Next month marks 20 years since Ottawa and the Bank of Canada decided policy makers should set interest rates to target a specific rate of inflation, a system economists say has mostly succeeded at keeping price gains stable, moderate and easy to plan around.
But the latest version of the central bank's agreement with the government expires at the end of 2011, so it's crunch time for the institution to figure out if the current regime - which aims to keep the consumer price index advancing by about 2 per cent a year - should be tweaked.
Some of Canada's leading central bank watchers argue the target should be lower, perhaps 1.5 per cent or 1 per cent, to slow decreases in the value of money - which will become more important as the population ages and more Canadians are living on fixed incomes. Others say the bank should try a virtually untested system that would aim to achieve a certain level for the consumer price index over time, as opposed to targeting the rate of change, by tolerating faster or slower price gains to make up for past misses.
Yet even as the central bank's own research shows a lower target or adoption of so-called price-level targeting could yield economic benefits, policy makers are non-committal about whether they'll try to sell the Finance Department on changes. Perhaps still spooked by memories of a global crisis that illustrated how questionable policy choices can cause severe economic damage, the central bank remains reluctant to tinker with the status quo.
Policy makers including Bank of Canada Governor Mark Carney consistently tout the promise of alternative approaches, while carefully adding that there's a "high bar" facing those pushing for change.
"We're very happy with the simplicity of our inflation targeting mandate," Mr. Carney said last week in an interview with Bloomberg Television from the World Economic Forum in Davos, Switzerland. "During the crisis, and coming out of the crisis, and at moments like this when the focus comes back on inflation, it's incredibly helpful to have the discipline of a simple target.''
The issue is more than academic, with inflation back on the radar and posing a risk to the global recovery. Surging demand for food and commodities in rapidly growing emerging markets like China is driving prices higher, and this is spilling over to places such as Britain where growth is tepid at best and raising interest rates to combat inflation hardly seems an option.
Backers of price-level targeting say setting a goal for price levels over a specified period would increase price stability, because consumers and investors would have a clearer idea of how to value purchases or longer-term assets. In 2009, the central bank published research showing yields on longer-term debt would probably fall under such a regime, which would help younger households that borrow more, and also make it easier for governments to finance deficit spending when necessary.
Many also say price-level targeting - tried only in Sweden, in the 1930s - could be a potent weapon in fighting deflation when an economy is in recession or barely growing and interest rates are near zero. The idea is that the mere expectation that the central bank will offset stagnant prices by spurring faster inflation down the road could push people to make purchases rather than put them off.
"As you get close to that zero lower bound people will look forward and say, 'Well, if we ever hit that zero lower bound, the Bank of Canada is going to be generating higher inflation in the future, so the economy won't be as bad as we think it's going to be a few months down the line and there's no reason for us to be afraid now,'" explained Angelo Melino, an economics professor at the University of Toronto who sits on the C.D. Howe Institute's monetary policy council.
Another team of Bank of Canada economists concluded in 2009 that on top of challenges policy makers would face in communicating such a change to the public - or convincing consumers and financial market players that they wouldn't break their pledge to let prices reach a certain level - not enough is known about how a price-level targeting regime would respond to shocks like a sharp rise or drop in commodity prices.
Prof. Melino, who last week published a paper recommending, among other things, that the central bank gradually cut its inflation target to 1 per cent and experiment with price-level targeting if its benchmark rate hits near-zero again, said he isn't holding his breath for changes.
"They certainly have been investigating very seriously, but I think you have to make a sharp distinction between what they're researching and what they'll end up choosing to do," he said.
Chris Ragan, a McGill University economics professor who leads the C.D. Howe Institute's research on monetary policy, said in an interview that he would prefer to see the central bank's inflation target reduced to 1 per cent, citing evidence that Statistics Canada's consumer price index is "biased upward" by about 0.6 percentage point. As a result, he argues, the change wouldn't be as big as some might think.
"Let's lower the inflation target from 2 per cent to 1 per cent, and in so doing we'll only be reducing true inflation from 1.4 per cent to 1 per cent," Prof. Ragan said.
At the very least, most say the central bank's narrow mandate should be expanded to somehow give it explicit leeway to help shield the financial system from asset bubbles of other potentially dangerous imbalances, such as Canadian households' growing debt loads.
While systemic oversight of the banking system in Canada is nominally handled by a committee that includes the central bank, explicit regulatory authority is in the hands of the Finance Minister and the Office of the Superintendent of Financial Institutions.
In December, Mr. Carney indicated the central bank is looking at whether there are cases where it might consider taking pre-emptive actions against building financial imbalances. Indeed, there is a growing view since the crisis that price stability over the long haul depends on making sure the financial system is stable too.
But that doesn't mean the notion that policy makers should stick to controlling inflation has gone away.
"It's very difficult to have more than one policy target and maintain your focus," said Benjamin Reitzes, an economist with BMO Capital Markets.
With files from Kevin Carmichael in Washington