you they are not automatic. because we are committed to having the best monetary policy framework for canadians, we use the term of each agreement to conduct an intensive research and consultation program to critically examine aspects of the policy. for example, leading up to the 2016 renewal we investigated three questions : 1. is 2 per cent still the appropriate target for inflation? 2. how do we incorporate financial stability considerations into the formulation of monetary policy? 3. how should core inflation be used and measured? our research led us to conclude that the 2 per cent target is still appropriate and that monetary policy should be adjusted to address financial vulnerabilities only in exceptional circumstances. 3 because the financial system is important for supporting economic activity and for transmitting monetary policy, financial system considerations are always taken into account in the formulation of monetary policy. for more information on our research into these issues, see s. s. poloz, “ 25 years of inflation targets : certainty for uncertain times ” ( speech to the business council of today, i want to focus on our findings on the third issue : the use and measurement of core inflation to assess the underlying trend of inflation. first, i ’ ll explain the purpose of core inflation measures in our policy deliberations and what we look for in reliable measures. lastly, i ’ ll review the three new core measures we have adopted and what they are telling us about current inflationary pressures. why is core inflation “ core ”? let ’ s start with the basics. inflation is simply a general increase in the average price of goods and services over a given time period, in other words, a trend increase in the cost of living. 4 we measure inflation using the increase in total cpi, which is estimated and published by statistics canada and tracks the cost of a representative fixed “ shopping basket ” of goods and services over time. 5 the bank of canada officially targets the 12 - month increase in the cpi because it is a broad gauge of inflation that is most relevant to canadians. it is essential that the inflation target be widely understood and visible so that citizens can hold their policy - making institutions accountable. our monetary policy framework posits that cpi inflation will be at 2 per cent on an ongoing basis when actual output equals potential output. this is the level of goods and services that an economy can produce and sustain without adding to inflationary pressures. 6 the difference between actual and potential output is the output gap, which can be positive or negative. we achieve our monetary policy target by helping

forecast in may, inflation is still expected to remain above the upper end of the target range until the third quarter of 2017 – and the risks to this forecast were assessed to be on the upside. in light of our flexible inflation - targeting mandate, we needed to ask ourselves a number of questions, including : • how strong and durable would the drivers of inflation prove to be? • to what extent should we take the weak state of the economy into consideration? • to what extent would the persistence of the output gap limit the pass - through from exchange rate depreciation to domestic prices? • how big was the risk that this unusually large depreciation ( 51 per cent in nominal effective terms since the end of 2010 ) would unanchor inflation expectations? indications of a lower exchange rate pass - through to inflation have been encouraging. if we look at the core rate of inflation ( i. e. headline inflation excluding food, petrol and energy ), it has accelerated by 2, 6 percentage points since it bottomed in early 2011. by contrast, in response to the previous cycle of significant exchange rate depreciation ( 58 per cent between 2006 and 2008 ), core inflation increased by 7, 9 percentage points. this suggests that the lack of dynamism in consumer demand as well as the absence of a credit boom or of significant wealth effects seem to have limited the ability of producers and retailers to pass through cost increases to the end consumer. yet, because this reduced pass - through, which incidentally is not unique to south africa, is not yet fully understood, we cannot become complacent and assume that it has become a permanent feature of our economic landscape. the pass - through has not been constant over time ; just as it fell, it could rise again. the role of inflation expectations therefore becomes paramount. historically – in part because of the major structural changes the economy went through in the last 50 years and in part because of a long period of high and volatile inflation ( from the 1970s to the 1990s ) – price expectations in south africa appeared to be adaptive, as reflected in the behaviour of price and wage setters, be they businesses or organised labour. the introduction of inflation targeting in 2000 helped, over time, to reduce the volatility and adaptive nature of inflation expectations. expectations have, in recent years, been relatively stable, although around the upper end of the 3 – 6 per cent target range. this “ upward bias ” in expectations limits the margin of manoeu