The Bank of Canada will continue to set interest rates with an eye to keeping the consumer price index (CPI) advancing at an annual rate of about two percent, although with more flexibility than it’s had in the past to test the economy’s non-inflationary speed limit.
Finance Minister Chrystia Freeland and central bank governor Tiff Macklem made the announcement in a joint statement on Monday.
“This renewal of Canada’s monetary policy framework is occurring at a time when changes to the economy are complicating the task of monetary policy,” the BoC said. “The global financial crisis and COVID-19 pandemic have had a significant impact on the global economy and financial system, and major trends such as shifting demographics and new digital technologies are altering the economic landscape.”
Among the tools, the renewal grants the central bank is how and when it will use “an extended set of monetary policy tools when circumstances warrant,” and how it will consider “a broader range of labour market indicators to actively seek the level of maximum sustainable employment needed to keep inflation on target.”
The Government of Canada and the Bank of Canada believe that the best contribution of monetary policy to the well-being of Canadians is to continue to focus on price stability. The Government and the Bank also agree that monetary policy should continue to support maximum sustainable employment, recognizing that maximum sustainable employment is not directly measurable and is determined largely by non-monetary factors that can change through time. Further, the Government and the Bank agree that because well-anchored inflation expectations are critical to achieving both price stability and maximum sustainable employment, the primary objective of monetary policy is to maintain low, stable inflation over time.
This renewal of Canada’s monetary policy framework is occurring at a time when changes to the economy are complicating the task of monetary policy. The global financial crisis and COVID-19 pandemic have had a significant impact on the global economy and financial system, and major trends such as shifting demographics and new digital technologies are altering the economic landscape. Climate change and the long-term transition to net-zero greenhouse gas emissions will drive structural change in the Canadian and global economies. Also, there is now greater recognition, supported by economic research, that when the benefits of economic growth and opportunity are more evenly shared, it leads to more prosperity for the whole economy. A strong and inclusive labour market helps reduce income inequality and supports robust demand for goods and services.
Monetary policy is well equipped to address some of these challenges, less so for others. Two developments are particularly salient to the conduct of monetary policy:
- Neutral interest rates are likely to be lower than in the past, which means that central banks will have less room to lower their policy interest rates in the face of large adverse shocks to the economy.
- Major forces, including demographics, technological change, globalization, and shifts in the nature of work, are having profound effects on the Canadian labour market. These evolving forces have increased uncertainty about the level of maximum sustainable employment (i.e., the level of employment beyond which inflationary pressures arise).
Consequently, the Government of Canada and the Bank of Canada agree to renew the inflation target on the following basis:
- The target will continue to be defined in terms of the 12-month rate of change in the total CPI.
- The inflation target will continue to be the 2 percent mid-point of the 1 to 3 percent inflation-control range.
- The agreement will run for another five-year period, ending December 31, 2026.
The Government and the Bank further note that:
- Given that there is uncertainty about the maximum level of employment that is consistent with price stability, the Bank will continue to use the flexibility of the 1 to 3 percent control range to actively seek the maximum sustainable level of employment when conditions warrant.
- The Bank will consider a broad range of labour market indicators and will systematically report to Canadians on how labour market outcomes have factored into its monetary policy decisions.
- The Bank will also continue to leverage the flexibility of the 1 to 3 percent range to help address the challenges of structurally low interest rates by using a broad set of tools, including sometimes holding its policy interest rate at a low level for longer than usual.
- The Bank will utilize the flexibility of the 1 to 3 percent range only to an extent that is consistent with keeping medium-term inflation expectations well anchored at 2 percent.
- The Bank will explain when it is using the flexibility in the framework.