Remarks by Tiff Macklem
Governor of the Bank of Canada
Empire Club of Canada
December 15, 2021
Toronto, Ontario
(delivered virtually)
Our monetary policy framework:
Continuity, clarity and commitment
Introduction
Good afternoon and thank you for the kind introduction. It's always a pleasure to
speak to the Empire Club. The last time I was with you was in March 2020, and I
was the Dean of the Rotman School of Management. I spoke about the
economic impact of COVID-19-when we were just a few weeks into it. What a
long journey it has been for everyone.
Canada's
Today, I am pleased to have the opportunity to talk with you about
monetary policy framework. Every five years the Government of Canada and the
Bank of Canada review and renew the monetary policy framework. Two days
ago, the Minister of Finance and I announced the renewed agreement. This
important framework provides continuity and clarity and reaffirms our
commitment to flexible inflation targeting.
framework we've had in place for the
The flexible inflation-targeting past three
decades has served us very well. It has delivered low, stable and predictable
inflation. This has contributed to a more stable economic environment, so
households and businesses can make spending and investment decisions with
confidence. It has supported sustained growth in output, employment and
productivity, and it has contributed to rising standards of living.
When we consulted Canadians as part of our review, they told us they value low
and stable inflation. And our expert analysis found that it is hard to do better than
flexible inflation targeting.
Our framework has also proven to be adaptable and resilient through economic
change and crisis. The COVID-19 pandemic has illustrated the value of a clear
and well-understood inflation target. Even as the complications of reopening the
global economy have caused inflation in Canada and many other countries to
rise, medium and longer-term inflation expectations in Canada have remained
well anchored on our inflation target. Keeping inflation expectations well
anchored is key to completing the recovery and getting inflation back to target.
For all these reasons, the Government and the Bank agreed to renew the flexible
inflation target at the 2 percent midpoint of a 1 to 3 percent inflation-control
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range. Our renewed agreement also articulates more clearly how we will
continue to use the flexibility that is built into our framework. This includes the
use of extended monetary policy tools when needed and the increased emphasis
we have been placing on the health of the labour market.
Today, I want to briefly review our experience with flexible inflation targeting. I will
then turn to the comprehensive review of our framework that we conducted over
the past three years. And, importantly, I will focus on our renewed agreement
and what it means as we pull out of this pandemic and prepare for the
postpandemic economy.
Our experience with flexible inflation targeting
Monetary policy in Canada has been anchored by an inflation target for 30 years.
Despite major external shocks-from the 2008-09 global financial crisis to the
COVID-19 pandemic-inflation has remained much lower and more stable than it
was prior to inflation targeting. In the 15 years before we began inflation targeting
in 1991, inflation, as measured by the 12-month rate of change in the consumer
price index, averaged 7.1 percent. Since then, it has averaged 1.9 percent. The
unemployment rate has also been lower on average.1
Low, stable inflation has delivered clear benefits for Canadians. It has made it
easier for households and businesses to plan for the future and has improved the
functioning of labour markets. Keeping inflation low and stable has protected
lowincome Canadians and those on fixed incomes from the loss of purchasing
Bank's
power caused by higher inflation. The success in hitting the target on
average over time has built credibility for both the target and the Bank. And
inflation expectations that are well-anchored on the target have been a stabilizing
force when the economy has been hit by shocks.2
Three elements of the framework have been key to its success. First, the target
is symmetric-we are equally concerned about inflation rising above or falling
below the target. Second, monetary policy is forward-looking. Policy actions take
time-usually six to eight quarters-to work their way through the economy.
That's
why our policy decisions are based on where inflation is likely to be in the
future, not where it is today. And third, our framework is straightforward to
communicate and has come to be well understood.
