause the aggregate demand curve to shift to the right restoring the economy to the natural level of GDP.[6]

Movements in a country’s exchange rates are generally caused by a combination of factors. Anderton outlines the factors which cause fluctuations in exchange rates. “Currencies find their own levels through the forces of supply and demand…an increase in the value of UK exports will increase the demand for pounds, causing the exchange rate to rise…an decrease in the value of UK imports will decrease the supply of pounds, causing the value of the pound to fall.”[7]

The Canadian central bank could affect exchange rates in a number of ways. As higher interest rates tend to attract capital from abroad, which in turn causes the currency to appreciate, the bank could opt to raise interest rates. The rate of inflation is often considered a determinant of the exchange rate as well. High inflation is likely to be accompanied by depreciation in exchange rates; therefore curbing inflation could be another tool in maintaining stable exchange rates. Once again monetary policy through the manipulation of interest rates would be a key tool for use by the Canadian central bank.

In addition to ensuring a relatively sound economy, the central bank helps to combat counterfeiting. Their website has an FAQ section dedicated to informing the public about ways to protect themselves from counterfeiting. Citizens can protect themselves from counterfeiting by using the TiLL method for verifying the security strip on all five denominations of newer bills. Older bills do not have the metallic strip. Bank notes are printed on 100 percent cotton paper and typically last up to nine years, although some bills can and do remain in circulation longer.

Although the Bank of Canada does not offer commercial banking services or accounts to the public, they do offer public services that can easily be accessed through their website. Anyone with inquiries regarding the Bank of Canada can contact the bank through the Public Information service. Citizens can also opt to receive email alerts. The central bank accepts media enquiries from journalists and offers a variety of free educational materials. They accept damaged and mutilated bank notes and offer help for those with unclaimed balances. Finally, they offer Canadian savings bonds and access to information and privacy. The Bank of Canada runs a currency museum that is open for the public.

The Bank of Canada also has information about government securities auctions. Their information about the status of financial markets can help investors make informed decisions about their investments. They offer free publications and research to anyone who wishes to view them.

In conclusion, the Canadian central bank is an integral part of the Canadian monetary system. It helps guard against recessions and depressions, aims to keep the market as stable as possible, and aids in corporate administration. The Canadian central bank also helps to guard against counterfeiting. Citizens can help make their communities safer and economically efficient by reporting suspected counterfeit bills to law enforcement or the bank of Canada. The Bank of Canada also has information about financial markets and free resources for investors.

Bibliography

Anderton, A. (2000) Economics, Lancs, Causeway Press Limited, Bank of Canada 2010 [online] available at http://www.bankofcanada.ca/en/inflation/index.html, Accessed on 25 September 2010

Hanson, J.L. (1976) A Textbook of Economics, London, Macdonald and Evans Limited

Krugman, P. R and Wells, R (2009) Macroeconomics, London, Palgrave Macmillan

Staley, C.E. (1991) A History of Economic Thought, Cambridge, Blackwell, p.228

“About the Bank.” Bank of Canada. http://www.bankofcanada.ca/en/about/are.html (accessed September 27, 2010).

[1] Hanson, J.L. (1976) A Textbook of Economics, London, Macdonald and Evans Limited, pp. 424-425

[2] Bank of Canada http://www.bankofcanada.ca/en/about/are.html

[3] Bank of Canada 2010 [online] available at http://www.bankofcanada.ca/en/inflation/index.html, Accessed on 25 September 2010

[4] Ibid

[5] Staley, C.E. (1991) A History of Economic Thought, Cambridge, Blackwell, p.228

[6] Krugman, P. R and Wells, R (2009) Macroeconomics, London, Palgrave Macmillan, p. 132

[7] Anderton, A. (2000) Economics, Lancs, Causeway Press Limited, p.258