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The Bank of Canada is conducting a 'horse race' pitting six monetary policy models against one another to see which does the best job guiding inflation and supporting financial stability while potentially meeting other goals like reducing inequality.

Chris Wattie/Reuters

Most Canadians want the Bank of Canada to stick with its existing inflation-targeting regime, even as many question whether the central bank’s 2-per-cent target reflects the reality of rising prices.

That’s according to a report published by the Bank of Canada on Wednesday, laying out findings from public consultations conducted over the past two years as part of a sweeping review of its mandate.

The central bank renews its monetary policy framework with the federal government every five years, and this time around it is looking at alternative models, including a “dual mandate” that targets full employment alongside inflation, and an “average inflation” model, which would let inflation run above or below target to make up for past misses.

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This is the bank’s most ambitious review since the 1980s and comes at a time when central banks around the world are assessing the effectiveness of their monetary policies in an ultralow interest rate world, while trying to trace a delicate path out of the pandemic and back to full-employment without triggering runaway inflation.

As part of its review, the Bank of Canada is conducting a “horse race” pitting six monetary policy models against one another to see which does the best job guiding inflation and supporting financial stability while potentially meeting other goals like reducing inequality.

The bank’s outreach efforts found Canadians generally favoured sticking with the status quo: a flexible inflation targeting model, which aims for 2-per-cent inflation within a 1-per-cent to 3-per-cent target range. Although it also showed Canadians have doubts about the 2-per-cent target itself, with 66 per cent of respondents to an online survey saying they believed inflation typically runs higher than this.

“Generally, when given the choice between the bank’s current inflation-targeting approach and an alternative framework, most opted for our existing approach. Participants perceived it to be easy to understand and the most achievable option, given the bank’s tools,” the report said.

This sentiment appears to align with the views of at least some of the bank’s governing council. In a February appearance, deputy governor Lawrence Schembri suggested the bank’s existing regime, which has been in place since the early 1990s with a few tweaks here and there, has served it well.

“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 said.

Of the five alternatives to the status quo, Canadians responded best to the dual-mandate and the average-inflation models, which were both seen as relatively easy to understand. Although there were concerns with both models, particularly with the dual mandate, which was seen by some survey respondents as hard to implement and a potentially a risk to central bank independence.

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Over the past year, there have been notable examples of innovation. Last summer, the U.S. Federal Reserve – which has long had a dual mandate – introduced something like average-inflation targeting, saying it would let inflation run above its 2-per-cent target for some time to encourage a broader labour market recovery. It broadened its notion of “full employment” to take into account disadvantaged groups that typically return to employment later in an economic recovery.

In New Zealand, the country’s government recently tasked the central bank with targeting housing prices alongside inflation. This move has been cheered by people looking to keep house prices in check, but it has been criticized by economists who worry a focus on house prices could lead to premature hikes in interest rates.

Rising home prices are central to fears about inflation in Canada, although the way Statistics Canada calculates the consumer price index plays down inflation in real estate. The bank’s online survey highlighted this “perception gap” between how Canadians experience inflation and how Statscan and the central bank measures it.

The survey found 55 per cent of respondents did not think 2-per-cent inflation was a “realistic representation” of their experience of inflation, and with 90 per cent of that group believing inflation was typically higher.

Eighty-eight per cent of respondents said they felt price increases most acutely at the grocery store. When it comes to housing, inflation perceptions were sharpest among younger people, with 56 per cent of people 18 to 44 saying they had felt the effects of housing price changes, compared with only 32 per cent of people above the age of 45.

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