1
Since moving to the 2 percent inflation target in 1995, the unemployment rate has averaged
7.4 percent, compared with 8.9 percent in the 15 years before we had an inflation target. Taking a
long-term perspective underscores the amazing success of flexible inflation targeting. We first
started collecting data on inflation in 1913. Since then, Canada has experimented with a number
of monetary policy frameworks, including the Gold Standard, the Bretton Woods system of
pegged exchange rates and monetary growth targeting. None of these frameworks was able to
deliver low and stable inflation.
2
(speech to the
See, for example, T. Macklem, "A Measure of Work" Winnipeg Chamber of
Commerce, Winnipeg, October 4, 2012); A. Côté, "Inflation Targeting in the Post-Crisis Era"
"Canada's
(speech to the Calgary CFA Society, Calgary, November 18, 2014); D. Dodge,
Monetary Policy Approach: It Works for Canadians" (speech to the Edmonton Chamber of
"Can a Bank Change? The Evolution
Commerce, Edmonton, June 26, 2001); and G. Thiessen,
of Monetary Policy at the Bank of Canada 1935-2000" (lecture to the Faculty of Social Science,
University of Western Ontario, October 17, 2000).
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It has also been tested by crisis. The COVID-19 pandemic has been an immense
shock to our economy, and our framework has proven resilient. When the
pandemic hit, economic activity plummeted and inflation fell sharply as many
prices were discounted. The combination of exceptionally weak demand and
negative inflation risked causing deflation and economic depression. At the
outset of this crisis, the framework guided our policy response, including the use
of forward guidance and quantitative easing. It also guided our decisions to taper
and then end quantitative easing. Our monetary policy was complemented by an
exceptional fiscal policy response, and together they put a floor under the crisis
and supported recovery. Combined with effective vaccines, these policies have
worked. Our economic recovery is now well advanced.
But as we are all aware, the global economic rebound has generated elevated
inflation in Canada and many countries. To a large extent, this reflects the unique
circumstances of the pandemic. With global demand recovering faster than
disrupted supply chains can respond, the prices for many goods have increased
sharply. While we expect inflation to ease in the second half of 2022, we are
closely watching inflation expectations and wage costs. And we will ensure that
the forces pushing up prices do not become embedded in ongoing inflation. Our
framework enables us to do just that.
Reviewing our framework
The review of our framework every five years is also a key feature of the
Canadian system. The joint nature of the agreement between the Government
and the Bank of Canada reinforces both the democratic legitimacy of the
framework and our operational independence to pursue the agreed-upon
objectives. The framework also allows Canadians to hold us accountable.
The current review has been our most wide-ranging to date. After 30 years with
an inflation target, it was time for a more systematic comparison of a range of
alternatives. It was also time to listen to Canadians from coast to coast to coast.
The review therefore encompassed two main elements. We undertook an
evaluation of the alternatives to flexible inflation targeting-a horse race between
what we have and what others have tried or have urged us to try.
We also consulted with Canadians to hear about their experiences with inflation
and the economy, and to learn about their aspirations for Canada's monetary
Talk
policy. To do this, we launched an online survey-Let's Inflation-and
conducted focus groups, held round tables and facilitated online community
discussions to listen to what Canadians had to say about our framework and
possible alternatives. The response was impressive. More than 8,500 Canadians
shared their views in our online survey, and hundreds more engaged with us in
more in-depth discussions.
The review was also the opportunity to consider how best to respond to two
challenges facing monetary policy: lower neutral interest rates and labour market
uncertainties. Let me say a few words about each of these challenges.
The neutral rate of interest-the interest rate at which monetary policy neither
stimulates nor holds back economic activity-is lower globally than in the past.
That means central banks have less room to lower their policy interest rate in
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response to a big negative shock to the economy. COVID-19 brought this
challenge into stark relief. The Bank of Canada, like many other central banks,
cut its policy rate as low as it could go, to what we call the effective lower bound,
or ELB. And we turned to other policy tools, including forward guidance and
quantitative easing. A lower neutral interest rate means we are likely to need to
use these policy tools more often in the future. These alternative tools work, but
we don't have
as much experience using them.
