Canada Sticks With G-7’s Longest-Running Inflation Target

Canada’s central bank is sticking with a 2 percent inflation target for another five years, saying the well-established mandate remains the best support for a weak economy.

The Bank of Canada had studied the possibility of raising the target to give it more room to add stimulus, and said in a joint statement with the finance department Monday that the costs of a change were too high.

“Given such challenges, monetary policy frameworks have themselves come under intense scrutiny” around the world, the bank said from Ottawa. “Throughout this period, the Bank of Canada’s flexible inflation targeting framework has continued to demonstrate its value.”

The effectiveness of inflation targeting, now a worldwide standard, has been thrown into question as countries struggle to meet their targets even with interest rates at historical lows. Canada’s inflation rate has been below the central bank’s goal for most of the past two years, and has averaged 1.4 percent over the last five years. That’s the biggest gap relative to target since the policy was adopted in 1991 -- including the period around the 2008 global financial crisis.

New Indicators

Canada’s main inflation target will remain untouched. The bank again defined it as the 12-month rate of the consumer price index, in the middle of a 1 percent to 3 percent band, the joint statement said.

Changes announced Monday were more of a technical nature. For example, the central bank said it will replace its single measure of core inflation by three new indicators. The central bank uses core inflation as a guide to future trends since it strips out short-term volatility.

The average of the three measures -- at about 1.8 percent - - is about the same as for the old core index, suggesting no major change in the track of monetary policy, according to James Rossiter, senior global strategist at TD Securities in London, and a former Bank of Canada official. The broader core measures allow officials to highlight price trends that better reflect their thinking, and “the bottom line here is keep calm and carry on,” he said.

The central bank also refrained from increasing the role of monetary policy in aiding financial stability, arguing regulators must take the lead on the issue.

The bank took the extra step of publishing Governor Stephen Poloz’s recommendation letter to Finance Minister Bill Morneau.

Benefits vs. Costs

To be sure, the Bank of Canada has already tweaked its mandate since the financial crisis. In 2011, it explicitly adopted what it calls “flexible inflation-targeting,” giving policy makers discretion to take extra time to meet their goal in situations such as a severe shock or slowdown.

The central bank also now believes it has more tools than it initially thought, meaning the 2 percent target is considered less of a constraint. Officials now calculate they are no longer bound by zero interest rates, and can effectively lower them to around negative 0.5 percent.

Poloz hinted as recently as last week there wouldn’t be any changes, when he told lawmakers there are few cases where a higher inflation target could actually be beneficial. That would have to be weighed against permanently higher inflation, which essentially would be akin to a tax on consumers, he said.

Another benefit of the current system is that it is well understood, the bank said Monday.

“The well-established credibility of this framework has reinforced the Canadian public’s confidence that monetary policy will continue to achieve the inflation target, and helped underpin the Canadian economy through challenging times,” the bank said.

Global Debate

Central banks’ failure to stoke growth and meet inflation targets has raised some global calls for change. U.S. Federal Reserve Bank of San Francisco President John Williams called earlier this year for studying options such as a higher inflation target.

Canada’s renewal of the 2 percent target can be seen globally as an important vote of confidence for the policy. Canada -- the classic small, open economy -- has been a harbinger of major changes in the global monetary system, from inflation targets to floating exchange rates.

“We have had some discussion around the globe about potential change” to inflation targets, said Craig Wright, chief economist at Royal Bank of Canada. For Poloz the consideration was that if “it’s not broken, don’t fix it.”

(Updates with analyst comment in seventh paragraph.)

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