The Bank of Canada and Government Announce New Monetary Policy Renewal

The aim of Canada’s fiscal policy is to enhance the economic and financial well-being of Canadians. Experience has proven that the best way to achieve this goal is to keep inflation low and stable. Doing so supports a strong and inclusive labor market, which provides every Canadian with opportunities for a good quality of life.

Currently, inflation has risen in Canada and other countries as the global economy reopens. While this is a global phenomenon, it makes it even more important to maintain a strong framework for monetary policy in Canada.

From a long-term perspective, since the adoption of the inflation-targeting framework 30 years ago, Consumer Price Index (CPI) inflation has averaged close to 2 percent, while there has been both upward and downward pressure on inflation. Maintaining low, stable, and predictable inflation has also contributed to Canada’s strong labor market performance. As things stand, Canada’s fiscal policy aims to ensure that inflation returns to 2% in the medium term.

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The Government of Canada and the Bank of Canada believe that monetary policy can best contribute to the well-being of Canadians by focusing on price stability. The Government and the Bank also agree that monetary policy should support maximum sustainable employment, recognizing that maximum sustainable employment cannot be measured directly and is primarily determined by non-monetary factors that can change over time. In addition, the Government and the Bank agree that stable inflation expectations are critical to achieving both price stability and maximum sustainable employment, so the primary objective of monetary The aim of the policy is to keep inflation low and stable in the long run.

This renewal of Canada’s monetary policy framework comes at a time when changes in the economy are complicating the task of monetary policy. The global financial crisis and the COVID-19 pandemic have had a significant impact on the global economy and financial system, and key trends such as shifts in demographics and new digital technologies are altering the economic landscape. Climate change and the long-term transition to zero greenhouse gas emissions will bring structural changes to the Canadian and global economies.

In addition, there is now greater recognition, supported by economic research, that when the benefits of economic growth and opportunity are shared more equitably, this leads to greater prosperity for the entire economy. A strong, inclusive labor market can slow the growth of income inequality and also boost aggregate demand for goods and services.

Elsewhere in this blog, I discuss one of these problems (when some issues may not be sensitive at all to changes in short-term interest rates ) and refer here only to monetary policy as an instrument that works better for certain other challenges. We see two aspects of the way in which monetary policy is being conducted as highly significant:

• Neutral rates: Neutral rates are forecasted lower by monetary policy committees, implying less space to cut their policy rate in response to a negative shock.

• Changing nature of work: Demographics, technological change, globalization, and other changes in the economy are affecting Canada’s labor market. This uncertainty being fed by these mutative forces will make defining the level of maximum sustainable employment (the point where inflation starts to build) trickier than ever.

Accordingly, the agreement between the Government of Canada and the Bank of Canada to continue this renewed inflation target will be:

• TARGET DEFINITION The target will remain to be expressed in terms of the 12-month measure of CPI inflation.

• The inflation target will continue to be at the 2 percent mid-point of the 1 to 3 percent inflation-control range.
• This agreement will last for another five-year period, ending on December 31, 2026.

The Government and the Bank further note:

• Given that there is uncertainty about the maximum level of employment compatible with price stability, the Bank will continue to use the flexibility of the 1 to 3 percent control range to actively seek the maximum sustainable employment level as the situation evolves.
  
• The Bank will consider a wide range of labor market indicators and systematically report to Canadians on how this contributes to monetary policy decisions.
  
• The Bank will continue to take advantage of the flexibilities in the 1 to 3 percent range to help address the challenges of structurally low interest rates, including at times keeping its policy interest rate low for longer than usual.

• The Bank of Canada said: ‘Any future increases in bank rate are expected to be at a gradual pace and to a limited extent, for example, some of those needing addresses regularly rent.

• The Bank will articulate when it is employing the flexibilities in the framework.

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The Government and the Bank also recognize that a low interest rate environment may be more prone to financial imbalances. In this context, the Government will continue to work with all relevant federal agencies to ensure that the arrangements for Canadian financial regulation and supervision are appropriate and consider changes if and where necessary.

Finally, while recognizing that there are limits to monetary policy, both the Government and the Bank recognize their joint responsibility to achieve the inflation target and promote maximum sustainable employment.