david dodge : low and predictable inflation and the performance of canadian labour markets1 lecture by david dodge, governor of the bank of canada, to the memorial university of newfoundland, st. john ’ s, newfoundland and labrador, 20 november 2003. the references can be found at the end of the speech on the bank of canada ’ s website : www. bankofcanada. ca. * * * the goal of canadian monetary policy is to contribute to solid economic performance and rising living standards. the best way we can do this is by keeping inflation low, stable, and predictable. this has important implications for labour market performance. although inflation is now low, stable, and predictable, this has not always been the case. indeed, in the 1970s, inflation was high, unstable, and unpredictable. this led to the establishment of the anti - inflation board ( aib ) in 1975, where i worked as research director. tonight, i would like to reflect on what we have learned since the aib closed its doors almost 25 years ago to the day. i ’ ll begin with a brief discussion of the theoretical foundation for the role that inflation expectations play. expectations are important for both price - and wage - setting, but i will concentrate on the wage - setting aspects. i would next like to discuss the bank of canada ’ s inflation - targeting framework, which serves to anchor inflation expectations. i will also address the issue that our inflation target may be too low because nominal wages are downwardly rigid. and i will discuss canada ’ s labour market performance and how it has improved substantially with the change in our monetary policy framework since 1991. finally, i will say a few words about the conduct of monetary policy today, and offer some brief concluding remarks. 1. inflation and the role of inflation expectations let me begin by going back to the 1970s. when we started that decade, the inflation rate was around 3 per cent. but it quickly rose to over 12 per cent in the span of three years. not only was inflation rising, it had become more variable, creating uncertainty over the future rate of inflation. 2 this made it difficult for workers and employers to decide on the appropriate rate of inflation to incorporate into wage settlements. in this environment, it was not surprising that some workers demanded wage increases, both as compensation for past inflation and as a precaution against future inflation. and many employers granted them. when they did not, workers often went on strike. on average, in the 1970s, over

participants take on. despite the risks, we can easily imagine a world in which p2p finance thrives. it has already begun to spread to a wide variety of new sectors, such as student loans, real estate, hedging, auto loans, equipment finance, medical loans, business - to - business lending, and so on. over time, we could see p2p finance become more global, and could also see the development of a deep secondary market in securitized p2p loans. if i am right that there will be less credit available from traditional banks, it ’ s not a stretch to think that the young, the small and the medium, and the risky companies, will begin to tap into this p2p finance channel to meet their credit needs. bis central bankers ’ speeches this evolution could be key to an eventual return to sustainable economic growth, as i am convinced that a return to natural growth – as opposed to policy - induced growth – will require a resumption of new firm creation, sustained by innovative financial intermediation. will a surge in p2p finance mean new risks to the financial system? perhaps. will those risks be systemic in nature? we don ’ t have a clear answer yet, but with the increasing participation of institutional investors in this space and increasing market shares of p2p finance, there could be financial stability implications. and what if mother nature does not fix all the imperfections in our financial system through market - based or private finance? the third channel that we might expect to play an enhanced role in a credit - constrained world is public finance. public financial intermediaries are active in such areas as lending to small and medium - sized enterprises and trade finance, and these demands could rise in the years ahead. but the bigger need for a public sector solution is more likely to be in the area of infrastructure investment. so - called “ green infrastructure ” is particularly susceptible to market failure, as it suffers from both the basic free - rider problem and societal mispricing – a double market failure, if you will. public - private partnerships ( or p3s ) have proven to be an increasingly effective tool for funding these investments, but they have not been a panacea. the p3 space is not exempt from our call for more financial innovation. innovative ways of risk - sharing in investment projects – for example, governments offering innovative guarantee structures where they take on a contingent fiscal risk as opposed to laying out large expenditures