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Low, stable and predictable inflation allows an economy to function more effectively, a situation that contributes to consistent economic performance over time and increased living standards for Canadians. The Bank of Canada is continuously conducting research and analysis to better understand the implications of monetary policy actions for a macroeconomy.
One of the Bank’s near-term priorities is to improve our understanding of the linkages between financial market developments and the macroeconomy, as well as the international dimensions of these links and their implications for monetary policy. This entails building theoretical and empirical models to help policy-makers discern how foreign financial shocks are transmitted to Canada, how financial channels affect the international propagation of shocks, and how domestic and financial developments affect the Canadian economy and the monetary policy transmission mechanism. Of particular interest are the interaction between monetary policy and financial stability, and the trade-offs that may arise in seeking to achieve financial stability, price stability and good overall macroeconomic performance. This research also examines the role of household and business debt, as well as balance sheets, in determining economic outcomes. Other related priorities are: (i) research on policy options at the effective lower bound for nominal interest rates and the effectiveness of different types of unconventional monetary policies used by other central banks; and (ii) work on how monetary policy influences the formation of expectations, perceived risk and uncertainty, and the relevance of each for macroeconomic developments and sound monetary policy.
A second research goal is to improve our understanding of the impact of international developments on the Canadian economy, and their implications for the conduct of Canadian monetary policy. This research agenda will include an effort to enhance our understanding and modelling of emerging-market economies, in particular, the Chinese economy. Moreover, we will continue our analysis of the international monetary system, particularly the evolution of global imbalances, reserve accumulation and sterilization, capital flows, exchange rate adjustment, and the role of the International Monetary Fund. This line of research will also involve work on the determinants of exchange rates.
A third research priority consists of developing economic models and other analytic tools to improve our techniques for monitoring and forecasting economic activity. A current focus is to better integrate financial and global developments into our monitoring activity, as well as to develop a more systematic approach to our analysis. We will also continue to enhance our tools for monitoring and forecasting commodity prices. Another area of ongoing research is the development of macroeconomic models for monetary policy analysis.
A fourth research objective is to improve our understanding of structural issues in Canada, specifically, the implications of wage inequality and income and wealth distribution, as well as the effects of demographic change; potential crowding-out effects of increases in public investment; and recent financial developments on labour productivity, savings behaviour and the outlook for potential output growth over the medium term.
An efficient and stable financial system is critical to the long-run stability and growth of the Canadian economy. It has immediate consequences for the effectiveness of monetary policy and for the Bank of Canada’s ability to fulfill its responsibilities related to the oversight of designated payment, clearing and settlement systems, as well as its roles as lender of last resort and fiscal agent for the Government of Canada. The Bank thus has a strong interest in minimizing systemic vulnerabilities and promoting the efficiency of Canada’s financial system. Research in this area aims to deepen our insight into the behaviour of financial institutions and the evolving role within the financial system of complex financial instruments, institutions, infrastructure and markets.
The first financial system research priority is to examine which policy tools are the most suitable for achieving macrofinancial policy objectives, given the structure of the financial system and financial and macroeconomic conditions. This goal supports one of the Bank’s medium-term priorities, which is to assess the effectiveness of various proposed macrofinancial policy tools in mitigating systemic risk, as well as their impact on macroeconomic performance. Of particular interest are the potential trade-offs between financial stability and economic growth. In addition, we consider the contributions made by robust market infrastructure and central bank policy to the stability and efficiency of financial institutions and markets and the continuous functioning of core funding markets.
A second, related research priority is to learn more about the behaviour of, and interactions among, financial institutions and financial markets. This research program includes further development of our macrofinancial risk assessment framework (i.e., a macro stress-testing model) to better incorporate important interlinkages among financial institutions, markets and the macroeconomy, both domestically and internationally. This area of research will also analyze the structure and behaviour of the shadow banking industry and its implications for the overall financial sector, the macroeconomy and financial stability policy. As well, this research will explore the link between the macroeconomic environment and risk-taking.
A third research priority is to better understand the features of the financial system that lead to the emergence of risks and vulnerabilities. This research focuses on developing models that identify risks and vulnerabilities in the financial system, including excess credit growth, balance-sheet imbalances and asset-price misalignments (e.g., early-warning and sectoral-vulnerability modelling). We will also continue to investigate the nature of credit risk and foreign exchange risk.
On behalf of the Government of Canada, the Bank of Canada oversees the funding and management of Canada’s foreign exchange reserves and the federal wholesale and retail debt programs. Our research focuses on providing effective policy advice related to these activities to optimize the trade-offs between cost (or return) and risk. Another focal point is promoting safer and more efficient payment, clearing and settlement systems.
One of the Bank’s medium-term research priorities is to develop a model to optimize the strategic portfolio of assets and liabilities for the Exchange Fund Account (EFA), which will enhance our policy advice on foreign reserves management. In 2012, we will continue our work on model development to inform decisions regarding the structure of the EFA liabilities (direct issuance versus cross-currency swaps) and the choices of portfolios for EFA reserve assets. We will integrate the strategic asset-allocation model and the liabilities model into an asset-liability framework to provide quantitative advice on the optimal joint composition of assets and liabilities.
A second priority is to enhance our knowledge of the risk and efficiency trade-offs in Canadian payment, clearing and settlement systems. As an important provider of liquidity to the financial system, the Bank is concerned about the safety and soundness of these systems, since poorly designed systems could generate significant liquidity and credit risks for participants. The goal of our research is to develop models of the payment, clearing and settlement systems that incorporate participants’ behaviour and system interlinkages. In particular, we plan to analyze the impact of various liquidity-policy tools on the settlement and overnight-lending activities of participants in Canada’s Large Value Transfer System (LVTS). Some of our research will also be directed toward building models to study the design of loss-sharing arrangements in a clearing and settlement system and the optimal role of a central bank in enhancing efficiency. Other research in this area will focus on developing statistical tools to measure and monitor the Bank’s exposure to default risk in the LVTS.
To support the Bank of Canada’s objective of supplying Canadians with bank notes that they can use with confidence, the Bank undertakes economic and technology research on issues related to the national currency.
The major theme of Currency’s economic research in 2012 is to improve our understanding of the evolution of the demand for bank notes in light of ongoing changes in the means of payment and, in particular, the introduction of innovative retail payment products. Our theoretical and survey-based research focuses on learning how consumers choose between various means of payment in making purchases, and how changes in policy and regulations, as well as other developments, will affect this choice. We will also examine the implications for the central bank of a possible change in the demand for bank notes.
In 2011, following five years of research and development, the Bank of Canada successfully issued Canada’s new $100 polymer bank note with leading-edge security features. The remaining four denominations will be issued through 2012–13. The Bank’s technology research has now transitioned from its near-term focus on the development of the new Polymer series to developing contingency responses to emerging counterfeiting threats and a longer-term focus on identifying and developing new security features for a future series of bank notes.