falling. and we expect inflation to increase gradually to the 2 per cent target. but with inflation persistently below target, we are more concerned about downside risks to inflation than upside ones. it is forward looking. monetary policy actions take time – about two years – to work their way through the economy and to have their full effect on inflation. for this reason, monetary policy must always be forward looking, with the bank setting the policy rate based on its judgment as to how inflation is likely to evolve. making that assessment requires a careful examination of the economic evidence pertaining to the balance of supply and demand in the economy and other factors affecting inflation. to help us see through temporary fluctuations in inflation, the bank uses core inflation, which strips out the volatile components of the cpi, as an operational guide for setting policy in pursuit of the target for total cpi inflation. 5 in our baseline forecast, demand is expected to strengthen, gradually absorbing excess capacity in the economy. as this slack is taken up, core and total inflation are expected to increase to target over the next two years or so. it is flexible. in assessing whether the stance of monetary policy is appropriate to achieve the inflation target, the bank must make a judgment regarding the horizon for returning inflation to target. flexible inflation targeting provides the scope to consider financial stability risks and to manage the volatility that monetary policy actions may induce in the economy and financial markets. in the current context, an important element in our monetary policy decisions – which has been highlighted in our recent policy announcements – is the need to weigh the risks of exacerbating elevated household imbalances against the downside risks to inflation when inflation is already below target. the bank ’ s record of inflation control over more than 20 years is impressive. since1991, inflation in canada has averaged 2 per cent, as measured by total cpi, and its standard deviation has fallen by roughly two - thirds compared with the 1970s and 1980s ( chart 2 ). moreover, the persistence of inflation, as measured by the serial correlation in inflation, fell from 0. 8 between 1975 and 1990 to only 0. 1 since 1995. nowadays, fluctuations around the target are typically short - lived, so the best forecast for inflation is 2 per cent – the target. what could be simpler? low inflation is also a means to an end – better economic performance. low, stable and predictable inflation has been associated with more stable economic growth in canada and lower and less - variable unemployment ( table 1

went up everywhere, including here in canada. it took monetary authorities around the world a while to realize that rising inflation was not just the product of a series of temporary special factors. by the time most central banks reacted, inflation had become entrenched and proved very difficult to bring down. the persistent inflation of the 1970s and 1980s undermined economic performance worldwide. canada did not escape unscathed. because inflation creates uncertainty, it makes it much more difficult for households and businesses to judge future prices and to make sound economic decisions. high inflation encourages speculation rather than productive investments. it raises interest rates. and, in the end, it exacerbates both the booms and the busts. restrictive monetary policies in the united states and in canada during the early 1980s finally brought inflation down from its double - digit levels. but fears of inflation lingered, encouraging continued debtfinanced speculation in real estate and other assets. by the late 1980s, inflation pressures were on the rise again. in canada, those pressures, and the fears of ongoing inflation that had been undermining our economic performance, finally eased after the successful implementation of the inflation - reduction targets adopted in february 1991. inflation promptly declined to around 2 per cent, and inflationrelated hedging and speculation gradually disappeared. i believe that the low - inflation environment that was firmly established in the first part of the 1990s contributed significantly to canada's improved economic performance later in the decade. since the early 1990s, there has been greater certainty about future prices. investment and savings horizons have, consequently, lengthened. interest rates have come down. and, in contrast to our experience during the mexican crisis, canada rode out the impact of the asian financial turbulence of 1997 – 98 with only a limited slowdown in output and employment growth. the way ahead partly because of the difficulties we experienced in the 1990s, many canadians remain sceptical about our economic future. they look at the extraordinary performance of the u. s. economy through much of the past decade, and canada's record looks lacklustre by comparison. but i believe that there are considerable grounds for optimism. i say that primarily because of the improvements in our economic fundamentals that i have described. indeed, good economic performance starts with a foundation of prudent economic policies. in this regard, low and stable inflation, together with a declining public sector debt, now provides a stronger base for the canadian economy than we have had in three decades. in addition, there