Yahoo Finance Bank of Canada: Why consumers need to care about it
Canadian consumer pop quiz for a Friday: Who is Mark Carney? And what is the Bank of Canada (BoC) responsible for?
Though Carney has been a prominent fixture in global headlines since the 2008 financial crisis hit, the BoC governor may not be as well known with many consumers here at home.
In a nutshell, Carney was appointed governor of the BoC on Feb. 1st, 2008 for a seven-year term. He is also chairman of the BoC's board of directors and he serves as chairman of the Swiss-based Financial Stability Board.
So widely respected is he for having successfully navigated Canada through the choppy global recession waters, the former Goldman Sachs investment banker is considered to be a leading figure in the struggle to shore up the fragile world economy.
"The governor is the head of the Bank of Canada and his role is to make sure it fulfills its mandate," explains BoC spokesperson Alexandre Deslongchamps. "Under the Bank of Canada Act, the governor is responsible for monetary policy. In practice, the governor shares that responsibility with fellow members of the Governing Council." The Governing Council is the policy-making body of the BoC and it is responsible for monetary policy, decisions aimed at promoting a sound and stable financial system, and setting the strategic direction of the BoC.
Monetary policy is a tool administered by the BoC to influence the economy. It controls the supply and availability of money. It differs from fiscal policy, which a government uses to adjust its levels of spending and taxation in order to monitor and influence a nation's economy.
Canada's central bank, based in Ottawa, is not a commercial bank that offers services to the general public. It is Canada's "lender of last resort" and its role includes promoting the economic and financial health of this nation.
Inflation, inflation, inflation
Citing a statement made by former senior deputy governor Paul Jenkins on why it's important for consumers to understand the role of the BoC and its governor, Deslongchamps says the BoC, through a clear explanation of why its policy objectives and actions are the right ones, aims to gain public support for what it does. Central to that effort is clarity of purpose.
"The Bank of Canada has found that a clear statement of our objective, an explicit inflation target, is crucial," he says. "With the clear recognition and appreciation of this objective, consumers, investors, businesses, financial market participants, begin to adjust their behaviour in ways consistent with an expectation that future inflation will be firmly in line with the inflation target."
The net effect is a more stable macroeconomic environment and greater success in keeping inflation low and stable. The public can measure the BoC's performance by how successful it is in achieving the 2 per cent inflation target. Meaning, the Bank is charged with keeping the cost of every-day goods from skyrocketing and seriously denting the wallet of the average consumer.
"The fact that we have had a pretty good record in this regard has reinforced our credibility and the public's confidence that we will keep inflation at, or near, the target."
Interest rates, bonds and your mortgage
As the central bank sets the overnight lending rate for banks, it affects the yield on bonds. That's important for Canuck homeowners and homebuyers to understand because when the BoC changes its target for the overnight rate, it sets in motion a complex chain of consequences that first influences prices in financial markets, and then affects spending, production, employment and, ultimately, inflation. Economists call this chain of developments the transmission mechanism.
If the overnight lending rate drops, it becomes cheaper for banks to borrow money from each other. In theory, the savings should trickle down to consumers in the form of lower interest rates for consumer products like mortgages. Fixed-interest rate mortgages are closely tied to yields in the bond market, where as variable-rate mortgages are closely tied to the Bank of Canada's rate and the prime rate dictated by your lender.
"With a change in the overnight rate, other interest rates along the maturity spectrum tend to change," Deslongchamps explains. "If the cost to borrow money for a one-day period becomes cheaper or more expensive, and this change is expected to persist, the cost to borrow money for a 30-day period, a 90-day period, a one-year period, should also change."
In addition, administered interest rates such as the prime lending rate, and the prices of many other financial assets, including the value of the Canadian dollar and equity prices, are affected.
"Thus, all else being equal, a change in the overnight rate of interest which is expected to persist will influence the overall level of short- to longer-term interest rates, and the prices of many other financial assets. But typically, all else is not equal," Deslongchamps says, quoting Carney. "Interest rates on various financial obligations include a risk premium that reflects the creditworthiness of borrowers and the degree of liquidity of the financial instrument. Meaning? Your credit history also plays a role in how your mortgage rate is set, allowing consumers with great credit to negotiate a lower rate.
For a complete list of FAQs about the Bank and other information, surf to the BoC website.
