CHANGES IN THE INFLATION PROCESS IN CANADA: Evidence and Implications

Doug Hostland

Staff Working Papers from Bank of Canada

Abstract: The Canadian economy is currently in transition from a period of disinflation to one with a very low and relatively stable inflation rate. Against this background, the author asks whether reduced-form parameters should be expected to be invariant to changes in the inflation process. This raises two empirical issues. The first relates to whether shifts in the Canadian inflation process can be identified over time. It appears so, since casual observation as well as various statistical procedures indicate that there was a unique period from the mid-1950s to the early 1970s when inflation was low and relatively stable. The second issue relates to whether there is evidence that parameter instability corresponds to shifts in the inflation regime. Statistical tests indicate that parameter instability is an important concern in reduced-form models of the inflation process, particularly for the early 1970s. The evidence for Canada suggests that inflation forecasts from reduced-form models may be unreliable in the presence of important changes in the inflation process. L'economie canadienne est en transition entre une phase de desinflation et une periode caracterisee par un taux d'inflation tres bas et relativement stable. Dans ce contexte, l'auteur se demande s'il faut s'attendre a ce que les parametres d'une equation de forme reduite soient insensibles aux changements qui s'operent dans le processus d'inflation. Deux questions empiriques se posent a cet egard. En premier lieu, il faut determiner si des modifications peuvent etre decelees au fil du temps dans le processus d'inflation au Canada. Il semble qu'il en soit ainsi, puisqu'une analyse des donnees, meme superficielle, de meme que diverses methodes statistiques revelent que le Canada a vecu une periode unique de taux d'inflation bas et relativement stables, soit du milieu des annees 50 au debut des annees 70. En deuxieme lieu, il faut etablir s'il y a des preuves que l'instabilite des parametres correspond a des changements du regime d'inflation. Les tests statistiques indiquent qu'il faut prendre en consideration l'instabilite des parametres dans les modeles de forme reduite relatifs au processus d'inflation, particulierement pour le debut des annees 70. Les resultats obtenus pour le Canada donnent a penser que les previsions d'inflation faites a l'aide de modeles de forme reduite peuvent ne pas etre fiables quand d'importants changements s'operent dans le processus d'inflation

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Working Paper: CHANGES IN THE INFLATION PROCESS IN CANADA: Evidence and Implications (1995)
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