In matters of finance, power is everything. For this reason, news this month of a new Bank of Canada governor is a big deal; a much bigger deal than the U.S. Federal Reserve Board acquiring a new chairman.
At the Bank of Canada, the governor holds all the decision-making power. Fed policy, in contrast, is ruled by a committee. This distinction between the Bank and the Fed is often lost on Canadian and international investors. As such, the ideology of the new Bank governor may have a much greater impact on the future direction of Canada's monetary policy than investors appreciate.
The confusion as to where the power lies at the Bank stems from the fact that the BoC Governing Council has come to be viewed by investors as the same as the Fed Open Market Committee (FOMC); a committee with power to conduct monetary policy.
This is not the case. By law, the Federal Reserve Act to be precise, the FOMC has well-defined powers to conduct monetary policy to ensure maximum employment, stable prices and moderate long-term interest rates. In contrast, the Bank of Canada Act makes no mention of the Governing Council. In essence, the Governing Council is a phantom and does not exist under current Canadian law. The BoC governor is solely responsible for monetary policy, and the only person with power to change interest rates to ensure inflation hits the 2 per cent target in a timely manner.
The structure of the Bank’s governance is a reflection of the Canadian political system, which constitutionally consolidates much more power within the federal government. As such, the Bank is a single public entity, with the federal government the sole shareholder. And according to the Bank of Canada Act, “the Governor of the Bank … has the direction and control of the business of the Bank …” Nowhere is “Governing Council” ever mentioned.
In contrast, the U.S. historically gives more power to the states than the federal government, via the 10th Amendment to the Constitution. Reflecting this desire to diffuse power, the U.S. central bank system was formed by the Federal Reserve Act of 1913, during the administration of President Woodrow Wilson, as an elaborate system consisting of a Board of Governors, based in Washington D.C., and 12 regional banks set up like private corporations, each with its own president and board of directors. In the 1930s, the Fed Act was specifically amended to create the FOMC, consisting of the Fed chairman, the six other governors of the Washington-based board, and five of the 12 regional Fed bank presidents who serve one-year terms on a rotating basis (except for the New York Fed president, who is also the vice chairman of the Board). The Fed chairman is but one vote on the 12-member FOMC.
This power disadvantage means that the Fed chairman cannot simply dictate the direction of the committee as he or she sees fit, but rather must influence the vote. The most recent two Fed chairmen displayed distinct different styles of persuasion to influence the voting on the FOMC. Current Chairman Ben Bernanke uses his power of persuasion by public discussion of policy in speeches and interviews with the media, and by internal conversations with committee members. Former Governor Alan Greenspan adopted a more Machiavellian approach to influencing the vote – for example, by establishing a procedure of first giving his policy views at the FOMC table, which made it awkward for other committee members to disagree. One thing the two methods had in common, however, is that once the committee convened, there was no absolute guarantee the vote would go the way the chairman wished.
The Fed chairman does exert more influence on the six governors within the committee, and therefore a block of votes exists. However, the consistent loyalty of the governors to the chairman is not assured, and dissenting votes from the ranks of governors have occurred. Moreover, the Fed Board frequently finds itself without a full complement of governors, since appointments must be approved by the difficult-to-please U.S. Senate. Up until last year there were only three governors at the Board, with nominations of other candidates stalled for years in the Senate.
For this reason, Fed policy does not always move in the direction the chairman wishes; hence, Fed policy watchers have developed an elaborate tradition of analyzing speeches and press quotes all FOMC voting members to gauge how the committee will shift policy.
Bank of Canada watchers do not have this depth of anecdotal information to comb through. Governing Council speeches are boiler-plate messages derived from official communiques, dictated and approved by the governor, such as the policy statement and quarterly Monetary Policy Report. It is also the reason why the Governing Council reaches a consensus decision rather than a vote. At the Bank, the only vote that counts is the governor’s.
Sheryl King is an independent macroeconomic strategist with more than 20 years experience in the international financial industry and central banking.