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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Endogenous Liquidity and Capital Reallocation

Staff working paper 2022-27 Wei Cui, Randall Wright, Yu Zhu
We study economies where firms acquire capital in primary markets then retrade it in secondary markets after information on idiosyncratic productivity arrives. Our secondary markets incorporate bilateral trade with search, bargaining and liquidity frictions.

Settlement Balances Deconstructed

Because of the COVID-19 pandemic, public interest in the Bank’s balance sheet and, more specifically, the size of settlement balances, has grown. This paper deconstructs the concept of settlement balances and provides some context on their history, current state and possible future evolution.

Financial Intermediaries and the Macroeconomy: Evidence from a High-Frequency Identification

Staff working paper 2022-24 Pablo Ottonello, Wenting Song
We provide empirical evidence of effects to the aggregate economy from surprises about financial intermediaries’ net worth based on a high-frequency identification strategy. We estimate that news of a 1% decline in intermediaries’ net worth leads to a 0.2%–0.4% decrease in the market value of nonfinancial firms.

Expectation-Driven Term Structure of Equity and Bond Yields

Staff working paper 2022-21 Ming Zeng, Guihai Zhao
Recent findings on the term structure of equity and bond yields pose serious challenges to existing models of equilibrium asset pricing. This paper presents a new equilibrium model of subjective expectations to explain the joint historical dynamics of equity and bond yields (and their yield spreads).

Nowcasting Canadian GDP with Density Combinations

Staff discussion paper 2022-12 Tony Chernis, Taylor Webley
We present a tool for creating density nowcasts for Canadian real GDP growth. We demonstrate that the combined densities are a reliable and accurate tool for assessing the state of the economy and risks to the outlook.
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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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