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The Bank of Canada's mandate is to conduct monetary policy in a way that promotes the economic and financial well-being of Canadians. The Bank does this by regulating money and credit in the economy so as to preserve the value (or purchasing power) of the nation's currency.

Monetary policy is focused on keeping inflation low, stable, and predictable

Experience has shown that the best way to foster confidence in the value of money and to contribute to solid economic performance and rising living standards is by keeping inflation low, stable, and predictable over the medium term. In this sense, low inflation is not an end in itself, but rather the means to an end – a stable, well-functioning economy.

Low and stable inflation is important because it creates an environment favourable to steady, healthy growth in output, employment, and incomes over time. It gives Canadians greater confidence about the future, allowing them to make sound economic decisions. Specifically, it helps to encourage long-term investments that contribute to lasting economic growth, job creation, and productivity gains that are critical to improvements in our standard of living. Among other benefits, low inflation preserves the purchasing power of Canadians on fixed incomes, such as pensioners.

How monetary policy works

At the heart of Canada's monetary policy is the inflation-control target, which the Bank and the Government of Canada jointly established in 1991. The current target for inflation is 2 per cent – the midpoint of a control range of 1 to 3 per cent – with inflation measured as the year-over-year increase in the total consumer price index (CPI).

The Bank of Canada carries out monetary policy through changes in its policy interest rate – the Target for the Overnight Rate. The process by which these changes feed through into the economy and into prices is known as the "transmission mechanism of monetary policy." Changes in the policy rate work through several channels to determine the level of total demand and spending in the economy.

To begin with, a change in the policy rate influences the whole range of market interest rates set by financial institutions, and thus borrowing costs for consumers, homebuyers, and businesses, as well as the interest rate earned by savers on bank deposits, GICs, etc. In general, lower interest rates encourage people to save less and to borrow and spend more. Higher interest rates do the opposite.

Changes in the policy rate can also influence the prices of assets, such as bonds, stocks, and houses, thus increasing or reducing household wealth, which in turn may encourage or discourage spending. A drop (or rise) in the policy rate in Canada relative to other countries may also make Canadian-dollar assets less (or more) attractive to investors, and this may weaken (or strengthen) the exchange rate for the Canadian dollar. A lower value for the Canadian dollar would boost exports and restrain imports, while a stronger dollar would do the opposite.

When all is said and done, a reduction in interest rates should boost total demand for goods and services. But if demand is too strong and exceeds the economy's production capacity, this will push inflation consistently above target. The Bank will then have to raise the policy rate in order to curb spending and return inflation to target.

Canada's monetary policy is symmetric and forward looking

Canada's monetary policy functions symmetrically around the inflation target. In other words, the Bank is equally concerned about inflation rising above or falling below the target and will act to rein in or to boost demand in order to bring inflation down, or push it back up, to its 2 per cent target.

Monetary policy actions (changes in the policy rate) take time – between 18 and 24 months – to work their way through the economy and to have their full effect on inflation. For this reason, monetary policy must always be forward looking. This means that the policy rate has to be set based on the Bank's judgment about what inflation might be 18 to 24 months down the road, not what it is today.

The Bank reassesses the outlook for the economy and inflation before each of its interest rate decisions which occur eight times a year. This exercise involves a careful examination of the economic evidence accumulated since the previous interest rate announcement. The lens through which the Bank assesses this information is always focused on the achievement of the inflation target.