The Bank of Canada Act is set to be amended to ensure the central bank's independence as part of the government's five-year review of the institution, according to a report released by the Bank of Canada.
on Tuesday.
Every five years
and the federal government will begin a review of central bank policy, with the next review scheduled for 2026.
The Bank of Canada has so far said its upcoming review will focus on finding better ways to measure core inflation and put more emphasis on the impact of monetary policy.
. Bank of Canada Governor Tiff Macklem said the two per cent inflation target will not be changed.
Last month, Bank of Canada deputy governor Rhys Mendes also said the central bank was considering whether to stop calling core inflation its “preferred” way of tracking price changes.
CD Howe's report, entitled Don't Take It for Granted: Strengthening the Independence of the Bank of Canada, points to the need to ensure the independence of the Bank of Canada at a time when the autonomy of central banks is being questioned, particularly in the United States.
“Storm clouds are on the horizon, especially given the political pressures on the Fed south of the border,” said co-author Steve Ambler, an economics professor at the University of Quebec at Montreal and the CD Howe Institute.
Chairman of Monetary Policy, in a statement.
“Action needs to be taken here in Canada. Targeted amendments to the Bank of Canada Act are a good start.”
The authors' first recommendation is to revise the provision in the Bank of Canada Act that allows the federal government to issue directives to Canada's central bank.
This change will ensure that directives are only used sparingly and that they will need to be promulgated through Parliament, with the Chancellor of the Exchequer introducing it as a motion in the House of Commons.
“Such an amendment would allow the directive to be debated in the House of Commons and subject to scrutiny by opposition parties,” the report said. “It would also allow markets to react before a directive is issued, allowing markets to, in other words, discipline the government, thereby raising the bar for issuing a directive in the first place.”
The second recommendation relates to the growing risk associated with the Bank of Canada's negative capital position, which the authors noted at the time of writing the report was about $9 billion.
Normally, the bank can finance its operations with the interest it earns on the bonds it holds, but the COVID-19 pandemic has threatened the central bank's finances and the bank has embarked on a quantitative easing (QE) program between 2020 and 2021.
“However, as the bank began to tighten monetary policy in 2022 in response to inflation, interest paid on short-term settlement balances, which had increased significantly as a result of QE, began to rise,” the report said.
“In early 2023, the interest it paid on settlement balances began to exceed the interest it earned on the bonds on its balance sheet, resulting in an operating loss for the bank.”
Although a central bank can operate independently with a negative capital position, if it becomes significant and persistent, it will ultimately impact its ability to finance operations.
“In Canada's case, reliance on direct funding through the federal government could expose the Bank of Canada to political pressure to pursue other goals and call into question its operational independence in achieving price stability,” the report said.
As a temporary measure, the 2023 federal budget added a new section to the Bank of Canada Act allowing surpluses earned by the bank during a fiscal year to be applied to its retained earnings rather than passed on to the government.
The second recommendation is to provide the central bank with a more permanent mechanism to cover its losses, as opposed to the temporary measures introduced two years ago.
“We recommend a specific change to section 27 of the Act to clarify that such withholding is indeed permitted and amounts to 100 percent when a bank is in a negative capital position,” the report said.
The report's authors also highlight the “mission creep” that occurs with the central bank's mandate, in which it is tasked with achieving various policy goals such as the green transition, reducing inequality and achieving maximum employment, which may be better suited to public policy.
“Once the Bank of Canada is more or less formally committed to achieving such goals, political pressure will arise to achieve them,” the report said. “The bank does not have the proper tools to achieve these goals, which puts its credibility at risk.”
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