Inflation Targeting Canada

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Inflation TargetingCanada

• Leonard Manalo, Terrance , Gregory Belcher,
  Renaldo Stultz

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Canada

• GDP 1.114 Trillion
• 13th in the world
• Growth Rate of 2.9 and Unemployment of 6.5 (AUG
  2006)

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Inflation Targeting Definition

• Implemented 1991
• Announcing a numerical goal for inflation
• The Bank of Canada (BOC) uses the total CPI to
  measure inflation
• But it looks more closely at the Core CPI
• Removes the eight most volatile elements of the
  CPI
• More Consistent measure of inflation

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Goals of Inflation Control

• Allows predictability of average inflation
• Lower market interest rates
• Positive climate of long-term investment
• Prevents significant deflation
• Sets a target range for inflation from 1 to 3
  percent
• To achieve this range monetary policy needs to
  aim for a 2 target midpoint

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Overnight Rate

• The rate that financial institutions borrow or
  lend between each other with the period on one
  day.
• Financial institutions need to cover their daily
  transactions by borrowing, either with public
  banks or the central bank.

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Overnight Rate

• The Monetary Tool of the Operational Band
• Targeted overnight rate is at the center and
  there are .25 margins at the top and bottom
• For example
• As of September 9, 2006 target rate is 4.25
• Banks borrow from the Bank of Canada at 4.50
• Banks can earn 4.00 on deposits in the Bank of
  Canada.
• Under this system, Bank of Canada has complete
  control of the overnight rate.
• Banks cannot borrow or lend outside of the
  operational band.

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Overnight Rate (Cont)

• Through the overnight rate, the Bank of Canada
  can influence other interest rates
• They can influence economic performance
• Including (at an aggregate level)
• Output
• Price

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Implementation

• When BOC wants to increase the price level, they
  will lower target rate.
• Influence money market and reduce the interest
  rate of individual financial institutions
• Lower interest rates gtgtgt increase investment and
  aggregate demand moves upward gtgtgt Price level
  increases

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Results of the Inflation Targeting Regime

• Must Sacrifice Price Stability for Employment
• AW Phillips suggests that policy makers must
  scarify the labor market in order to keep prices
  stable.
• Core Inflation has been low, and under control

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Results (Cont)

• The inflation rate in 1991 was 5.9
• By December 1993, inflation had been reduced to
  2
• The government extended the inflation-control
  target range in 1998, 2001, and 2006.

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Economic Growth

• Economic Growth due to Inflation Targeting is
  ambiguous.
• Growth may have to do more with stronger Canadian
  Dollar.
• Current Growth in Canada is 2.9.