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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Regulation, Emissions and Productivity: Evidence from China’s Eleventh Five-Year Plan

Staff working paper 2024-7 Brantly Callaway, Tong Li, Joel Rodrigue, Yuya Sasaki, Yong Tan
We study the degree to which China’s 11th Five-Year Plan softens trade-offs between emissions and output. Our model suggests efficient regulation could have further increased aggregate productivity by 3.5% and output by 4.7% without any increase in aggregate emissions.

What has been putting upward pressure on CORRA?

Staff analytical note 2024-4 Boran Plong, Neil Maru
From the autumn of 2023 into early 2024, the Canadian Overnight Repo Rate Average (CORRA), a measure of the cost of overnight general collateral Canadian dollar repos, was consistently well above the Bank’s target for the overnight rate. We find that, among several factors, long bond positions that require repo financing are the main driver of the recent upward pressure on CORRA.

How changes in the share of constrained households affect the effectiveness of monetary policy

Staff analytical note 2024-3 Felipe Alves, Sushant Acharya
We measure how the change in the share of constrained households in Canada following the COVID-19 recession has impacted the effectiveness of monetary policy.

How Do Agents Form Macroeconomic Expectations? Evidence from Inflation Uncertainty

Staff working paper 2024-5 Tao Wang
The uncertainty regarding inflation that is observed in density forecasts of households and professionals helps macroeconomists understand the formation mechanism of inflation expectations. Shocks to inflation take time to be perceived by all agents in the economy, and such rigidity is lower in a high-inflation environment.

The Role of International Financial Integration in Monetary Policy Transmission

Staff working paper 2024-3 Jing Cynthia Wu, Yinxi Xie, Ji Zhang
We propose an open-economy New Keynesian model with financial integration that allows financial intermediaries to hold foreign long-term bonds. We study the implications of financial integration on monetary policy transmission. Among various aspects of financial integration, the bond duration plays a major role. These results hold for conventional and unconventional monetary policies.
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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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