After a period with the interest rate at the effective lower bound, temporarily overshooting inflation may offer important economic benefits. This may be especially true for vulnerable segments of the population, such as workers with low attachment to the labour force and the long-term unemployed.
Staff analytical notes
In light of the financial crisis and its aftermath, several economists have argued that inflation-targeting central banks should reconsider the level of their inflation targets. While the appropriate level for the inflation target remains an open question, it’s important to note that any transition to a new target would entail certain costs.
What path should policy-makers select for the nominal rate when faced with a liquidity trap during which the effective lower bound binds?
Conventional models imply that central banks aiming to raise inflation should lower nominal rates and thus stimulate aggregate demand. However, several economists have recently challenged this conventional wisdom in favour of an alternative “neo-Fisherian’’ view under which higher nominal rates might in fact lead to higher inflation.
Staff discussion papers
Strengthening Inflation Targeting: Review and Renewal Processes in Canada and Other Advanced JurisdictionsWe summarize the review and renewal process at four central banks (Reserve Bank of New Zealand, Bank of England, Sveriges Riksbank and the US Federal Reserve Bank) and compare them with the process at the Bank of Canada, which has been well-established since 2001.
Staff working papers
Are summers getting hotter? Do daily temperatures change more than they used to? Using daily Canadian temperature data from 1960 to 2020 and modern econometric methods, we provide economists and policy-makers evidence on the important climate change issue of evolving temperatures.
The Great Recession and current pandemic have focused attention on the constraint on nominal interest rates from the effective lower bound.
We add downward nominal wage rigidity to a standard New Keynesian model with sticky prices and wages, where the zero lower bound on nominal interest rates is allowed to bind. We find that wage rigidity not only reduces the frequency of zero bound episodes but also mitigates the severity of corresponding recessions.
The long-run relation between growth and inflation has not yet been studied in the context of nominal price and wage rigidities, despite the fact that these rigidities now figure prominently in workhorse macroeconomic models.
In this paper, we use an economics decision-making experiment to test a key assumption underpinning the efficacy of price-level targeting relative to inflation targeting for business cycle stabilization and mitigating the effects of the zero lower bound on nominal interest rates.
There appears to be a disconnect between the importance of the zero bound on nominal interest rates in the real-world and predictions from quantitative DSGE models. Recent economic events have reinforced the relevance of the zero bound for monetary policy whereas quantitative models suggest that the zero bound does not constrain (optimal) monetary policy.
This paper studies the steady-state costs of inflation in a general-equilibrium model with real per capita output growth and staggered nominal price and wage contracts.
The authors provide a detailed empirical analysis of Canadian city housing prices. They examine the long-run relationship between city house prices in Canada from 1981 to 2005 as well as idiosyncratic relations between city prices and city-specific variables.
The authors study the macroeconomic effects of non-zero trend inflation in a simple dynamic stochastic general-equilibrium model with sticky prices.
This paper summarizes the results of recent research evaluating the Bank of Canada's Quarterly Projection Model (QPM).
Bank of Canada Review articles
May 16, 2016 The article examines the extent of downward nominal wage rigidity in Canada and its implications for monetary policy. The authors ask whether its existence is a sufficient argument for a higher inflation target if concerns about the effective lower bound are adequately addressed.
November 13, 2014 This article describes experimental economics, in general, and new developments in experimental macroeconomics, in particular. The approach has a clear niche in providing evidence on economic phenomena that cannot be observed directly or that are difficult to measure. Experimental work conducted by Bank of Canada economists has shed light on a number of issues important to monetary policy, such as the relative efficacy between price-level and inflation targeting, and the nature of inflation expectations formation.
August 19, 2010 The recent financial crisis and global economic slowdown have renewed interest in monetary policy options when the policy interest rate is at or near zero.
August 19, 2010 Although the current inflation-targeting regime has served Canadians well, sound public policy demands the continuous exploration of possible improvements in the monetary policy framework.
April 9, 2009 In 2006, the Bank initiated a research program exploring two alternatives to the current inflation-targeting framework: (i) lowering the inflation target and (ii) shifting to a price-level target. This article discusses progress to date, places the Bank's findings in the context of a broader literature, and identifies avenues for future research.
April 15, 2006 The Bank of Canada's 2005 conference focused on two critical issues: price-level targets versus inflation targets, and the appropriate level of inflation. Session topics included new methodological approaches to examining the validity of the New Keynesian Phillips curve for Canada; the monetary policy implications of border effects and the financial-accelerator model; the zero lower bound on nominal interest rates; and inflation and welfare in general-equilibrium macroeconomic models. A panel of invited speakers discussed the issues of each session, and two distinguished speakers gave their perspectives on inflation.
May 21, 2003 The 2002 Bank of Canada Conference focused on price adjustment, a critically important issue for monetary policy. Given the acceptance throughout the 1990s and 2000s of the existence of price stickiness in goods or labour markets, or both, and of the important role that monetary policy can play in an economy, the time was right for a conference that would focus on current developments in this area of research, particularly within a Canadian context. Conference papers covering both theoretical and empirical studies explored such themes as sources of the persistence of inflation, forward-looking models of inflation, models of inflation in open economies, the macroeconomic effects of technology shocks, and models of the interaction between wages, prices, and real economic outcomes.
May 15, 2000 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.
- "Risk Premium Shocks and the Zero Bound on Nominal Interest Rates"
(with Malik Shukayev). Forthcoming Journal of Money, Credit, and Banking.
- "Optimal Price-Level Drift Under Commitment in the Canonical New Keynesian Model"
(with Steven Ambler and Malik Shukayev). Canadian Journal of Economics, 45 (3): 1023-1036.
- "Trend Inflation, Wage and Price Rigidities, and Productivity Growth"
(with Kevin Moran, Stephen Murchison, and Andrew Rennison) Journal of Monetary Economics (2009) 56: 353-364.
- "Canadian City Housing Prices and Urban Market Segmentation"
(with Jason Allen, David P. Byrne, and Allan W. Gregory). Canadian Journal of Economics (2009) 42: 1132-1149.
- "The Macroeconomic Effects of Non-Zero Trend Inflation"
(with Steve Ambler and Nooman Rebei). Journal of Money, Credit and Banking (2007) 39: 1819-1836.
- "Inflation Persistence and Monetary Policy: A Simple Result"
Economics Letters (2007) 94: 26-31.
- "Government Expenditures and the Permanent-Income Model"
(with Tony Wirjanto) Review of Economic Dynamics (1998) 1: 719-730.
- "Intratemporal Substitution and Government Spending"
(with Tony Wirjanto) Review of Economics and Statistics (1997) 79: 605-609.
- "Intertemporal Substitution, Imports and the Permanent-Income Model"
(with Tony Wirjanto) Journal of International Economics (1996) 40: 439-457.
- "Nonstationary Regression Model with a Lagged Dependent Variable"
(with Tony Wirjanto) Communications in Statistics: Theory and Methods (1996) 25: 1489-1503.
- "Terms of Trade and Real Exchange Rates: The Canadian Evidence"
(with Simon van Norden) Journal of International Money and Finance (1995) 14: 83-104.