Bank of Canada deputy governor Lawrence Schembri is expecting little change to the central bank’s current inflation targeting regime, even as it examines alternative monetary policy targets, including a potential “dual mandate” that would put a more explicit focus on employment.
The bank is currently reviewing its policy objectives as part of a regular five-year review process. This means looking at alternative monetary policy models, such as a dual mandate that targets inflation and maximum employment, or an “average inflation targeting” model – recently adopted by the U.S. federal reserve – that allows inflation to run high after periods of economic contraction.
In a speech to the Hoover Institute at Stanford University on Wednesday, Mr. Schembri said the Bank of Canada’s current “flexible inflation targeting” regime, which seeks to achieve 2-per-cent inflation within a 1-per-cent to 3-per-cent range, has been effective and that “incremental adjustments to the framework may be best.”
“This notion that we can use a more sophisticated framework like average inflation targeting or price level targeting, where we can actually move inflation expectations in such a way it actually helps the effectiveness of monetary policy, I think is a bridge too far,” Mr. Schembri told the virtual gathering of economists.
Much of the success of the current model has to do with its simplicity. It is easy to explain the 2-per-cent inflation target to Canadians. That helps anchor business and household expectations about inflation, and provides a signpost by which Canadians can judge the performance of the central bank.
“I’ve worked in non-profit organizations where they’re doing their budget for next year and they simply increase their costs by 2 per cent. So it’s become, to a large extent, hardwired in people’s brains as they’re setting wages, setting prices, establishing budgets,” Mr. Schembri said.
“That kind of anchoring is really a dream for a central bank, because it makes our policy much more effective. When we cut nominal rates, real rates go down by the same amount,” he said.
Former Bank of England governor Mervyn King, who attended the speech and asked a question, endorsed the Bank of Canada’s status quo on inflation targeting. While central bankers around the world have been tweaking their models to account for persistently low interest rates, Mr. King said that these academic discussions can easily lose sight of how policy works in the real world.
“For my money, I’d worry about what’s going on in the economy and stick to the simple and clear framework with which you’ve been very successful for such a long time,” Mr. King said.
While Mr. Schembri signalled that no major policy changes are likely to result from the mandate review, which is scheduled to wrap up later this year, he did say that the bank could take advantage of the flexibility already built into its 1-per-cent to 3-per-cent inflation target range.
“We might be willing to target a small overshoot [of the 2-per-cent target], like the Fed has done, actually aim for an overshoot. That’s a question that we’re pondering right now,” he said.
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