Bank of Canadas Experience with Inflation Targeting: Partnering with - PowerPoint PPT Presentation

Bank of Canada’s Experience with Inflation Targeting: Partnering with the Government John Murray Brookings Institution Washington, January 8, 2018

Introduction of inflation targeting in Canada • Government’s proposal • Bank of Canada’s response • G- 10 Governors’ reaction • Initial inflation-reduction framework (1991): - Target of 3 per cent for 1992 - Declining to 2 per cent by 1995 - 1 per cent bands on either side of target mid-point • Post-1995 agreement to be guided by 1991-1995 experience

Key aspects of the inflation targeting agreement • Joint public announcement by the Government and the Bank • Simple press release without any supporting legislation • Government-Bank of Canada partnership, with one more equal than the other • Goal vs operational independence and the directive power • Early ambitions regarding the ultimate price stability goal • Origins of the renewal process

Aiming for price stability vs. low inflation • Excerpts from the 1991 press release - “The specific targets for the year -over-year rate of increase in the consumer price index (CPI) are as follows: … 2 per cent by the end of 1995” - “Thereafter the objective would be further reduction in inflation until price stability is achieved.” - “A good deal of work has already been done for Canada. This works suggests a rate of increase that is clearly below 2 per cent.”

Performance under inflation targeting • Target renewed in 1993 (instead of 1995) and again in 1998, 2001, 2006, 2011, and 2016 • 2 per cent maintained as the target mid-point • Objective recast as “low, stable and predictable inflation” as opposed to “price stability” • Performance over the last 27 years better than expected: - Lower average inflation and interest rates (and growth) - Lower volatility of inflation, interest rates and growth • Suspicions the Bank has been price-level targeting covertly

Chart 1: Inflation performance has been better than expected __________________________________________________ % Consumer price index inflation, year-over-year, monthly data 14 Start of inflation targeting 12 10 8 6 4 2 0 -2 1975 1980 1985 1990 1995 2000 2005 2010 2015 Inflation control range CPI inflation Inflation target

Chart 2: Suspicions that the Bank of Canada has been price-level targeting __________________________________________________ 1995=100 Monthly data 160 150 140 130 120 110 100 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Hypothetical 2% price-level target path CPI Source: Statistics Canada and Bank of Canada Last Observation: November 2017

Advantages of the regular renewal process - Critical part of the Bank’s accountability and fiduciary duties - Way of diffusing potential problems – “just business as usual” - Deliberate and transparent mechanism to engage stakeholders and get feedback - Means of promoting public awareness and understanding - Driver for more focused research effort within the Bank - Something new has been learned on each occasion

Possible disadvantages of the renewal process • Disadvantages: - Expectations less well-anchored, greater inflation uncertainty - Increased scope for unhelpful outside interference - Waste of time and energy - Trying the public’s patience (announcement fatigue) • Counter-arguments - No evidence of fragile or unanchored inflation expectations - Mechanism for enhancing central bank independence - Important confirmation (or not) of the framework’s soundness

Chart 3: Inflation expectations have become well anchored Medium term inflation expectations, year-over-year percent change % 3 2.5 2 1.5 1 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Consensus economics – 2-3 years Survey of Private Sector Forecasters – 2 years

Issues the Bank of Canada has examined • Two types of issues examined as part of the renewal process • Fundamental: - Should the inflation target be lowered (raised)? - Would a price-level target be better? - How much recognition should be given to financial stability? • Operational/housekeeping: - Is the CPI the best target price index? - What is the best measure of core inflation? - How important is measurement bias?

Looking ahead • Next renewal is set for 2021 • BoC already mapping out a research program for the next five years • Final questions not yet determined but intend to take a broader sweep • Three main categories: objectives, tools, and communication • Some old issues will likely be revisited, other new issues will be added Main Takeaway – The Bank of Canada values the renewal process and believes it provides significant net benefits