you in may 2000, our economy was growing vigorously, bolstered by strong domestic and u. s. demand. indeed, with signs of emerging capacity pressures, and with the need to sustain non - inflationary economic growth in canada, the bank raised interest rates the day after our appearance before this committee. these higher interest rates led to some cooling off in domestic demand in canada. what we, and most other analysts, did not anticipate was the abrupt slowing in u. s. economic growth. this is the factor that has contributed to a greater - than - expected moderation in economic activity in canada. since february, the bank has been saying that we expect growth in the first half of this year to be very modest. and we have indicated that, by the middle of 2001, the canadian economy will probably be operating somewhat below potential. overall, the information received to date is broadly in line with the bank's expectations. the monthly numbers have been volatile : some have been weaker and some have been stronger than anticipated. but they are generally consistent with our view that the weakness in the first half will be mainly associated with inventory adjustments in markets facing soft demand — in particular, motor vehicles — and with adjustments in other industries — notably electronics and telecommunications equipment. the bank continues to believe that, after very modest growth in the first half of 2001, economic activity in canada will pick up in the second half and strengthen further in 2002. let me explain what we are basing this on. despite lower production in the three high - profile sectors i just mentioned, aggregate economic activity continues to grow, buttressed by underlying strength in other areas, including the energy sector, retail sales, housing, non - residential construction, and most service industries. supported by recent tax cuts that boost disposable income, final domestic demand should continue to expand. and we expect a recovery in foreign demand in the latter part of the year, encouraged by the substantial reductions in u. s. interest rates. nonetheless, there are uncertainties about the exact timing and strength of the pickup in u. s. growth. here in canada, we have lowered interest rates significantly to support growth in total demand in line with our objective of keeping inflation close to 2 per cent over the medium term. since january, the bank of canada has cut rates by a total of 100 basis points, bringing the overnight rate — the rate that corresponds to the u. s. federal funds rate — down to 4¾ per cent

bank of canada, we spend a lot of time thinking about confidence, because it is important to the conduct of monetary policy, which is focused on inflation targeting. we aim to keep the trend of inflation at the 2 per cent target midpoint of a 1 to 3 per cent range. when the trend strays away from that midpoint, either upwards or downwards, we take action to return it to 2 per cent over the medium term. we do that by adjusting our target for the overnight interest rate. over the past decade or so, we have successfully kept inflation at around 2 per cent, on average. here ’ s where the confidence factor enters into the equation : canadians now expect that inflation will stay near the target - not just for the near term, but into the future. they believe that the value of their earnings and savings won ’ t be eroded by inflation and that the real burden of their debt won ’ t be increased by deflation. that confidence has paid a real dividend in terms of monetary policy effectiveness. inflation targeting works best when canadians believe that it will work - in other words, when they have confidence that we will keep inflation near the 2 per cent target. with this confidence, inflation and inflation expectations, as well as interest rates, have become more stable - and this benefits the whole economy. how did we achieve this confidence dividend? by establishing a track record of credible, consistent monetary policy, together with greater accountability and transparency. like many other major central banks, we have embraced the notion that monetary policy is more effective when people can understand what their central bank is doing and why. that is the motivation behind our semi - annual monetary policy reports and updates, our eight interest rate announcements every year, and our many public appearances and speeches. of course, monetary policy does not function in isolation. it works best when it is complemented by fiscal policies aimed at avoiding deficits and lightening government debt burdens. reducing, and ultimately eliminating, the federal deficit in the 1990s helped canada ’ s international credibility, lowered the risk premium demanded by investors, and gave canada more flexibility to adjust to changing economic circumstances. and continued fiscal prudence has given us the flexibility to weather the recent economic turmoil rather well. canadians have now seen the benefits of low, stable, and predictable inflation, and balanced budgets. and they expect that their central bank and their governments will continue to deliver those benefits through responsible monetary policy and prudent fiscal management. confidence in markets so, good