Governor Tiff Macklem discusses how inflation targeting became a leading strategy among central banks for maintaining price stability. He also talks about structural change ahead, shifts in global trade and ensuring monetary policy is fit for the future.
The emergence of inflation targeting
Following World War II, central banks around the world tried different strategies to control inflation. But global inflationary pressures continued to build. Then, when oil prices jumped in the 1970s after steep production cuts, inflation surged in many countries.
To counter fast-rising prices, Canada and others tried to cap wage and price increases. But as soon as those controls were removed, inflation shot back up. Some countries tried to tame inflation by curbing the growth of money. This method also failed. And inflation continued to rise.
Central banks needed a way to control inflation that was:
- simple—relatively easy to do and easy for the public to understand
- flexible—able to work under a variety of domestic and international conditions
- able to control inflation over time, while still allowing prices to adjust with supply and demand
Inflation targeting fit the bill. Since Canada introduced its inflation-targeting framework in the early 1990s, inflation has mostly stayed close to the 2% target. The post-pandemic surge in inflation tested the framework like never before. But the framework succeeded, and the Bank of Canada got inflation back to target without causing a recession.
More shocks and change ahead
The world is changing. Some trends that have supported global economic growth over the past few decades—such as favorable demographics and globalization—are now slowing or reversing. Supply shocks are expected to become more frequent. This will likely lead to more volatile inflation. The dramatic shifts in US trade policy and steep new tariffs have also increased uncertainty. Global supply chains are shifting as businesses around the world look for new suppliers, new markets and new pathways to trade.
Monetary policy cannot solve the trade conflict. Nor can it alter the reality of structural change and more frequent supply shocks. But central banks can adapt to confront these new realities.
At the Bank, we are adjusting in several ways, including:
- Increasing our use of surveys and non-traditional data to complement the traditional data we’ve always used.
- Doing more outreach. We meet with businesses and communities across Canada to better understand how economic conditions are affecting their regions and industries.
- Improving the models we use for forecasting.
- Using scenarios to better understand how different variables—such as tariff rates—could affect our economy.
These adjustments give us a more complete picture of the economy. That helps us make better policy decisions.
To prepare for more structural change and greater volatility, central bankers need to reduce uncertainty where we can and manage it where we can’t.”
Future-proofing our framework
Canada’s inflation-targeting framework has worked well over the past few decades. But we still need to review our framework every few years to ensure it is fit for the future. Our next framework renewal is in 2026. The review is currently underway.
Given that we expect more shocks and uncertainty in the future, we are asking three broad questions:
- How can we best use the flexibility built into our framework when faced with supply shocks?
- How should we measure core inflation and use it to inform our policy decisions?
- How does monetary policy affect the housing sector, and how should we consider the affordability of housing in our focus on overall price stability?
One question we are not asking in this review is whether 2% is the right target for inflation. Our target has proven its worth in keeping inflation low and stable over time.
We are already facing a more uncertain and unpredictable world. Now is not the time to question the target.”