January 12, 2021 – The Bank of Canada built an impressive track record with its policy moves pre-COVID, then the pandemic knocked its plans off track, says the first annual review of the Bank’s monetary policy performance from the C.D. Howe Institute.
In “For the Record: Assessing the Monetary Policy Stance of the Bank of Canada,” authors Steve Ambler and Jeremy M. Kronick look at whether the stance of monetary policy was appropriate for hitting the Bank of Canada’s inflation target during 2018 and 2019, and examine how to determine in real time whether monetary policy is too loose or too tight.
The main objective of the Bank of Canada’s monetary policy is to keep Canada’s inflation rate low, stable and predictable. This helps households and businesses make spending and financial decisions with more confidence, fostering greater output and higher economic growth.
The authors define monetary policy as too loose when it leads – or is likely to lead – to inflation being above the 2 percent target over the Bank’s planning horizon of six to eight quarters, and too tight when it leads inflation to be below target over that horizon.
To establish the validity of indicators measuring the stance of monetary policy in normal times, Ambler and Kronick look back to 2018 and 2019 and find the Bank’s stance was largely right.
The authors conclude that, in general, determining whether monetary policy in real time is too loose or too tight depends on the evaluative methodology, and suggest using an eclectic approach to evaluating monetary policy stances and multiple methodologies as robustness checks.
Canada’s headline inflation in 2018 averaged 2.3 percent and in 2019 it was 1.95 percent – almost indistinguishable from the target. “Headline inflation in both 2018 and 2019 was very close to the Bank’s 2 percent target despite volatile conditions in the world economy,” say the authors.
The COVID pandemic then knocked monetary policy off track. “If the economy hadn’t been hit with a massive shock in 2020 due to COVID, it’s likely the Bank would be on target for 2021,” says Kronick.
With the most massive expansion of its balance sheet outside of wartime, the Bank now faces challenges hitting its 2 percent target. With the overnight rate at its effective lower bound, unconventional tools, such as forward guidance and quantitative easing, will be vital in fighting the current crisis.
The authors suggest based on the overnight rate alone, indicators would show that the Bank’s monetary policy at the end of 2020 was too tight. “COVID prevented the Bank from being expansionary enough through the overnight rate,” says Ambler. “Looking ahead, indicators will have to make use of unconventional tools.”
For more information contact: Steve Ambler, David Dodge Chair in Monetary Policy and Professor of Economics (retired) at the Université du Québec à Montréal; Jeremy M. Kronick, Associate Director, Research, C.D. Howe Institute; or Nancy Schlömer, Communications Officer, C.D. Howe Institute, email: email@example.com.
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.