August 15, 2000
Publications
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August 14, 2000
Approaches to Current Stock Market Valuations
The increase in North American stock prices in 1999 and early 2000 has generated interest in the valuation assumptions that would make these price levels sustainable. Here, commonly used valuation techniques are applied to stock markets in Canada and the United States. For the comparative yield approach, real interest rates (rather than nominal rates) are preferred as the comparator of choice to yields on stock market indexes. The spreads between real interest rates and stock market yields have generally increased over the last two years. The dividend-discount model (DDM) approach provides an analytic linkage between the equity-risk premium and the expected growth of dividends. It suggests that market values (measured at the end of February 2000) could be sustained only by rapid growth of dividends in the future or by the continued assumption of an uncharacteristically low risk premium on equity. The spectacular rise in the value of technology stocks in 1999 is noted (Chart 4), and then the valuation measures for the Canadian stock market excluding the technology sector are examined. When this is done with the comparative yield approach, yield spreads are slightly lower, and for the DDM approach, one does not need to assume as high a growth of dividends or as low a risk premium to validate market valuations. Two effects of the "new economy" on the stock market are noted. One is the lowering of dividend yields, as new-economy technology companies tend to have a high reinvestment rate and a low dividend payout rate. Another relates to the potential for a higher track for the economy's productivity growth, which would mean that higher-than-historical assumptions about future earnings growth would be more plausible. Several explanations for the decline in risk premiums on equity are considered. While short-term volatility in the stock market has, if anything, increased in recent years, low inflation and improved economic performance, along with demographics and investor preferences, may have contributed to a decline in the risk premium demanded by investors. A scenario of rapid growth of dividends in the near term slowing to historical norms in the longer term is examined. While this approach can go partway towards explaining high stock market valuations, it requires assumptions that are outside historical experience. -
May 16, 2000
Recent Developments in the Monetary Aggregates and Their Implications
Narrow Money—Transactions Money The growth rate of the narrow monetary aggregates picked up in 1999, reflecting the expansion in economic activity and the stabilization of interest rates. The sharp acceleration of the narrow aggregates in recent months suggests buoyant growth in GDP in coming quarters. Signs of a possible rise in inflation are also emerging. Over the longer run, for inflation to remain in the Bank's 1 to 3 per cent target range, the growth of narrow money would have to slow down from its current pace. In 1999, the growth rate of M1 also began to converge with that of the other narrow aggregates, M1+ and M1++. This suggests that the influence of the special factors that have been affecting the growth rate of M1 has diminished. Broad Money—"Store of Value" Household savings represent deferred consumption, and therefore the broad monetary aggregate provides information about future spending and, hence, inflation. In 1999, the very broad measure of money, M2++, grew at much the same rate as it did in 1998. This outcome is in line with inflation remaining in the inflation-control target range over the next couple of years. -
May 16, 2000
Bank of Canada Review - Spring 2000
Cover page
A Seventeenth-Century Collector's Guide
This volume, as well as the coins, forms part of the National Currency Collection, Bank of Canada, which, in addition to its numismatic holdings, also houses a reference library of more than 8,000 books, pamphlets, periodicals, and catalogues about money and banking.
Photography by James Zagon.
