david dodge : our approach to monetary policy - inflation targeting remarks by mr david dodge, governor of the bank of canada, to the regina chamber of commerce, regina, saskatchewan, 12 december 2005. * * * i am happy to have the opportunity to speak in regina during saskatchewan's centennial year. throughout 2005, the people of saskatchewan have been celebrating the many remarkable contributions that this province and its citizens have made to canada. gerald bouey and gordon thiessen, two of my predecessors as governor, are examples of individuals with deep saskatchewan roots who have made great contributions to the bank and to our country. as this province turns 100, you can be proud not only of your history, but also of your modern, increasingly diversified economy that positions saskatchewan for success in the future. this year also marks the 70th anniversary of the creation of the bank of canada, and we too have taken the time to celebrate our contributions to canada. at such times, while it is appropriate to look back and celebrate history and accomplishments, it is also a good opportunity to look forward and think about where we are headed. in this spirit, i'd like to talk to you today about one of our main responsibilities ; that is, the conduct of monetary policy. i want to recount a bit of the bank's history and talk about how we developed our current framework for conducting monetary policy. at the bank of canada, we strongly believe that targeting inflation is the best way for us to fulfill our mandate to canadians. i also want to look forward a bit, and talk about the future of inflation targeting, as we prepare to renew our inflation - targeting agreement with the federal government next year. the bank's mandate let me begin with a brief discussion of the bank's legislative mandate. the preamble to the bank of canada act instructs us to " regulate credit and currency in the best interest of the nation. " it goes on to say that the bank should mitigate " fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally... promote the economic and financial welfare of canada. " so the question is, how can the bank best provide the conditions for sustainable economic growth, bearing in mind the words in our mandate : " so far as may be possible within the scope of monetary action "? over time, it has become clear that the best way for monetary policy to promote sustainable economic

. paying close attention to signs that inflation is moving away from our target - in either direction - promotes timely action. this is how we keep the economy operating near its full capacity and thus keep inflation low, stable, and predictable. the second point i want to stress is that having an inflation target as an anchor is very helpful in terms of the bank's accountability. if inflation persistently deviates from the target, we are committed to explaining the reasons why, what we will do to return it to target, and how long we expect the process to take. the third point is that any central bank that runs an independent monetary policy and targets inflation must allow its currency to float. it is simply not possible for a central bank to successfully control both the domestic and external values of its currency at the same time. we have only one instrument - our policy interest rate - so we can have only one target. thus, with inflation as our target, we naturally operate with a floating currency. canada's experience under inflation targeting now, let me quickly review our record with inflation targeting. as we look at inflation and economic growth in canada since 1991, it is quite clear that the benefits we had hoped would come from inflation targeting have, in fact, materialized. we expected inflation to become more stable - and it did so, sooner than we had anticipated. since settling on the 2 per cent target for inflation at the end of 1995, actual inflation has averaged very close to 2 per cent. and it has remained within the 1 to 3 per cent target range, with only rare exceptions. we expected our credibility to increase and inflation expectations to become well anchored - and this has also happened. we also thought that inflation targeting would help the economy to avoid the exaggerated " boom - bust " cycles of previous decades - and it has. the business cycle is still with us, but economic volatility has diminished. by keeping inflation close to the target, monetary policy has helped to keep the economy operating near its potential. finally, and very importantly, our transparent framework has allowed markets and analysts to better predict how we will react to different economic outcomes. within the bank, too, focusing on inflation has brought increased discipline and clarity to our monetary policy decision process. canada was the second country after new zealand to adopt explicit inflation targets. but over the past decade and a half, about 20 other central banks have also adopted this framework. some, like the central banks of the united kingdom and sweden, are from advanced