The second challenge is that the labour market is undergoing structural
adjustment, and the relationship between employment and inflation is not as
clear as it once was. My colleague Deputy Governor Larry Schembri spoke about
this in November.3 Shifting demographics, technological change, globalization
and the changing nature of work have made it harder to gauge when the
economy has achieved the maximum sustainable level of employment. And the
short-run relationship between output and inflation-what economists call the
Phillips curve-appears weaker than in the past in Canada and in many other
countries.4 Again, COVID-19 has only reinforced this challenge, accelerating
structural change and affecting workers very unevenly.
What we learned
With our horse race, we set out to compare flexible inflation targeting with
alternatives-average inflation targeting (AIT), a dual mandate that targets both
inflation and employment, nominal gross domestic product targeting and
pricelevel targeting.
In our modelling and simulations, three frameworks-flexible inflation targeting,
AIT and a dual mandate-had broadly similar overall performance and were
superior to the other alternatives. The benefits of AIT were concentrated when
inflation was below the target and the policy interest rate was at the ELB. But
when inflation was above target, AIT tended to lead to increased volatility in
employment and output.
In our economic models, the dual mandate performed similarly to flexible inflation
targeting.5 But it affected employment only very modestly, despite prioritizing it.
3
"Labour (speech to the Canadian
See L. Schembri Market Uncertainties and Monetary Policy"
Association for Business Economics, Toronto, delivered virtually November 16, 2021) and the
discussion in Bank of Canada, "Chapter 3: Key challenges for the conduct of monetary policy,"
Monetary Policy Framework Renewal
(December 2021): 20-32.
4
The combination of these two uncertainties makes it harder to assess whether the economy has
reached its full economic potential and therefore whether inflation will be sustainably on target.
For a review of the literature on the estimates on the slope of the Phillips curve and labour market
"Uncertainty and Monetary Policy
changes, see M. Cacciatore, D. Matveev and R. Sekkel,
Bank of
Experimentation: Empirical Challenges and Insights from the Academic Literature,"
"Has
Canada Staff Discussion Paper (forthcoming) and A. Landry and R. Sekkel, the Canadian
Phillips Curve Flattened? Evidence from Vector Autoregressions," Bank of Canada Staff
Analytical Note (forthcoming) for recent estimates of the slope of the Canadian Phillips curve.
5
"The Bank of Canada's 'Horse Race' of Alternative
J. Dorich, R. Mendes and Y. Zhang,
Monetary Policy Frameworks: Some Interim Results from Model Simulations,"
Bank of Canada
Staff Discussion Paper No. 2021-13 (August 2021).
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This is because employment already plays a central role in the flexible
inflationtargeting framework. For inflation to reach its target sustainably, the economy
has to reach full employment. The two go hand in hand.
Our public consultations complemented the expert analysis. The results
Canadians'
highlighted both the diversity of experiences and some common
themes. When asked about the alternative monetary policy frameworks, the
people we engaged with gave the most support to flexible inflation targeting, AIT
and a dual mandate. And overall, flexible inflation targeting was the preferred
framework.6
The overriding message that came though from the consultations is that
Canadians value low and stable inflation. Inflation is difficult for many. When the
cost of living goes up, they have trouble stretching to cover all their expenses.
Canadians are also concerned about the unequal impacts of inflation and
economic cycles.
It is striking to me that the results of our historical experience, modelling,
simulations and public consultations were all in broad alignment. What comes
through clearly is that flexible inflation targeting is hard to beat in theory and in
practice. Its 30-year record of success has demonstrated that it is built for all
seasons-it has survived the test of large global crises and done well in ordinary
times. But some of the insights of AIT and a dual mandate could help us address
the two important challenges facing monetary policy.
What we agreed
The new agreement on our monetary policy framework secures the continued
benefits of flexible inflation targeting. And it provides increased clarity on how we
will implement the framework to control inflation and help the economy reach its
full potential.
