When Malcolm and I appeared before you last November, a heavy cloud of uncertainty hung over the outlook for the world economy and for Canada. Much of that uncertainty stemmed from the September terrorist acts in the United States, which came at a time when the global economy had slowed more than expected.

To counter that uncertainty and bolster consumer and business confidence, the Bank of Canada moved aggressively to provide monetary stimulus. Between last September and January 2002, we lowered interest rates by 200 basis points, bringing the total reduction since January 2001 to 375 basis points.

As it turned out, consumer confidence was not as badly shaken in the aftermath of those tragic events as had been widely feared. Indeed, confidence bounced back as perceived geopolitical and economic uncertainties diminished. The world economy has begun to strengthen. Here in Canada, a robust recovery appears to be underway. Growth in the fourth quarter of last year and the first quarter of 2002 was appreciably stronger than expected, so that the level of economic activity is now higher than we thought it would be six months ago. This momentum is reflected in the extraordinary number of new jobs created since the beginning of 2002. In terms of the two scenarios we had painted last November, clearly, we are into the more optimistic one, in which a recovery in consumer confidence leads to an early resumption of economic growth.

What do we see now as we look ahead?

The Bank projects that, in the first half of 2002, the Canadian economy will grow by between 3 ½ and 4 ½ per cent, at annual rates. And we expect that it will continue to expand in the second half of the year and in 2003 at a rate somewhat above that of its production capacity (or potential), which we estimate to be around 3 per cent a year. This means that our economy should return to full capacity in the second half of 2003.

The output path I have just sketched is consistent with core CPI inflation being at 2 per cent by about the end of next year. Total CPI inflation will probably continue to fluctuate in coming months as oil and natural gas prices move around. But, like core inflation, we expect it to be at the 2 per cent target midpoint by about the end of 2003.

Although we no longer face the same degree of uncertainty as we did last fall, there are still important risks and uncertainties in the outlook—some of which are working on the upside and others on the downside.

Given the amounts of monetary and fiscal stimulus in the economy, output growth could be even stronger than projected. But it is also possible that some of the recent strength in spending on consumer durables was borrowed from the future, so that the growth of household expenditures will be weaker than expected. At the same time, there is still considerable uncertainty about the timing and strength of the pickup in business investment in North America, mainly because of the continued weakness in profits. Moreover, tensions in the Middle East could have implications for crude oil prices and the global economy.

But what do recent economic developments in Canada mean from a policy perspective?

With our economy now operating at a significantly higher level than we had expected, the amount of spare capacity is smaller, and is projected to be absorbed sooner, than we thought last November. In these circumstances, our job will be to gauge the strength of the economy as it approaches its capacity to produce and to reduce the amount of monetary stimulus in place in a timely and measured manner. We want to ensure that inflation stays close to the target so that, over the medium term, our economy can continue to grow at full capacity.

Over the past year, we put the "pedal to the metal" to help us get up the hill of economic difficulties. The prudent thing now, as we return to more normal driving conditions, is to ease off on the gas pedal—ease off, not slam down on the brakes—to make sure that we continue our journey along the highway at a safe cruising speed.

It is in line with this that we moved, on 16 April, to raise the target for the overnight interest rate by 25 basis points.