it out of the system. once this had been accomplished, money growth could be set just high enough to meet the legitimate needs of the economy - thereby ensuring long - run price stability. if the new money targets were publicly announced and fully credible, some monetarists argued, it might even be possible to achieve this disinflation without any significant loss in output. if this proved to be impossible, some deterioration in economic performance would have to be accepted. a “ gradualist ” approach, however, would ensure that this was kept to a minimum. while fixed money targets might not deliver the best of all worlds, they were regarded as the safest alternative in a second - best world. trying to forecast the future and optimally adjust fiscal and monetary policy settings had proved not only to be impossible but also potentially destabilizing. canada adopted a target for the narrow monetary aggregate, m1, in the autumn of 1975, a short time after the united states and germany. for a while, the strategy appeared to be working. inflation began to decelerate, and the economy began to recover from the 1974 - 75 recession. while some of this early success could be credited to the wage and price controls that the government had introduced in late 1975, proponents of the monetarist view believed that canada would soon be on its way to price stability. initial optimism over what the monetary targets could deliver soon gave way to frustration as inflation began to rise again in the late 1970s. a second oil shock and continued fiscal expansion added to the inflation pressures that were already in place. by the early 1980s, inflation had returned to doubledigit levels, and inflationary expectations were again beginning to accelerate. research at the bank revealed that one of the reasons for the weak relationship between the movements in m1 and subsequent changes in prices was the high interest elasticity of the demand for this narrow money aggregate. the modest changes in interest rates that were required in the short run to keep m1 within its target band were not enough to have much impact on real output or prices. 20 another, more serious problem in using m1 was the uncertain impact of financial innovation. technological developments had allowed financial institutions to introduce a number of new products designed to help depositors protect themselves from high inflation by shifting their idle balances into daily interest savings accounts. this weakened the relationship between m1 and the other macroeconomic variables that normally influenced its behaviour, and made it difficult for the bank to interpret its movements. 2. 5 the search for

sound fiscal and monetary policy thanks to our sound fiscal policy, canada is among a select and dwindling group of countries with a risk - free rate. this is underpinning our privileged access to global capital. canada ’ s competitive position is improving as other countries must increase taxes to address fiscal imperatives. and while returning to budget balance in canada will require a determined effort, it pales in comparison to the scale and duration of the adjustment needed in the united states. there are very real benefits to canada ’ s record of sound fiscal management. finally, monetary policy. what can it do? canadians can remain confident that inflation will remain low, stable and predictable. after more than 20 years of low inflation, the consequences of high and variable inflation are fading in the collective memory of canadians, making it easy to discount the value of this commitment. that would be a mistake. low and stable inflation has allowed consumers and businesses to manage their finances with greater certainty about the future purchasing power of their savings and income. interest rates have also been lower and less variable in both nominal and real terms across a range of maturities. by working to stabilize inflation, monetary policy has helped to encourage more bis central bankers ’ speeches stable economic growth, lower and less variable unemployment, and greater efficiency in financial markets. 11 maintaining low and stable inflation is the primary focus of monetary policy, but it is not the singular focus. consistent with our mandate to “ promote the economic and financial welfare of canadians, ” our flexible inflation - targeting framework requires that we consider the consequences for volatility in output, employment and financial markets when determining the optimal path and horizon over which to return inflation to target. in practice, the variation in that optimal path has resulted in an inflation - target horizon as short as two quarters and as long as 11 quarters since the bank began publishing its projections in 1998. 12 this flexibility is enhanced by the credibility of canada ’ s monetary policy. inflation expectations are well anchored at the 2 per cent target. but this flexibility is also an asset that must be used with care. credibility is hard to earn and easy to lose. while the crisis of 2008 re - affirmed the value of our flexible inflation - targeting framework, it was also a powerful reminder that price and financial stability are inextricably linked, and pursuing the first without due regard to the second risks achieving neither. the primary tools to deal with financial stability are micro - and macroprudential regulation and supervision. however, it may be