Under the microscope

Evaluating our approach to monetary policy

James (Jim) C. MacGee
James (Jim) C. MacGee
Rhys R. Mendes
Rhys R. Mendes

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Inflation targeting has been successful in Canada over the past 30 years. But is it the best we can do? The Bank of Canada asks itself, and Canadians, that question every five years.

Targeting inflation

Low and stable inflation means that prices rise slowly and predictably. This makes it easier for people and businesses to plan ahead. And it means that, over time, our money holds its value better.

Since the early 1990s, the Bank of Canada has adjusted interest rates to keep inflation around 2 percent. We call this inflation targeting, and it's one of the most popular monetary policy frameworks in the world. Every five years, we work with the federal government to review whether:

  • inflation targeting is still the best approach, or
  • we can make any improvements.

We’re reviewing the agreement now. In 2021, we’ll sign a new agreement.

Senior Deputy Governor Carolyn A. Wilkins explains how we’re consulting with Canadians as we review our monetary policy framework and what we’ve heard so far.

A success story

Central banks around the world have tried many different approaches to monetary policy for decades—from the gold standard to fixing their exchange rates against other currencies to inflation targeting.

Canada has been part of four different monetary policy frameworks in the past 100 years

Canada was one of the first countries to adopt inflation targeting. And we’ve had clear, impressive results:

  • stable and predictable price changes—averaging nearly 2 percent a year for three decades
  • fewer boom and bust cycles
  • a steadier job market
  • less volatile and much lower borrowing rates for consumers and businesses

In fact, people have become so used to low inflation that they just expect it. This is very powerful: it means people act in ways that help inflation targeting remain successful. It takes the guesswork out of what inflation might be next year, so people don’t have to adjust their spending plans suddenly or figure out what pay raise they might need to keep up with the cost of living.

Modern times

A lot has changed in the past 30 years:

  • People can shop the globe from the comfort of their couch using their smartphone.
  • Workers in multiple countries design, produce and assemble a given product before the product is shipped globally.
  • Household debt levels in Canada are at historic highs, as are house prices.
  • Society is, on average, quite a bit older than it used to be.

All these factors have had an effect on inflation and the economy in Canada.

The fallout from the global financial crisis

The 2008 global financial crisis was another event that had a huge effect on the economy and inflation. As many people around the world lost their jobs, they cut back on their spending. Businesses lowered their prices to encourage people to keep buying their products.

Central banks around the world responded by dropping interest rates to record lows and kept them low by historical standards.

  • Some central banks even put in place negative interest rates.
  • Others tried new tools like quantitative easing—a way to lower longer-term interest rates—to boost their economies.
  • Still others, including Canada, established new rules to make the financial system more stable.

More recently, some countries have imposed tariffs and other trade barriers. These could end up reversing the globalization of the world economy—including many of its benefits, one of which was to help lower prices for many of the goods we buy.

Modern challenges

With all these changes, central banks face many challenges:

  • Because interest rates are already so low, we have less room to cut interest rates if the economy really cools off.
  • We need to make sure both the economy and the financial system are stable—this is trickier when debt levels are already high.
  • We have to better understand how inflation and monetary policy can affect different people in different ways.

We also need to remember that changes to interest rates are not the only way to support the economy: government spending and rules to keep the financial system safe play an important a role.

A wide-ranging review

All of this means we need to look closely at whether other approaches to monetary policy might serve Canadians better than inflation targeting. Given the success we’ve had, the bar is undoubtedly high. But that doesn’t mean we should stop looking. Some of the alternatives we’re considering include targeting:

  • both inflation and employment
  • an average inflation rate over the medium term
  • the price level
  • income growth

Bank staff are hard at work comparing inflation targeting with other possible frameworks.

Our review isn’t limited to what’s happening in Canada. We also look at how some of these approaches have worked in other countries and whether they could work in Canada. An important part of this research involves testing how easy it would be to communicate these things to the public.

Our work is cut out for us

In addition to all this research, we study other tools we could use to conduct monetary policy:

  • interest rates, including negative rates
  • communication—giving explicit guidance about future policy
  • buying assets, like bonds, on the open market
  • lending money to financial institutions with the condition they lend it to people and businesses

None of this can be done in isolation: we also research how monetary policy can best work with other policies.

Our staff discuss the policy tool kit and how monetary policy works with other policies.

Your opinion matters

Let’s be honest: this stuff is pretty technical and, understandably, most people aren’t that interested in the details. But what we do and how well we do it really matters for everyone in Canada, so we are consulting more widely with Canadians than ever before.

That means asking businesses, workers and groups that represent other segments of society what they think. This means asking Canadians to tell us their views:

  • How does inflation targeting affect you?
  • What do you think of negative interest rates?
  • What else do we need to think about?

We’re keen to hear your views on these and other questions. Drop us a line. We’d love to hear from you.

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