The Government of Canada and the Bank of Canada agreed that the best
contribution of monetary policy to the well-being of Canadians is to continue to
focus on price stability.
The Government and the Bank also agreed that monetary policy should continue
to support maximum sustainable employment. We also recognized that
maximum sustainable employment is not directly measurable and is determined
largely by non-monetary factors that can change over time.
Further, the Government and the Bank agreed that because well-anchored
inflation expectations are critical to achieving both price stability and maximum
sustainable employment, the primary objective of monetary policy is to maintain
low and stable inflation over time.
The inflation target continues to be the 2 percent midpoint of a 1 to 3 percent
inflation-control range. We want to maintain and safeguard the advantages of a
clear and achievable target that is well understood and highly credible.
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The agreement also articulates how we will continue to use the flexibility that is
an integral part of the framework. The agreement notes that our extended
monetary policy tools can help address lower neutral interest rates. It notes that
in the right circumstances, actively seeking maximum sustainable employment
can help us address the inherent uncertainty about the level of employment that
is consistent with price stability. And we will continue to consider a broad range
of job market indicators to gauge the health of the labour market.
This framework is what we need to complete the recovery from the pandemic.
Having ended quantitative easing, we are now focused on our forward
guidance-on assessing the diminishing degree of slack in the economy and on
bringing inflation sustainably back to target.
This framework is also what we need post-pandemic. While we all hope that we
will never again see a recession as sharp as the one caused by COVID-19, it
won't be the last recession we face. We need to ensure that monetary policy has
the ability to provide stimulus when needed in a world of low neutral rates. And
even as the economy normalizes, uncertainty about maximum sustainable
employment is not going away.
The Government and the Bank also acknowledged that a low interest rate
environment can be more prone to financial imbalances. In this context, the
Government will continue to work with all relevant federal agencies to ensure that
Canadian arrangements for financial regulation and supervision are fit for
purpose and consider changes if and where appropriate.
Additionally, while monetary policy cannot directly tackle the threats posed by
climate change, the Bank will develop the modelling tools needed to take into
account the important implications of climate change for the Canadian economy
and financial system.
In my remaining time today, let me expand on our extended monetary policy
tools and the attention we are giving to labour markets.
Using our tools to address low neutral rates
With low global interest rates, the Bank is likely to lower its policy rate to the ELB
more often in response to shocks. That means we may need to use forward
guidance and our balance sheet more often than has been required in the past.
We know that the rates that matter most for consumers and businesses are
medium-term rates for mortgages, lines of credit and business loans. Forward
guidance and quantitative easing can help us push these rates down.7
In certain circumstances, to support employment and return inflation to target, we
can leverage the flexibility that already exists in our framework to make monetary
policy more effective at the ELB. One of the best ways to do that is to use
exceptional forward guidance. This involves committing to holding rates low for
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longer to instill greater confidence in the economic recovery. This can be done on
its own or in combination with quantitative easing. This will help us avoid
prolonged periods of below-target inflation and high unemployment. An
implication of exceptional forward guidance is that inflation will likely go a little
above the target after we exit from the ELB before it comes back to the target
over the medium term. When we use forward guidance in this way, we will
communicate this inflation dynamic clearly.
Interestingly, the benefit of average inflation targeting relative to flexible inflation
targeting is that it allows this kind of overshoot in inflation at the ELB. By using
forward guidance in combination with the flexibility of our 1 to 3 percent control
range, we can get this benefit too-without the costs of AIT when we are away
from the ELB.8
A broad range of labour market indicators
Canadians told us that they want employment to play a central role in our
monetary policy framework. And our simulations illustrated the important role that
maximum sustainable employment plays in successfully hitting the inflation target
and helping to stabilize the economy.
