Canada Mulls Higher Inflation Target Amid Lower Growth

The Bank of Canada is considering whether it should raise its 2 percent inflation target as it adapts to a future of slower global growth and lower policy interest rates.

The so-called neutral interest rate in Canada -- the longer-term level needed to keep inflation and growth balanced - - has fallen by 1.5 percentage points to between 3 percent to 4 percent since the global financial crisis, Deputy Governor Agathe Cote said today in Calgary. That will probably increase the frequency of occasions when the central bank needs to increase stimulus but is “constrained” by interest rates at about zero percent, Cote said.

“These factors suggest that consideration should be given to an inflation target that is above 2 percent,” Cote said in a speech today in Calgary. The success of inflation targeting in Canada means “the bar for change is high,” she said.

Cote said with an unchanged inflation target, the probability of being constrained by the so-called zero lower bound rises to 15 percent, from 5 percent. Global financial regulatory reform will work in the opposite direction, reducing the likelihood of such episodes, she said.

Any move to raise inflation targets would be the first since they were introduced in 1991. The goal is set under five-year agreements with the federal government and the next renewal is in 2016. Canada cut its benchmark overnight rate to a record low 0.25 percent in 2009, and it has been at 1 percent since September 2010 because of lagging business investment and exports.

‘Very Credible’

“The 2 percent target has been in place so long, it’s become very credible,” Bank of Montreal senior economist Robert Kavcic said by phone from Toronto. Any change may risk some of the bank’s credibility, he said.

The Bank of Canada is also studying whether its core inflation measure should be the main guide to future price trends, Cote said. The core index excludes eight volatile items.

“Various measures of core inflation will be re-examined to determine whether the Bank should continue the practice of identifying one pre-eminent measure of inflation as its operational guide,” she said.

The central bank is tracking household “imbalances” that have built up through the crisis, Cote said, reiterating comments by Governor Poloz that setting monetary policy to correct them is not an “attractive” solution. Other regulators should take the lead in fixing those kinds of strains in the financial system, she said.

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