Under the Microscope
Evaluating our approach to monetary policy
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.
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:
We’re reviewing the agreement now. In 2021, we’ll sign a new agreement.
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 was one of the first countries to adopt inflation targeting. And we’ve had clear, impressive results:
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.
A lot has changed in the past 30 years:
All these factors have had an effect on inflation and the economy in Canada.
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.
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.
With all these changes, central banks face many challenges:
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.
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:
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.
In addition to all this research, we study other tools we could use to conduct monetary policy:
None of this can be done in isolation: we also research how monetary policy can best work with other policies.
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. It also means providing an open platform for anyone in Canada to tell us their views:
We’re keen to hear your views on these and other questions. Later this year, we’ll create a space on our website where you can share your thoughts. In the meantime, drop us a line. We’d love to hear from you.