Oct. 29 (Bloomberg) -- Bank of Canada Governor Mark Carney signaled he wants to broaden his inflation-fighting mandate and may seek changes that would allow policy makers to ease swings in lending that can generate asset-price bubbles.

The central bank shouldn’t target asset prices themselves, Carney told the Senate banking committee last night in Ottawa. He said he’s working with the country’s banking regulator on rules to bolster financial stability by smoothing the credit cycle, and there needs to be more cooperation between policy makers to do that.

“It’s not to target an asset, but it’s to begin to lean into the wind of credit growth, whether positive or negative, that amplify economic cycles,” Carney said.

While central banks worldwide are taking greater account of asset prices when they set policy, the Bank of Canada may be seeking to cement a broader mandate. Carney’s comments to senators come after he and his deputies have used public speeches, one per month since August, to raise the possibility of changes to their mandate when the current agreement with the government expires in 2011.

Lean vs. Clean

In an August speech at a Federal Reserve conference in Jackson Hole, Wyoming, Carney addressed the debate on whether central bankers should “lean” against asset-price bubbles or wait until they pop to “clean” up the damage. Carney said the best solution is to have rules that limit swings in credit growth to prevent bubbles in the first place.

Speaking to senators, Carney said rather than targeting asset prices directly, the bank “would change the topic, if we could, to credit formation, credit growth. Is credit growth too fast, is it too slow, is it exacerbating cycles?”

“The Governor seems to be more sympathetic to leaning” against asset-price bubbles, Andrew Spence, head of global interest rate and foreign exchange research at TD Securities and a former central bank adviser, said in an interview before Carney’s remarks yesterday.

The biggest global financial crisis since the Great Depression happened in part because central banks paid too little attention to financial stability, both Finance Minister Jim Flaherty and Carney have said.

Flaherty said that “central banks, including Canada’s, can and should look for ways to improve the implementation of monetary policy in the interest of financial stability,” in an Aug. 31 speech he gave in Vancouver.

Primary Focus

The primary focus of the Bank of Canada’s monetary policy for about two decades has been keeping consumer prices in check, with the bank consistently saying this was the best contribution it could make to the economy. The bank and government formally agreed on Canada’s initial inflation targets in 1991, only months after New Zealand first adopted the regime.

The global credit crunch and recession has helped trigger the biggest drop in consumer prices in half a century, and Carney repeated last night he has “options” to slow a rise in the Canadian dollar that’s also holding down prices. The currency has gained 14 percent this year, and today appreciated 0.9 percent to C$1.0718 at 10:46 a.m. in Toronto, from C$1.0811 yesterday.

Carney also repeated last night that inflation will remain below his 2 percent target until the third quarter of 2011 because there is a lot of “slack” in the economy.

Shifted the Grounds

“They really have shifted the grounds of the ongoing discussion,” said David Laidler, a former visiting economist at the Bank of Canada and author of several books on monetary policy. “Deploying monetary policy to try and stabilize financial markets, that can actually destabilize price-level behavior in a big way.”

The impact of less stable inflation could be wide-ranging. The consumer price index is used as benchmark for wage and pension increases, and it affects bond yields used to price government and mortgage debt.

“We could be in an environment of somewhat more volatile inflation, which I suppose at the end of the day creates a bit more risk for bondholders over the full cycle,” said Doug Porter, deputy chief economist with BMO Capital Markets in Toronto, in a telephone interview.

Broadening the bank’s responsibility risks “at a minimum, causing concern to markets that the bank won’t be as vigilant at policing price stability,” said Derek Holt, economist at Scotia Capital in Toronto. “You can place policy at odds with itself if you’re unclear just what you’re targeting.”

Price-Level Target

In his August remarks, Carney said that trying to promote financial stability can make inflation more volatile. He added a central bank could maintain investor confidence that inflation will remain stable by adopting a price-level target.

Having both Carney and Flaherty talk about the bank’s mandate doesn’t signal a decision has been made, “but it does suggest to me that the Bank is taking a much more serious look at the notion of price-level targeting,” said Angelo Melino, a University of Toronto economics professor and former central bank adviser.

A formal expansion of the bank’s mandate could come at the 2011 renewal of the monetary policy agreement. The bank has said it is looking at two key issues ahead of that renewal: whether it should adopt some type of price-level target, or whether it should lower its inflation target from the current 2 percent.

“The price-level targeting research merits continued focus,” Carney told the senators. “We will continue to invest in it, but it’s too early honestly to come back with any leaning one way or another.”

In a document published at the last renewal, the bank said while it should continue to focus on the consequences of asset- price movements on inflation and growth, the bank might need “some flexibility” in the time it would take to get inflation back to target.

“You can expect to hear more from us on this subject,” Senior Deputy Governor Paul Jenkins said Oct. 8 in Vancouver.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.

Last Updated: October 29, 2009 10:56 EDT