1 1 Inflation Targeting in Canada: Inflation Targeting in Canada: Outcomes, Evolutions, and Outcomes, Evolutions, and Ch ll Challenges Challenges XI Annual Inflation Targeting Seminar XI Annual Inflation Targeting Seminar Central Bank of Brazil Central Bank of Brazil 14–15 May 2009 14 15 May 2009 Rio de Janeiro David Longworth David Longworth D t G Deputy Governor Introduction Introduction • Brazil celebrates 10 years of inflation • Brazil celebrates 10 years of inflation targeting (IT) targeting (IT) • IT in Canada has come of age (18) IT in Canada has come of age (18) • 10 years ago important policy work 10 years ago, important policy work d tB C underway at BoC IT i h ih t d t i • IT regimes have inherent advantages in dealing with current storm dealing with current storm 2
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Inflation Targeting in Canada:Inflation Targeting in Canada:Outcomes, Evolutions, andOutcomes, Evolutions, and
Ch llChallengesChallenges
XI Annual Inflation Targeting SeminarXI Annual Inflation Targeting Seminar
Central Bank of BrazilCentral Bank of Brazil
14–15 May 200914 15 May 2009
Rio de Janeiro
David LongworthDavid LongworthD t GDeputy Governorp y
IntroductionIntroduction
• Brazil celebrates 10 years of inflation• Brazil celebrates 10 years of inflation targeting (IT)targeting (IT)
• IT in Canada has come of age (18)IT in Canada has come of age (18)
• 10 years ago important policy work10 years ago, important policy work d t B Cunderway at BoCy
IT i h i h t d t i• IT regimes have inherent advantages in g gdealing with current stormdealing with current storm
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OutlineOutline
1 Outcomes in Canada1. Outcomes in Canada
2 Evolution: Improvements in IT regime2. Evolution: Improvements in IT regime
3 Challenges for IT Regimes3. Challenges for IT Regimes
3
OutcomesOutcomes
• Inflation: Levels Expectations and• Inflation: Levels, Expectations, and VariabilityVariability
• Interest Rates: Levels, Spreads (vs. U.S.)Interest Rates: Levels, Spreads (vs. U.S.) d V i bilitand Variabilityy
L th d N t f L b d Fi i l• Length and Nature of Labour and Financial gContractsContracts
• Output and Unemployment: Growth Gaps• Output and Unemployment: Growth, Gaps, and Variabilityand Variability
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Outcomes: InflationOutcomes: InflationG h 1Graph 1
C P i I dConsumer Price Index Year-over-year percentage changey p g g
Outcomes: Interest RatesOutcomes: Interest RatesG h 12Graph 12
Canadian and U.S. 2-Year Government Bond RateSeven-Year Standard Deviation*
3 0%
33.0 3Feb. 1991 Feb. 1998
2.5 2.5
U it d St tUnited States
C d2.0 2
Canada
1 5 1 51.5 1.5
1.0 1
0.5 0.5
1984 1988 1992 1996 2000 2004 2008
* Monthly data • Within-cycle variability for the 2-year rate lower in15
• Within cycle variability for the 2 year rate lower in Canada, as policy rate has been less variabley
Outcomes: Interest RatesOutcomes: Interest RatesG h 13Graph 13
Canada and U.S. 10-Year Government Bond RateSeven-Year Standard DeviationSeven Year Standard Deviation
3 0%
3 03.0 3.0
F b 1991 Feb 1998
2 5 2 5
Feb. 1991 Feb. 1998
2.5 2.5
2 0 2 02.0 2.0
1 5 1 51.5 1.5
1 0 1 0United States1.0 1.0United States
CanadaCanada
0.5 0.5
0.0 0.0
1980 1984 1988 1992 1996 2000 2004 2008
16* Monthly data • Within-cycle variability for the 10-year rate has declined in C d d i i il t th t i th U it d St tCanada, and is similar to that in the United States
99
Outcomes: ContractsOutcomes: Contracts
• Longer labour contracts• Longer labour contracts
• Increased transparency regarding• Increased transparency regarding economic outlookeconomic outlook
• Changes when IT agreement renewedChanges when IT agreement renewed i 2001in 2001
Ch h IT t d• Changes when IT agreement renewed g gin 2006in 2006
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Evolution: FADsEvolution: FADs
• Prior to Dec. 2000, decisions taken anytimePrior to Dec. 2000, decisions taken anytimeI i l ft th t t li ti d t• Impression left that our monetary policy tied to Federal Reserve’sFederal Reserve sDesired benefits of Fi ed Anno ncement Dates• Desired benefits of Fixed Announcement Dates– Reduced uncertainty in financial marketsReduced uncertainty in financial markets
Greater attention on situation in Canada– Greater attention on situation in Canada– Greater emphasis on medium termp
Increased transparency accountability public– Increased transparency, accountability, public dialoguedialogue
• Studies have shown that these benefits haveStudies have shown that these benefits have transpiredtranspired
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Evolution: TransparencyEvolution: Transparency
• Monetary Policy Report Update introduced inMonetary Policy Report Update introduced in F b 2000February 2000
• Increased transparency of economic projection• Increased transparency of economic projection– Core inflation, total CPI inflation, oil price (April 2003)( )
Annual contributions to Canadian GDP growth (April 2004)– Annual contributions to Canadian GDP growth (April 2004)
