The Bank of Canada’s response to high inflation

Inflation in Canada and around the world reached 40-year highs in 2022. The Bank of Canada responded by:

  • front-loading increases to the interest rate
  • deepening its analysis of inflation dynamics
  • updating its communications strategy
  • undertaking a concerted lessons-learned exercise

Shifting the Bank’s monetary policy stance

Throughout 2022, the Bank responded forcefully to high and rising inflation by undertaking the most rapid tightening cycle in Canada’s history. It also took a series of deliberate steps to help Canadians prepare for a swift rise in interest rates, after a long period when rates were extraordinarily low.

Removing forward guidance

In the summer of 2020, Canada faced a second wave of COVID‑19, and restrictions on economic activity remained across the country. The Bank implemented extraordinary forward guidance on the policy interest rate, committing to keeping the rate at its lowest possible level until slack in the economy had been absorbed.

By January 2022, the Bank’s Governing Council judged that this condition had been met, and the Bank announced the end of forward guidance. The Bank stated that this represented the conclusion of its emergency measures to support the economy and that interest rates would start rising.

This change occurred even as Canada was in the middle of the Omicron wave of the COVID‑19 pandemic and widespread public health measures were still in place. By this time, it had become increasingly evident that businesses and consumers were adjusting, and economic activity was being less and less negatively affected by each successive wave of the pandemic.

Front-loading increases to the interest rate

In March 2022, the Bank’s Governing Council raised the policy interest rate by 25 basis points—the first increase since before the pandemic. The Bank then moved the policy rate up rapidly to cool inflation and help prevent high inflation from becoming embedded in people’s expectations. The Bank pursued this strategy of front-loading increases to avoid the need for even higher interest rates later, which would be more painful for the economy and for Canadians.

The year ended with the policy rate at 4.25%—its highest level since before the 2008–09 global financial crisis.

Implementing quantitative tightening

The Bank announced in April that it was ending the reinvestment phase of its Government of Canada Bond Purchase Program and beginning quantitative tightening. This meant that maturing Government of Canada bonds on the Bank’s balance sheet would no longer be replaced and that, as a result, the size of the balance sheet would decline over time.

In its communications, the Bank clearly explained that the policy interest rate is its primary monetary policy tool and that quantitative tightening would complement increases in the policy rate.

Deepening the Bank’s understanding of inflation dynamics

Given the unprecedented circumstances, the Bank took advantage of a variety of innovative approaches to improve its understanding of global and Canadian inflation dynamics. To help Governing Council make better policy decisions, Bank staff:

  • drew on new and novel sources of data
  • used advanced analytical and survey techniques
  • enhanced the Bank’s modelling capabilities

Shifting the Bank’s communications strategy

In conjunction with the shift in the stance of monetary policy, the Bank worked harder than ever to communicate with Canadians—with a particular emphasis on reaching broader audiences. Through speeches, press conferences and interviews, Bank officials prepared Canadians for higher interest rates, while explaining both their intended impact and the rationale behind them. The greater use of English and French television interviews and social media helped the Bank reach Canadians in both official languages.

Learning lessons

The pandemic and the associated economic crisis have provided many lessons for policy-makers:

  • While its monetary policy tools supported demand during the COVID‑19 pandemic, the Bank underestimated supply challenges. Supply did not recover alongside demand because waves of the pandemic hit various parts of the world at different times.
  • The forces driving demand diverged greatly across sectors, making it challenging for the Bank’s economic models to accurately predict the rise in inflation. A more detailed understanding is needed about the balance between demand and supply when this divergence occurs.
  • Supply disruptions cause increased inflationary pressures when the economy is overheated. Typically, supply shocks affect inflation temporarily, and central banks look past them. But, with the economy in excess demand, the inflation response to supply shocks was faster and more pronounced than expected.

The Bank is already applying these lessons to improve its monetary policy decisions.

Looking forward

The Bank’s top priority in 2023 remains getting inflation back to the 2% target. It has indicated that future decisions about the policy rate will depend on incoming data and judgments about the outlook for inflation.

The Bank is watching closely to see how:

  • the economy responds to higher interest rates
  • supply chain bottlenecks resolve
  • businesses pass on changes in costs to consumers
  • measures of core inflation evolve to gauge underlying inflationary pressures
  • inflation expectations behave, because keeping them well anchored is critical to restoring price stability

The Bank also remains focused on communicating clearly and openly with Canadians while continuing to learn and adapt as the economy experiences what is expected to be a period of very slow growth.

More information

Expecting the unexpected: Central bank decision making in turbulent times (remarks by former Deputy Governor Timothy Lane)

The Bank of Canada: A matter of trust (remarks by Senior Deputy Governor Carolyn Rogers)

The perfect storm (remarks by Deputy Governor Toni Gravelle)

Macroeconomics of the 2020s: What we’ve learned, and what’s to come (remarks by Deputy Governor Paul Beaudry)

What’s happening to inflation and why it matters (remarks by Governor Tiff Macklem)

Economic progress report: More transparency in uncertain times (remarks by Deputy Governor Sharon Kozicki)

Putting the resolute in resolutions: Looking ahead to lower inflation (remarks by Governor Tiff Macklem)

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