The Bank of Canada has been criticized in recent months over runaway inflation, most prominently by Conservative Party leadership candidate Pierre Poilievre, who tweeted in April that the institution is financially illiterate. At Wednesday’s Conservative leadership debate, Mr. Poilievre said that, if he forms government, he would remove the Bank of Canada’s Governor, Tiff Macklem.
The following day, Prime Minister Justin Trudeau took Mr. Poilievre to task for jeopardizing the Bank of Canada’s independence, adding that he seems to “either misunderstand that or not care about the facts at all.”
So what does the Bank of Canada do exactly, who runs it and how does that affect average Canadians? Here’s a breakdown.
What is the Bank of Canada and where is it located?
The Bank of Canada is a Crown corporation and financial institution that sits at the heart of the Canadian economy. Located in Ottawa, the central bank is in charge of banknotes – in other words, Canadian cash – and monetary policy: setting interest rates, stabilizing the value of the Canadian dollar, and supporting the economy through downturns. It is also the banker for the government, managing its public debt programs and foreign exchange reserves, and it works with other financial regulators to ensure the banking system is stable.
Why do we need a central bank, anyway?
The Bank of Canada’s main goal is to protect the purchasing power of the Canadian dollar. That means keeping inflation – the speed at which consumer prices rise – low and stable, at around 2 per cent each year.
In the past, the value of money was tied to the amount of gold in bank vaults. Later, the Canadian dollar became fixed to the US dollar, which in turn was pegged to gold. This global currency system collapsed in the 1970s, forcing central banks to come up with other ways of anchoring the value of their money. In the 1990s, the BoC began “inflation targeting” – that is, setting monetary policy with the goal of keeping inflation at around 2 per cent.
The Bank of Canada also acts as a “lender of last resort” to financial institutions in the event of a financial panic or bank run. It can do this because of its unique ability to create money out of thin air. It was acting in this capacity in March 2020, when it pumped billions of dollars of cash into the financial system to prevent Canada’s credit markets from seizing as the economy went into lockdown.
What is happening to inflation?
Over the past year, inflation has run well above the central bank’s target, hitting a three-decade high of 6.7 per cent in March. There’s quite a durable pandemic about the causes of this inflation, but mosts agree that it’s due to a combination of supply-chain blockages caused by COVID-19, a surge in consumer demand for goods instead of services during lockdowns, super low interest rates , and massive government support for businesses and households during the pandemic. More recently, Russia’s invasion of Ukraine has sent commodity prices soaring, squeezing people at the gas pump and grocery store.
How does the bank control inflation?
The Bank of Canada controls inflation by influencing demand in the economy. It can’t do much to bring down global commodity prices or fix supply chain issues, but it can moderate demand for goods, services and housing by adjusting borrowing costs. When the economy is running hot and prices are rising too quickly, the bank raises interest rates to lower demand.
In practice, the central bank changes interest rates primarily by adjusting its policy rate: the short-term interest rate that determines how much commercial banks pay for overnight loans. This short-term rate influences other interest rates in the economy. The bank can also influence rates by communicating with financial markets and buying huge amounts of…