– Quarterly growth of GDP (October 2005)
– More explicit assumptions about exchange rate, p p g ,
non-energy commodity prices terms of tradenon-energy commodity prices, terms of trade
• Forward-looking statements about monetary g ypolicypolicy
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Evolution: 2001 RenewalEvolution: 2001 Renewal
G t h i t t id i t• Greater emphasis on target midpointp g p• Length of agreement extended to 5 yrs from 3• Length of agreement extended to 5 yrs from 3• Role of core inflation made more preciseRole of core inflation made more precise
D fi iti f i fl ti h d• Definition of core inflation changed– Excludes 8 most volatile elements– Excludes 8 most volatile elements
• Accountability when persistent deviations from y ptargettarget
• Discussion of appropriateness of 2 % target pp p % g
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Evolution: 2006 RenewalEvolution: 2006 Renewal
Elaboration of the Targeting Framework:Elaboration of the Targeting Framework:
T t H i• Target Horizon
• 6-8 quarters still generally appropriate• 6-8 quarters still generally appropriate
• But specific occasions may arise when longer, shorterp y g
• Asset Prices• Asset Prices
• No explicit recognition in target index (beyond housing p g g ( y gin CPI)in CPI)
Mi ht b i t t d i ti l• Might be appropriate to respond in exceptional circumstancesc cu s a ces
Issues warranting further research:• Issues warranting further research:
• Lower inflation targetLower inflation target
P i l l t ti• Price level targeting29
ChallengesChallenges
• Asset price booms• Asset price booms
• Commodity price boom• Commodity price boom
• Financial crises• Financial crises
Zero lower bound• Zero lower bound
Can e do better?• Can we do better?
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Challenges: Asset PricesChallenges: Asset Prices
• Canada fortunate that housing servicesCanada fortunate that housing services i l d d i CPIincluded in CPI
Feeds off new house price index• Feeds off new house price index
• Have not changed our view since 2006• Have not changed our view since 2006
M i iti t i b tt d ti l• Main mitigant is better macroprudential g ppolicy (regulators)policy (regulators)
• Scope to ease monetary policy quickly• Scope to ease monetary policy quickly
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Challenges: Zero lower boundChallenges: Zero lower bound
• Inflation targeters have distinct• Inflation targeters have distinct d t f t i th i t liadvantages of tying their monetary policy g y g y p y
decisions to achieving their inflation targetdecisions to achieving their inflation target• Number of quarters at effective lower• Number of quarters at effective lower
b d b ti d t i fl ti j tibound can be tied to inflation projectionp jActions in terms of credit and q antitati e• Actions in terms of credit and quantitative qeasing need to be tied to principleseasing need to be tied to principles
• Lower Inflation Target?• Lower Inflation Target?• Many theories would suggest itMany theories would suggest it
B t t f t iti ld b tl• But costs of transition could be costly• Effective lower bound for interest rates• Effective lower bound for interest rates
• Price Level Targeting?Price Level Targeting?W ld h l i h ff i l b d• Would help with effective lower boundp
• Much theory and calibration would favour it• Much theory and calibration would favour it• But doesn’t perform well with persistentBut doesn t perform well with persistent
terms of trade shocksterms-of-trade shocks
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ConclusionsConclusions
• Good economic performance aided by ITGood economic performance aided by IT
• Significant changes in last 10 yearsSignificant changes in last 10 years• Great increase in transparencyp y
S k h ll t d d i f t• Some key challenges today and in futurey g y
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A diAppendixAppendixG h 3Graph 3
O fExpected and Observed Inflation Rates7 7%
Feb 1991
6 6Conference Board
Feb. 1991
6 6(2 years)
5 5
4 4
3
4
3
4
3 3
2 2
1 11 1Overall CPI*
0 0
-1 -11
1984 1987 1990 1993 1996 1999 2002 2005 2008
1
1984 1987 1990 1993 1996 1999 2002 2005 2008* The low point in 1994 reflects a cut in taxes on tobacco products.
37• Since 1992, expectations influenced little by actual inflation
A diAppendixAppendixG h 6Graph 6
Annual Standard Deviation of Wage SettlementsAnnual Standard Deviation of Wage Settlements Private SectorPrivate Sector
38• Variation of wage settlements across contracts has declined
2020
A diAppendixAppendixG h 11Graph 11
Canadian and US 90-Day Commercial Paper RateSeven-Year Standard Deviation
%
5%
5
Feb. 1991 Feb. 1998
4 44 4
3 3
United States
2 2
United States
Canada2 2
1 1
0 00
1980 1984 1988 1992 1996 2000 2004 2008
0
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A diAppendixAppendix Graph 14Graph 14
Wage Settlements: Average Length (Months) andWage Settlements: Average Length (Months) and Proportion with Cost of living Adjustment ClauseProportion with Cost-of-living Adjustment Clause50 50Feb. 1991