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The Bank of Canada should not squander its hard-won credibility by increasing its target rate of inflation

June 29, 2016 – The Bank of Canada should not squander its hard-won credibility by increasing its target rate of inflation, says a new report from the C.D. Howe Institute. In “Toward the Next Renewal of the Inflation-Control Agreement: Questions Facing the Bank of Canada,” author Steve Ambler concludes that Stephen Poloz should stay with 2 percent in the new inflation-control agreement due before year-end.

“The Bank of Canada has been an oasis of stability through recent financial crises, and the current situation is no different,” states Ambler. “The Bank has said it is focusing on three main questions ahead of the 2016 renewal.” These are:

1.Should the targeted rate of inflation be above 2 percent?

2.How should considerations of financial stability be integrated with monetary policy?

3.What should the Bank use as its measure of core inflation?

The report notes that success in hitting 2 percent inflation since the mid-1990s has given the Bank of Canada hard-won credibility: increasing the target rate would jeopardize that credibility, and could be more economically damaging than often believed. As for financial stability policy, the Bank should refine and extend its guidelines for extending liquidity to financial markets. Further, Ambler suggests targeting a type of “core” inflation in which components of the consumer price index are weighted by their degree of stickiness.

“Targeting a core-like measure in which components of the index are weighted by stickiness could lead to increased economic welfare by making monetary policy more effective, even if it is overall headline inflation that is costly to households,” says Ambler.

“Although it might not be feasible to coordinate on such an index in time for the 2016 agreement, the Bank should prepare to move to target a different index in the medium term.”

To read the full report, click here.

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.

For more information contact: Steve Ambler, David Dodge Chair in Monetary Policy at the C.D. Howe Institute, and professor in the Economics Department at the at the Université du Québec à Montréal; or Jeremy Kronick, Senior Policy Analyst, C.D. Howe Institute: 416-865-1904 or email: amcbrien@cdhowe.org