surprises in demand. and this helps to reduce the ups and downs of the business cycle and to promote sustained economic growth. the forward - looking framework of inflation targeting also allows us to handle temporary supply shocks, so long as these shocks do not feed into inflation expectations. the monetary credibility gained through our inflation - targeting system means that changes in volatile energy or food prices no longer feed into other prices and into wages the way they did in the past. that is why, unlike some other central banks, we focus on the underlying trend of inflation, and use as our operating guide a core rate that excludes the eight most volatile components of the consumer price index ( cpi ) and the effect of changes in indirect taxes on the remaining components. such a measure of core inflation is a better predictor of future inflation than the total cpi. with this approach, monetary policy responds only to fundamental trends and does not turn temporary price shocks into something that can destabilize the economy. how the bank of canada deals with international disturbances so far, i have described how our monetary policy framework, based on an inflation target, helps us respond to, and deal with, important surprises that have an impact on our economy. i would now like to say a few words about how the bank of canada incorporates external economic shocks into its decision - making process. canada is a small and very open economy. we export more than 40 per cent of what we produce and, in general, we are price - takers ( that is to say, the prices of what we buy and sell abroad are largely determined in world markets ). thus, the external environment is extraordinarily important to us. as part of its decision - making process, the bank has always followed world economic developments very closely. the bank's governing council starts its deliberations by looking at changes in the external environment. in particular, we focus on economic prospects for the united states and the major overseas countries, as well as on world commodity prices. then we look at the implications of all this for aggregate demand in canada. next, we focus on domestic demand, taking into account anecdotal information gathered by our regional offices, as well as trends in credit, money, and financial markets. all this feeds into our decision on interest rates. let me try and relate this to recent experience. take last year, for example. through the first half of 2001, we moved to loosen monetary policy at a measured pace. this approach was based on

david dodge : the conduct of monetary policy in the presence of economic shocks remarks by mr david dodge, governor of the bank of canada, to the national association for business economics, washington, d. c., 26 march 2002. * * * globalization - the trend towards greater economic integration around the world - has brought important benefits to us all. it has boosted world trade, opened up access to sources of global finance, and facilitated the diffusion of far - reaching technological advances in transportation, communications, and information processing. a more integrated world also tends to speed up the transmission of economic and financial disturbances across national frontiers and increase their spillover effects. over the past decade, monetary authorities around the world have had to deal with a number of such disturbances. in 1994 - 95, we had the mexican financial crisis. in 1997 - 98, we had the asian and russian crises. and last year we had the global economic slowdown, which was greatly exacerbated by the tragic events of 11 september in the united states. to be sure, the conduct of monetary policy has become more complicated and challenging - but not impossible or ineffective. in fact, i would argue that in most countries, including canada, monetary policy has been very effective in mitigating the impact of global shocks on the domestic economy. today, i would like to discuss how canadian monetary policy has been conducted in the presence of economic surprises or shocks - both domestic and external. i would also like to add some thoughts on the issue of the appropriate monetary response, nationally and internationally, to common economic disturbances. economic surprises and canada's inflation - targeting approach to monetary policy to put things in context, let me start by providing a bit of background about canada's inflationtargeting system. when it comes to conducting monetary policy, our formal mandate is not dissimilar to that of the u. s. federal reserve or to those of many other central banks. the preamble to the bank of canada act enjoins the bank " to mitigate by its influence 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 to promote the economic and financial welfare of canada. " we have chosen to achieve the objectives of the act through a policy focused on inflation control. this is because we believe that a monetary policy that consistently delivers low, stable, and predictable inflation is likely to be the greatest contribution that the central bank can