The following is an abridged and updated version of an article entitled Information and Analysis for Monetary Policy: Coming to a Decision, by Tiff Macklem.
In late 2000, the Bank of Canada adopted a system of eight pre-set dates per year on which it announces its key policy rate. This system is often referred to as the Bank's fixed announcement dates, or simply fixed dates.
The following sections describe the information and analysis presented to the Bank's Governing Council in the two or three weeks leading up to a fixed announcement date.
This process includes an economic projection based on a model of the Canadian economy; an analysis of the information from monetary and credit aggregates, interest rate credit spreads, and changes in credit access; and information on the interest rate expectations of participants in financial markets.
The steps involved in reaching a decision on the setting of the policy rate are also explained.
The staff economic projection is the first analysis presented to the Governing Council. It is the staff's assessment of the most likely path for the economy - the "base-case projection." It includes a recommendation to the Governing Council on the appropriate level for the key policy rate so as to keep inflation near the 2 per cent midpoint of the inflation-control range.
The staff projection is organized around the quarterly national income and expenditure accounts, which are the most comprehensive measures of economic activity. It is the reference point from which the implications of other sources of information are assessed.
The projection exercise begins by looking beyond Canada's borders. The Bank's International Department assesses developments and future prospects in overseas economies, drawing on the analyses and forecasts of the International Monetary Fund, the Organisation for Economic Cooperation and Development, and private sector forecasts.
The second step is a detailed analysis of the current state of the Canadian economy and its near-term prospects. This includes high-frequency indicators, such as car sales, housing starts, employment, manufacturers' shipments, retail sales, and merchandise trade.
High-frequency data must be handled with care. These data are extremely volatile - because of short-term factors, such as labour disruptions, unusual weather, and special promotions such as sales or financing incentives - and are subject to large revisions. A key challenge is to figure out whether the latest movement in the data simply reflects short-term volatility or is indicative of the direction in which economic activity and prices are headed.
The projection combines the above information with a structural macroeconomic model of the Canadian economy. The model helps trace the link from the target for the overnight rate to inflation. It also highlights the very indirect nature of the Bank's influence on inflation and the fact that this influence becomes apparent only over time.
Following the presentation of the projection, the Council meets and begins to discuss its views about the most likely path for the economy and the main risks and uncertainties around the outlook.
About a week before the announcement, the Governing Council is briefed on four important topics:
The staff projection is an outlook for the economy's most likely path. There is, of course, much uncertainty around this outlook, and the economic model is used to assess the main "risks" to it.
Examples of risks include different assumptions about the current amount of slack in the economy or the growth rate of economic capacity; different assessments of the prospects for the U.S. economy; and alternative views on the future path for the price of oil or other commodities. The staff's "risk analyses" assess the sensitivity of the baseline forecast to such risks and provide the Governing Council with a range of forecasts and policy recommendations.
The staff also consider alternative policy scenarios; for example, one in which interest rates are held constant for a period of time. This would indicate the consequences of delaying the interest rate response proposed by the model.
As well, staff review various indicators of capacity pressures and inflation.
Information on economic activity gathered from industry contacts across the country provides a very different lens through which to view the economy.
Four times a year, regional representatives visit about 100 companies. They ask a set of standard questions on past and expected future sales growth, investment intentions, inventories, employment plans, wage growth, and prices.
The survey is small, but it is designed to reflect the diversity of the Canadian economy by region, by type of activity, and by firm size. The information gathered gives the Council insight into what business people are seeing and planning. Based on the survey and other factors, regional staff forecast the growth in each region of the country for the current and next year. These are then aggregated to produce a national forecast that can be compared with the staff economic projection. View the survey.
This review includes indicators of activity and capacity in the goods, labour, and real estate markets, as well as various measures of wage and price inflation, and measures of inflation expectations.
The economic model used in the staff projection focuses on the links from interest rates to spending by households and firms. Information on various holdings of money and credit provide another view of what consumers and firms are doing and planning to do.
The challenge for the staff is to separate the genuine signals about economic activity and inflation from volatility caused by other factors. Regular contact with financial institutions provides useful insight into developments that appear to be affecting the growth of money and credit. Information is also obtained on credit spreads in bond markets and on any changes in the conditions under which banks are lending to businesses and households.
The staff in the Bank's Department of Monetary and Financial Analysis assemble this information to provide an overall view from the financial side of the economy on the outlook for output growth and inflation, as well as on the risks surrounding this outlook. They then make a recommendation to the Governing Council on the appropriate level for the key policy rate.
The Financial Markets Department assesses market expectations for interest rates; in particular, what the markets expect the Bank to do with the key policy rate, and what the U.S. Federal Reserve is expected to do at their next few meetings.
This assessment is based on interest rate futures and expectations implicit in the term structure of interest rates, as well as on market commentary, the published reports of investment banks, and the Bank's contact with dealers and investors. The discussion highlights what the market is expecting and what factors participants are focusing on. The market perspective acts both as a reference point against which to compare the staff's analysis and as a guide to the issues that may need to be addressed when communicating the decision.
At the final briefing, the Governing Council meets with the other members of the Monetary Policy Review Committee, which includes the six advisers, the chiefs of the four economics departments, and the directors of the financial markets divisions in Montréal and Toronto. This meeting typically takes place on the Friday morning preceding a fixed announcement date.
The meeting begins with an update on any economic or financial information received since the staff completed its analysis.
This is followed by a wide-ranging discussion of the economic outlook, the balance of risks, and of the appropriate setting for interest rates. Each of the advisers, chiefs, and directors provides his or her assessment and makes a recommendation on the appropriate interest rate setting.
The Chief of the Financial Markets Department then discusses market expectations regarding the Bank's upcoming decision. This discussion highlights what market participants see as the factors weighing on the decision and how key messages should be communicated.
On the Friday before the fixed announcement date, the Governing Council begins its own deliberations in earnest. The Council operates on a consensus basis. This means that as differing views and interpretations are presented, the process of debate and discussion moves towards a shared view that all Governing Council members can support.
The Council begins by developing a common view on the most likely future path for the economy and the underlying trend in inflation. They then reach agreement on the main risks around this outlook and the overall balance of risks. Finally, they begin their deliberations on the appropriate path for the key policy rate and the related communications activities.
The Council reconvenes the following Tuesday, and by the end of the day reaches a consensus decision on the setting of the rate. With support from a senior communications staff member, they prepare the press release that outlines the reasons behind the decision. Early Wednesday morning, the decision is confirmed. At 10:00, the key policy rate is announced. A media lockup at the Bank before 10:00 allows reporters to prepare their stories in advance for prompt release when the rate is announced.
Four times a year, the same day as the fixed announcement date, the Bank releases the Monetary Policy Report. This publication provides details on the Governing Council's outlook for economic activity and inflation, the key risks around this outlook, and the reasons for the recent rate decision. The release of the Report is accompanied by background briefings of the media by the deputy governors and a press conference by the Governor and Senior Deputy Governor.
The Report is also followed by testimony before parliamentary committees and by presentations by deputy governors and other senior staff across the country and in international financial centres.