Changes in the Inflation Process in Canada: Evidence and Implications

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The Canadian economy is currently in transition from a period of disinflation to one with a very low and relatively stable inflation rate. Against this background, the author asks whether reduced-form parameters should be expected to be invariant to changes in the inflation process.

This raises two empirical issues. The first relates to whether shifts in the Canadian inflation process can be identified over time. It appears so, since casual observation as well as various statistical procedures indicate that there was a unique period from the mid-1950s to the early 1970s when inflation was low and relatively stable.

The second issue relates to whether there is evidence that parameter instability corresponds to shifts in the inflation regime. Statistical tests indicate that parameter instability is an important concern in reduced-form models of the inflation process, particularly for the early 1970s. The evidence for Canada suggests that inflation forecasts from reduced-form models may be unreliable in the presence of important changes in the inflation process.