As I have already outlined, price stability and maximum sustainable employment
go hand in hand. Achieving maximum sustainable employment is central to
keeping inflation on target. In addition, there is now greater recognition-backed
by economic research-that when the benefits of economic growth and
opportunity are more evenly shared, prosperity improves for everyone.9 Few
things are more central to the prosperity of Canadians than having a good job.
But maximum sustainable employment is not directly observable, so we have to
work to find it as well as to achieve it. To do this we are undertaking a broader
and deeper assessment of the health of the labour market. We are looking
beyond headline employment numbers to gauge the inclusiveness of the
recovery and its job characteristics. Our new dashboard of labour market
indicators compares the health of the labour market today with the situation just
before the pandemic.10 We have some further work to do to use this broader set
of indicators to assess where maximum sustainable employment is going
forward. And you can expect to see more discussion from us linking our analysis
of labour markets to our monetary policy decisions.
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The agreement also notes that when conditions warrant, the Bank may use the
flexibility of the 1 to 3 percent control range to actively seek the maximum level of
sustainable employment. When might conditions warrant? When inflation is close
not sure if we've
to target, interest rates are at more normal levels, and we're
really reached maximum sustainable employment. That is not the current
situation, of course, since inflation is now already considerably above our target
and our policy interest rate is very low. But as we move beyond this pandemic
and the economy normalizes, uncertainty about maximum sustainable
employment will persist. When conditions warrant, we can probe by being more
patient to help us better gauge the level of employment that is consistent with
price stability.
This not a new idea. In the two years before the pandemic, unemployment in
Canada was around 40-year lows. Based on past economic cycles, we would
have expected inflationary pressure to begin to increase. But inflation was not
rising above the target. By being patient, the Bank learned that the level of
employment that is consistent with price stability was higher than most previous
estimates. Our flexible inflation-targeting framework contemplates seeking or
probing for maximum sustainable employment in the right circumstances. When
we do this, we will be transparent, communicating that we are probing and what
we are seeing in our labour market and inflation indicators as we do so.
Communication is key
This brings me to the final, and very important, point. We know that monetary
policy works better when people understand it. This starts with a clear mandate.
And it is enhanced by transparency.
The move toward increased transparency by central banks over the past
30 years has increased the credibility and effectiveness of monetary policy. By
explaining how our decisions link to our mandate and by delivering low inflation
for 30 years, our monetary policy framework has earned the trust of Canadians.
To keep that trust, we will be clear about how we are implementing flexible
inflation targeting. Because monetary policy needs to be forward-looking, our
decisions and our communication are anchored by our inflation forecast, our
interpretation of incoming data relative to that forecast, and our assessment of
the risks.11 This will include how a broad set of labour market indicators are
affecting our estimates of potential output and our assessment of inflationary
pressures.
We will continue to use the flexibility built into our framework when that flexibility
will help us better manage risks and achieve our mandate. And when we use that
flexibility, we will be clear about why and how we are using it. You will see it in
our inflation forecast, and we will discuss it relative to incoming data and our
assessment of the risks.
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Conclusion
It's
time to conclude. Our monetary policy framework has delivered prosperity to
Canadians by keeping inflation very close to 2 percent, on average, for 30 years.
Flexible inflation targeting is well understood and broadly supported by
Canadians. And the credibility of the target helps to stabilize both inflation and
output. This agreement reaffirms our commitment to price stability and the
2 percent target. This is the framework we need now as we face elevated
inflation and the challenge of reopening the economy.
Looking beyond the pandemic, the renewed agreement also articulates clearly
how we will continue using the flexibility in our framework to address future
challenges confronting our economy. It explains how we will use our extended
set of monetary policy tools when needed. And it outlines how we have begun to
use a broader range of labour market indicators to assess full employment and
the economy's potential output.
This will help us achieve our inflation target.
This agreement provides continuity and clarity, and it strengthens our framework
to manage the realities of the world we live in. And it is what we need today and
tomorrow to foster continued prosperity for Canadians.
Thank you.