Independence for The Bank of Canada

Milana Mihic

New Economics Columnist

Hey everyone!

I am glad to announce that Mindthis has a new Economics Columnist: Milana Mihic. Her focus will be on explaining the basics of key economic players and theories to create solid grounding in the both the jargon and general significance of economics.  Through a simplistic writing style Milana will ensure that a young professional seeking to expand his/her general knowledge will have a place to find an easy read on hard topics within the realm of economics.  Originally from Bosnia & Herzegovina, Milana and her family moved to Canada to escape the dreadful after-war economy in the Balkans. Inspired by her past and after completing her degree in the sciences, she now passionately studies economics at the University of Ottawa with an intent to further her education with a Masters. Alongside economics she thoroughly enjoys languages as she is fluent in Serbian, French, Spanish and is working on expanding her Russian. Being an avid choreographer of a Serbian dance group and a dedicated volleyball player she is always living life to the fullest with purpose. After visiting the southern and central parts of Europe, she plans on discovering more cultures while working in the field of economics at various transnational corporations around the globe. 

Mind the Gap,


Economics vs. Politics: the independence of the Bank of Canada

We all know how economists speak one language and politicians another. In other words:  there is a gap between the two.  Politicians consider economists as too “mathematical and rational”, not thinking enough about what is fair. Economists have one thing in mind: “optimization of long-term welfare”.

But one thing that should STAY in the hands of the economists is….well the state of the economy rather than the hands of the general public.  People always wonder to what extent is The Bank of Canada independent of political pressure?

Oh, first what is a central bank?

It is essentially to our country what the hypothalamus is to our body: it regulates. For example, when our temperature reaches 37 degrees Celsius, we start sweating and the evaporation will cool off our body. Similarly, the Bank of Canada will raise interest rates to cool off the economy, when the inflation is high (when the output gap is positive). On the contrary, the Bank will lower interest rates if demand is too low and prevent inflation from falling below approximately 2 %. But that’s only one of the important roles the Bank has, perhaps the most important. It also prevents counterfeiting, and promotes a healthy financial system.  Our central Bank is the government’s crown corporation; it acts independently, but still has some rules to follow. Our Country as most is governed by both fiscal and monetary policy, thus half of the game is played by the Central Bank.

Some people argue that it should be more independent.

In fact, there is negative correlation between the lowest inflation rates and the level of independence, but correlation does not mean causality! That is one thing all economists learn in their econometrics class. That there is a link between these two, it is good to know but is it independence that causes a low inflation rate or something else that causes both the inflation and the degree of independence to be respectively lower and higher. I like to use the example that I’ve read in Freakonomics, about winter. Snow and cold weather are positively correlated, but does snow cause cold weather, cold weather cause snow or is it something else, like the position of the Earth for example that causes both of them to happen at the same time? Yet, It is a fact that some-if not most- of the politicians will promote whatever will be in their advantage for election, therefore promoting what the public thinks is best.

With politicians being forced by the general public for “fast and swift action” we see this pressure being placed on the Central Banks. This is wrong.  If we take China as a prime example, much of the recent rise in Chinese inflation is coming from the massive injection liquidity in 2008/9 in an effort to avert a slowdown from the USA. As we know it takes time for monetary policy to take effect. The consequences of the liquidity injection is only now evident. People on the international stage in return criticize China’s lack of monetary skill although in reality it is time that is the key to solid monetary policy.

An independent central bank could pursue what is in the public interest, yet not always being the most popular decision.  The more the Bank is federal dependent, the more it is dangerous! We all know how the government hates to print money to pay off the bills- says Bernanke -and that a debt cannot be paid off by 3 other debts- says Trichet.  Before entering in crisis situations, instead of being one against another, politicians and economists have to align their policies to the maximization of macroeconomic performance.