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May 15, 2000
Credibility and Monetary Policy
A highly credible monetary policy helps to reduce the degree of uncertainty that can surround the objectives of such policy. When the monetary policy pursued by the central bank is credible, the expectations of the public are focused on a target. If the public believes that the Bank will act to bring inflation back to the target, then its expectations will not react so strongly to fluctuating price trends. In turn, fluctuations in inflation, interest rates, output, and employment should be less pronounced than in the absence of such credibility. The adoption of inflation control as a monetary policy objective by some countries has led central banks to take steps to enhance the credibility of monetary policy. For the Bank of Canada, these include * the publication of our Monetary Policy Report each May and November, with formal updates each February and August * the initiation of communications activities across the country * the use of the overnight interest rate as a short-term operating target * the issuing of a press release each time the Bank changes its key rates To date, most of the studies on this topic have concluded that success in keeping inflation within a target range has helped to increase the credibility of Canadian monetary policy. These surveys suggest that expected inflation, which stood at about 5 per cent in 1990, declined to around 2 per cent by 1999 (Chart 1, page 15). Indeed, according to these surveys, for the entire period during which the Bank has had a target range for inflation, expected inflation rates have remained within that range. Inflation expectations have also reacted very little to changes in the total CPI, suggesting that the targets have helped to focus expectations on the target rate and have thus enhanced the credibility of monetary policy (Chart 2, page 16). One particular study shows that the life of collective wage agreements in Canada has been increasing and that the number of such agreements containing cost-of-living adjustment (COLA) clauses has steadily declined. The authors of this study suggest that this may reflect the greater credibility of Canadian monetary policy (Table 1, page 16). The proportion of mortgages with five-year terms is now higher than it was in the mid-1980s, and many financial institutions have been offering 7- to 10-year mortgages. This also suggests that inflation targets have gained credibility. -
May 11, 2000
Monetary Policy Report – May 2000
The global economy has shown greater strength than was anticipated at the time of the November Report. -
February 16, 2000
Monetary Policy Report Update – February 2000
Information received since the last Monetary Policy Report, released on 17 November, points to a stronger pace of economic expansion in the United States and Europe than was expected at that time, and confirms the hesitant nature of the recovery in Japan. -
January 29, 2000
Annual Report 1999
The Canadian economy regained strong momentum in 1999 as the U.S. economy remained vigorous, the global economy recovered, and commodity prices moved upwards.
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January 16, 2000
Bank of Canada Review - Winter 1999–2000
Cover page
Coins from Y1K
The largest of these coins is about the size of a twenty-five cent piece. They form part of the National Currency Collection, Bank of Canada.
Photography by James Zagon.
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December 16, 1999
Economic and Financial Developments to 16 February 2000: An Update to the Monetary Policy Report
Highlights * The pace of economic activity in the United States remains strong, exceeding earlier expectations. * With the stronger momentum of external demand, the Bank now expects Canada's real GDP growth in 2000 to be in the upper half of the 2.75 to 3.75 per cent range projected in the last Monetary Policy Report. * Core inflation was below expectations in November, partly because of price discounting on certain semi-durables. * The Bank expects core inflation to increase to 2 per cent in the first quarter of 2000. * Because of higher energy prices, the rate of increase in total CPI is expected to rise to close to 3 per cent early in the year. * Developments during the last three months underscore the risks to Canada's economic outlook highlighted in the last Report : stronger momentum of demand for Canadian output from both domestic and external sources and potential inflationary pressures in the United States. Information received since 14 January, when the update to our November Monetary Policy Report was completed, continues to point to a strengthening outlook for the world economy and for Canada. In the United States, real GDP again exceeded expectations—rising at an annual rate of 5.8 per cent in the fourth quarter. While some price and cost pressures are evident in the United States, strong productivity growth has thus far held unit labour costs down. Because of the rapid expansion of demand above the growth of potential capacity, however, and the associated inflation risks, the Federal Reserve increased its federal funds rate by 25 basis points to 5.75 per cent on 2 February. Although trend inflation remains low in the industrial countries, a number of other major central banks have also raised their policy rates in the last couple of weeks because of concern about future inflation pressures, given strengthening demand. The buoyancy of external demand, particularly that coming from the United States, continues to show in our latest merchandise trade numbers. Export growth in November remained strong, with the overall trade balance in large surplus. World prices for our key primary commodities also continue to firm in response to rising global demand. On the domestic side, the latest information on demand and production points to continued robustness. Real GDP (at factor cost) rose 0.6 per cent (4.6 per cent year-over-year) in November, and employment continued to grow strongly through year-end and into January. Other indicators, including the latest data on the monetary aggregates, support this strong economic picture. The Bank now expects real GDP growth in 2000 to be near the top of the 2.75 to 3.75 per cent range projected in November. Our core measure of inflation was 1.6 per cent (year-over-year) in December, slightly below expectations, partly because of temporary discounts on certain items. Core inflation is still expected to move up to the midpoint of the Bank's 1 to 3 per cent target range in the first quarter. Over the same period, the total CPI will likely rise to close to 3 per cent because of the recent sharp step-up in energy prices but is still expected to come down towards the core rate during the course of 2000 as energy prices moderate. The Bank of Canada raised its Bank Rate by 25 basis points to 5.25 per cent on 3 February. The factors behind this decision included the strong momentum of demand in Canada from both external and domestic sources, the importance of approaching full capacity in a prudent way, and the risk of a spillover of potential inflation pressures from the United States.