The objective of monetary policy is to preserve the value of money by keeping inflation low, stable and predictable. This allows Canadians to make spending and investment decisions with more confidence, encourages longer-term investment in Canada's economy, and contributes to sustained job creation and greater productivity. This in turn leads to improvements in our standard of living.
The Inflation-Control Target
At the heart of Canada’s monetary policy framework is the inflation-control target, which is two per cent, the midpoint of a 1 to 3 per cent target range. First introduced in 1991, the target is set jointly by the Bank of Canada and the federal government and reviewed every five years. However, the day-to-day conduct of monetary policy is the responsibility of the Bank’s Governing Council. The inflation-control target guides the Bank’s decisions on the appropriate setting for the policy interest rate, which is aimed at maintaining a stable price environment over the medium term. The Bank announces its policy rate settings on fixed announcement dates eight times a year.
Target for the overnight rate
The target for the overnight rate, also known as the key policy interest rate, is the interest rate that the Bank expects to be used in financial markets for one-day (or "overnight") loans between financial institutions. This key rate serves as the benchmark that banks and other financial institutions use to set interest rates for consumer loans, mortgages and other forms of lending.
Influencing short-term interest rates
To achieve the inflation target, the Bank adjusts (raises or lowers) its key policy rate. If inflation is above target, the Bank may raise the policy rate. Doing so encourages financial institutions to increase interest rates on their loans and mortgages, discouraging borrowing and spending and thereby easing the upward pressure on prices. If inflation is below target, the Bank may lower the policy rate to encourage financial institutions to, in turn, lower interest rates on their loans and mortgages and stimulate economic activity. In other words, the Bank is equally concerned about inflation rising above or falling below the target. Such an approach guards against both high inflation and persistent deflation.
Monetary policy actions take time
Monetary policy actions take time - usually between six and eight quarters - to work their way through the economy and have their full effect on inflation. For this reason, monetary policy is always forward looking and the policy rate setting is based on the Bank’s judgment of where inflation is likely to be in the future, not what it is today.
The inflation-control target has helped to make the Bank's monetary policy actions more readily understandable to financial markets and the public. The target also provides a measure of the effectiveness of monetary policy, since it is evident whether or not inflation is near 2 per cent and the target is being achieved. A clear inflation target helps anchor expectations of future inflation. This allows individuals, businesses and governments to make spending and investment decisions that stimulate non-inflationary growth in the economy.
Canada’s Flexible Exchange Rate
Canada’s flexible exchange rate, or floating dollar, permits us to pursue an independent monetary policy that is best suited to Canada’s economic circumstances and is focused on achieving the inflation target. Movements in the exchange rate also provide a “buffer,” helping our economy to absorb and adjust to external and internal shocks.
A backgrounder explaining the role of the exchange rate in Canada's economy.
Governor Stephen S. Poloz discusses the role of a floating exchange rate in the Canadian economy and in the Bank’s monetary policy framework.
The Canadian economy has undergone a dramatic transformation over the past decade. And it has emerged as a low-inflation economy, with declining levels of public and foreign debt and a private sector that is more cost-conscious, productive, and efficient, thanks to restructuring and investments in new technology.
This paper explores the arguments for and against a common currency for Canada and the United States and attempts to determine whether such an arrangement would offer any significant advantages for Canada compared with the present flexible exchange rate system. The paper first reviews the theoretical arguments advanced in the economics literature in support of fixed and flexible currency arrangements. A discussion of Canada’s past experience with the two exchange rate systems follows, after which there is a survey of the empirical evidence published on Canada’s current and prospective suitability for some form of fixed currency arrangement with the United States. The final section of the paper examines critically a number of concerns raised about the behaviour of the current flexible exchange rate system.
Monetary Policy Backgrounders
28 September 2012 Bank RateExplains what the Bank Rate is and its relationship to the target for the overnight rate.
28 September 2012 Target For The Overnight RateDefines this important policy interest rate and describes the role it plays in influencing various market interest rates.
1 November 2006 Renewal of the Inflation-Control Target - Background InformationCommentary and technical data relating to the 2006 target renewal.
This video describes, in general terms, the “transmission” of monetary policy-i.e., how changes in the Bank’s policy typically affect the economy and inflation over time.