Monetary policy

Our commitment is to keep inflation low, stable and predictable. To do this, we must understand what causes inflation and ensure our tools and framework remain fit for purpose in a world with more frequent supply disruptions.

In recent years, Canada has faced high inflation and used exceptional monetary policy tools, such as quantitative easing, to restore price stability. Looking back on this period offers a valuable opportunity to understand the underlying drivers of inflation and evaluate the effectiveness of these monetary policy tools.

The future of the economic environment remains uncertain, and structural challenges are making both the global and Canadian economies more susceptible to supply disruptions. That makes it important to gain a comprehensive understanding of how these challenges affect production, employment, inflation dynamics and the transmission of monetary policy.

Studying these issues will help monetary policy adapt to changes in the economy and maintain price stability. We are looking at issues in several areas, including:

  • the pricing strategies that firms use, including during supply shocks
  • the best approaches for setting monetary policy in periods of high uncertainty
  • the impact of monetary policy on the supply and demand of housing
  • the effectiveness of various monetary policy tools used during the COVID-19 pandemic
  • the ability of flexible inflation-targeting to maintain price stability when the economy is unpredictable

Inflation dynamics

Our research on inflation dynamics aims to further our understanding of the factors behind inflation, particularly since the end of the COVID-19 pandemic. To do so, we are using new data sources, innovative research methods and advanced economic models. For example, we are using novel business- and product-level data to explore how businesses pass on costs to consumers. Similarly, consumer-level data help us understand how households adjust their spending and expectations as inflation rises and falls.

Transmission and conduct of monetary policy

Canada is entering a period of rapid economic transformation. In this context, we need to understand how monetary policy affects different households and businesses and how it works its way through the economy. We must also find the best way to set monetary policy and manage risks—responding to trade-offs between stabilizing growth and controlling inflation—particularly if Canada faces more frequent supply shocks.

Monetary policy tools and implementation

The economic effects of the COVID-19 pandemic prompted the Bank to use extraordinary tools, such as quantitative easing. The use of these tools has had a significant impact on the size and structure of the Bank’s balance sheet. Our research focuses on the impact and effectiveness of these tools and on how the Bank can effectively influence market interest rates with an expanded balance sheet.

Monetary policy framework

Jointly with the Government of Canada, the Bank reviews its monetary policy framework every five years to keep pace with changes in the economic environment. Since the COVID-19 pandemic, more frequent shocks and unprecedented challenges have increased volatility, generated persistent imbalances in the housing market and reduced the reliability of our key measures of underlying inflation. Our research will help future reviews of our framework to ensure that monetary policy remains effective in promoting the economic and financial well-being of Canadians.

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Interpreting Volatility Shocks as Preference Shocks

Staff working paper 2016-45 Shaofeng Xu
This paper examines the relationship between volatility shocks and preference shocks in an analytically tractable endogenous growth model with recursive preferences and stochastic volatility. I show that there exists an explicit mapping between volatility shocks and preference shocks, and a rise in volatility generates the same impulse responses of macroeconomic aggregates as a negative preference shock.

The Paul Storer Memorial Lecture—Cross-Border Trade Integration and Monetary Policy

Staff discussion paper 2016-20 Stephen S. Poloz
In this paper we explore the nexus between cross-border trade integration and monetary policy. We first review the evidence that trade liberalization has increased the degree of integration in North America and conclude that, while robust structural inferences remain elusive, there is sufficient supporting evidence for central banks to treat the issue seriously.

On What States Do Prices Depend? Answers from Ecuador

Staff working paper 2016-43 Craig Benedict, Mario J. Crucini, Anthony Landry
In this paper, we argue that differences in the cost structures across sectors play an important role in firms’ decisions to adjust their prices. We develop a menu-cost model of pricing in which retail firms intermediate trade between producers and consumers.

A Primer on Neo-Fisherian Economics

Staff analytical note 2016-14 Robert Amano, Thomas J. Carter, Rhys R. Mendes
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.

The Global Benefits of Low Oil Prices: More Than Meets the Eye

Staff analytical note 2016-13 Robert Fay, Justin-Damien Guénette, Louis Morel
Between mid-2014 and early 2016, oil prices fell by roughly 65 per cent. This note documents the channels through which this oil price decline is expected to affect the global economy. One important and immediate channel is through higher expenditures, especially in net oil-importing countries.
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Disclaimer

Bank of Canada staff produce research and analysis to support the work of the Bank and to advance knowledge in the fields of economics and finance. The research is non-partisan and evidence based. All research is produced independently from the Bank’s Governing Council. The views expressed in each paper or article are solely those of the authors and may differ from official Bank of Canada views.

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