Canada Extending Central Bank’s 2% Inflation Target Policy for Five Years

The Bank of Canada renewed its target for 2 percent inflation for the next five years after considering a plan to adopt the world’s only price-level target.

The agreement with the government to keep the annual rise in the consumer price index at the middle of a 1 percent to 3 percent range was to expire at the end of the year. The bank had looked into whether the target should be lower, if the level of the consumer price index should be the focus instead of the inflation rate and whether monetary policy should be used to discourage asset bubbles.

Finance Minister Jim Flaherty and the Bank of Canada published the agreement in a joint statement from Ottawa today. Canada led the Group of Seven by adopting an inflation target in 1991, a policy about two dozen central banks now use, including the Bank of England and the European Central Bank. U.S. Federal Reserve Chairman Ben S. Bernanke also has expressed some support for establishing an inflation target.

“When you have a status quo that’s working pretty well, you want to make a pretty serious case for changing it,” said Christopher Ragan, a former adviser to the central bank and finance department and a McGill University economics professor. “I don’t think there were obvious policy options that would have unquestionably improved performance.”

The Bank of Canada will hold a briefing for reporters about the new agreement tomorrow morning in Ottawa.

Research to Continue

“The experience of the global economic and financial crisis underscored the value of Canada’s flexible inflation- targeting framework,” according to the statement posted on the central bank’s website today. “The Bank will continue its research into potential improvements in the monetary policy framework.”

Inflation has averaged 2 percent since the Bank of Canada adopted targets in February 1991, compared with an average of 6.9 percent during the previous 15 years, according to data compiled by Bloomberg.

Consumer prices advanced 3.2 percent in September from a year earlier, Statistics Canada said Oct. 21, the 10th month in a row it exceeded the bank’s target. The core rate that excludes eight volatile items reached the highest in almost three years at 2.2 percent.

“At a time of continuing global economic uncertainty, it is more important than ever to provide a stable economic environment that bolsters confidence and supports growth,” Flaherty said in a statement. “The flexible approach to inflation targeting we have in Canada helps create these conditions.”

No Change Predicted

Seven of 11 economists polled from Sept. 22 to Sept. 29 said the bank’s goal would not change at the renewal.

“What has served this country extremely well over the course of the last 20 years has been flexible inflation targeting,” Bank of Canada Governor Mark Carney said earlier today at a press conference in London.

At the time of the last renewal in 2006, the bank said policy should aim to get inflation back to target within 18 to 24 months in most cases.

Carney said today “there may be financial stability considerations that affect the length” of time the bank takes to bring inflation back to target, adding there have been nine times over last decade where inflation took longer than the normal timeframe to return to target.

The governor has also said economic recoveries linked to the global financial crisis will take longer than past recessions, and that the policy interest rate -- currently 1 percent -- may not return to normal levels by the time output does.

No History

While studies have suggested price-level targeting may allow people to predict prices more accurately over longer periods, it has almost no history outside Sweden, which used it in the 1930s to help stop deflation, according to a 1998 paper by Claes Berg and Lars Jonung of Sveriges Riksbank, the country’s central bank.

The main difference between the bank’s current target and a so-called price-level target is how officials take past inflation into account when making decisions about interest rates. With inflation targeting, “bygones are bygones,” the Bank of Canada said in a paper it published in 2006, the last time the agreement was renewed.

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

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net; David Scanlan at dscanlan@bloomberg.net.

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