In the lead-up to the 2016 agreement renewal, the Bank focused its review and research in three areas: The Level of the Inflation Target, Financial Stability Considerations in the Formulation of Monetary Policy, and Measuring Core Inflation. Read more about these three research priorities
Research Priorities, 2011-2016
In the lead-up to the 2016 agreement renewal, the Bank focused its review and research in three areas:
1. The Level of the Inflation Target
Canada targets 2 per cent inflation, the midpoint of a 1 to 3 per cent inflation-control target range. Since 2011, the experience of advanced economies with interest rates near the effective lower bound has put the 2 per cent target under increased scrutiny. The Bank undertook a careful analysis of the costs and benefits of adjusting the target.
Key Supporting Material
Prudent Preparation: The Evolution of Unconventional Monetary Policies
Forward Guidance at the Effective Lower Bound: International Experience
Quantitative Easing as a Policy Tool Under the Effective Lower Bound
The International Experience with Negative Policy Rates
The Optimal Level of the Inflation Target: A Selective Review of the Literature and Outstanding Issues
Should Forward Guidance Be Backward-Looking?When constrained by the zero lower bound, some central banks have communicated a threshold that must be met before short-term interest rates would be permitted to rise. Simulation results for Canada show that forward guidance that is conditional on achieving a price-level threshold can theoretically raise demand and inflation expectations by significantly more than unemployment thresholds. This superior performance is attributable to the fact that the price-level threshold depends on past inflation outcomes. In practice, however, history-dependent thresholds such as this might be more challenging for central banks to communicate.
Monetary Policy and the Underwhelming Recovery
The Neutral Rate of Interest in Canada
Unconventional Monetary Policies: Evolving Practices, Their Effects and Potential CostsFollowing the recent financial crisis, major central banks have introduced several types of unconventional monetary policy measures, including liquidity and credit facilities, asset purchases and forward guidance. To date, these measures appear to have been successful. They restored market functioning, facilitated the transmission of monetary policy and supported economic activity. They have potential costs, however, including challenges related to the greatly expanded balance sheets of central banks and the eventual exit from these measures, as well as the vulnerabilities that can arise from prolonged monetary accommodation.
Is There a Quality Bias in the Canadian CPI? Evidence from Micro Data
Inflation and Growth: A New Keynesian Perspective
Measurement Bias in the Canadian Consumer Price Index: An UpdateThe consumer price index (CPI) is the most commonly used measure to track changes in the overall level of prices. Since it departs from a true cost-of-living index, the CPI is subject to four types of measurement bias—commodity substitution, outlet substitution, new goods and quality adjustment. The author updates previous Bank of Canada estimates of measurement bias in the Canadian CPI by examining these four sources of potential bias. He finds the total measurement bias over the 2005–11 period to be about 0.5 percentage point per year, consistent with the Bank’s earlier findings. Slightly more than half of this bias is caused by the fixed nature of the CPI basket of goods and services.
Unconventional Monetary Policy and the Great Recession: Estimating the Macroeconomic Effects of a Spread Compression at the Zero Lower Bound
Unconventional Monetary Policy: The International Experience with Central Bank Asset PurchasesAs part of their policy response to the financial crisis of 2007–09, central banks introduced numerous unprecedented monetary policy measures to provide monetary easing. This article defines and documents these measures, focusing on central bank asset purchases and their impact on central bank balance sheets. It then discusses the challenges of identifying the effects of these measures and explores possible exit strategies. The potential costs of these policies are also analyzed, as well as the broader implications for monetary policy frameworks.
Aggregate and Welfare Effects of Redistribution of Wealth Under Inflation and Price-Level Targeting
Inflation, Nominal Portfolios, and Wealth Redistribution in Canada
Trend Inflation, Wage and Price Rigidities, and Welfare
2. Financial Stability Considerations in the Formulation of Monetary Policy
In 2011, the Bank concluded that monetary policy should be the last line of defence against financial imbalances. More recently, financial stability risks have been taken into account as part of the Bank’s risk-management approach to monetary policy. To more fully understand the circumstances under which it could be appropriate for the Bank to use monetary policy for financial stability purposes, the Bank continued its research into how best to integrate price stability and financial stability, the effectiveness of macroprudential tools, and the optimal mix of policy tools.
Key Supporting Material
Housing Market Dynamics and Macroprudential Policy
On the Nexus of Monetary Policy and Financial Stability: Is the Financial System More Resilient?
On the Nexus of Monetary Policy and Financial Stability: Effectiveness of Macroprudential Tools in Building Resilience and Mitigating Financial Imbalances
Monetary Policy and Financial Stability—Looking for the Right Tools
On the Nexus of Monetary Policy and Financial Stability: Recent Developments and Research
The Legacy of the Financial Crisis: What we know, and what we don’t
Making Banks Safer: Implementing Basel IIIÉric Chouinard and Graydon Paulin review the progress to date in implementing Basel III, the new framework of global regulatory standards for the banking sector developed by the Basel Committee on Banking Supervision. The report highlights the expected net benefits of implementing Basel III, as well as the challenges in ensuring international consistency in measuring the risk-weighted capital of banks. It includes a discussion on how implementing Basel III has affected the banking system in Canada and other important jurisdictions, and demonstrates the need for ongoing assessment of the effects on the financial system and the macroeconomy.
Monetary Policy as Risk Management
Monetary Policy and the Risk-Taking Channel: Insights from the Lending Behaviour of Banks
The financial crisis of 2007-09 and the subsequent extended period of historically low real interest rates have revived the question of whether economic agents are willing to take on more risk when interest rates remain low for a prolonged time period. This increased appetite for risk, which causes economic agents to search for investment assets and strategies that generate higher investment returns, has been called the risk-taking channel of monetary policy. Recent academic research on banks suggests that lending policies in times of low interest rates can be consistent with the existence of a risk-taking channel of monetary policy in Europe, South America, the United States and Canada. Specifically, studies find that the terms of loans to risky borrowers become less stringent in periods of low interest rates. This risk-taking channel may amplify the effects of traditional transmission mechanisms, resulting in the creation of excessive credit.
Should Monetary Policy Be Used to Counteract Financial Imbalances?The authors examine whether monetary policy should and could do more to lean against financial imbalances (such as those associated with asset-price bubbles or unsustainable credit expansion) as they are building up, or whether its role should be limited to cleaning up the economic consequences as the imbalances unwind.
3. Measuring Core Inflation
While the Bank of Canada aims for low, stable, and predictable inflation, there will always be sharp movements in the Consumer Price Index (CPI), driven by volatile price changes in a small number of goods and services. In setting monetary policy, the Bank seeks to “look through” such transitory movements in the CPI, using “core” inflation measures as an operational guide to help it achieve the target for CPI inflation.
From 2001 to 2016, CPIX was the Bank’s preferred measure of core inflation. The properties of alternative measures of core inflation were re-examined to determine whether the Bank should continue the practice of identifying one preeminent measure as its operational guide, and if so, whether CPIX should continue to play that role. The Bank decided that starting in January 2017, it would cease using CPIX as its preferred measure of core inflation and focus instead on three new measures—CPI-trim, CPI-median and CPI-common.