 Toward the Next Renewal of the Inflation-Control Agreement: Questions Facing the Bank of CanadaSteven Ambler
C.D. Howe Institute Commentary, 2016, issue 453 Abstract: With the Bank of Canada set to renew its inflation-control target agreement with the federal government later in 2016, this paper investigates three directly related questions: • Should the targeted rate of inflation be raised above 2 percent? • How should considerations of financial stability be integrated with monetary policy? • What should the Bank use as its measure of core inflation? As for the first question, this paper argues that the Bank of Canada should not squander its hard-won credibility by increasing the target rate of inflation, especially since the costs of even moderate trend inflation (in the range of 3–4 percent) might be higher than previously estimated. Given worries about the zero lower bound, the Bank should consider alternative monetary policy frameworks, including some form of level targeting. The rapid adjustment in expectations to the inflation-targeting regime in 1991 should allay the Bank’s fears concerning its communication and how quickly the public would adapt to a new policy framework. Concerning financial stability policy, the Bank of Canada should refine and extend its guidelines for extending liquidity to financial markets. In particular, it should consider under what limited circumstances it would extend credit bilaterally to individual financial institutions while still favouring a market-based allocation mechanism. It should also consider if and under what circumstances it would intervene in frozen markets for particular asset classes by acting as market maker of last resort. In addition, macroprudential policy should concentrate on simple heuristic strategies based on the principle of “skin in the game.” To the extent that macroprudential policy involves nonmarket control over the allocation of resources, it would be better for the Bank to participate as one of several experts in an independent body tasked to promote financial stability. Otherwise, it would leave itself open to criticism for a lack of accountability and thereby risk jeopardizing its operational independence. The independent body should be directly responsible to the Department of Finance. Strong arguments exist for actually targeting a core-like measure of inflation in which components of the index are weighted by their degree of stickiness. Targeting such an index could lead to increased economic welfare by making monetary policy more effective, even if it is overall headline inflation that is costly to households. Although it might not be feasible to coordinate on such an index in time for the 2016 agreement, the Bank should prepare to move to target a different index in the medium term. Keywords: Monetary; Policy (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cdh:commen:453 Access Statistics for this article More articles in C.D. Howe Institute Commentary from C.D. Howe Institute Contact information at EDIRC. |
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