carolyn wilkins : liquid markets for a solid economy remarks by ms carolyn wilkins, senior deputy governor of the bank of canada, to the chambre de commerce du montreal metropolitain, montreal, quebec, 5 may 2015. * * * i ’ d like to thank alexandra lai, cesaire meh, chris graham and jing yang for their help in preparing this speech. introduction good afternoon. it ’ s a real pleasure to be here in montreal, where i have family roots. i want to talk today about an important financial force that affects all of us who invest and borrow. i ’ m talking about financial liquidity, in all of its forms. right now, liquidity is going through some important changes. we are all affected by liquidity, whether we realize it or not. if you are a business person, you need funding liquidity, which means that you have reliable access to financing on reasonable terms. if you invest in the stock market or in corporate bonds, you need market liquidity so you can buy or sell assets quickly, at predictable prices. the same is true if you are a saver through certain kinds of mutual funds that promise you access to your savings when you want them. as a central banker, i want the economy to have the right level of liquidity available at the right price so the financial system can keep working smoothly for businesses and households and the bank ’ s monetary policy actions work the way they are supposed to, in order to meet our inflation target. 1 today i ’ ll talk about what has been happening to liquidity in the financial system. i ’ ll start by looking back at the recent financial crisis and the lessons we learned. then i ’ ll review the reforms that are being implemented in canada and elsewhere and talk about how the financial system is evolving and what all this may mean for you. finally, i ’ ll discuss the next steps we ’ re planning at the bank of canada to promote a smoothly functioning and safe financial system. the crisis and its lessons the seeds of the crisis were sown in a time when liquidity seemed to be everywhere. think back to 2006, when it was relatively easy for businesses to get loans and households to take out mortgages. financial institutions, particularly in the united states, were so eager to boost profits by extending credit that they started bundling mortgages and securitizing them. these securities satisfied the demand for so - called safe assets that gave a higher return. memories become more painful

time, other parts of the economy were experiencing excess demand as consumers bought goods to replace the services they couldn't get. but the inflationary impact of excess demand for goods was larger than the disinflationary forces in close - contact services. as a result, our inflation models that focus on the average or aggregate imbalance between demand and supply in the economy had a hard time predicting the rise in inflation. third, supply disruptions are more inflationary when the economy is overheated. for the last 30 years, supply shocks - typically energy - have tended to have a temporary effect on inflation. a run - up in oil prices, for example, would boost inflation for a year or so, but oil prices would typically plateau or reverse, and inflation would come back down all by itself. since it takes more than a year for the full effect of monetary policy to work through the economy, central banks have tended to look through the direct impact of supply disruptions on inflation. that means we don't respond by raising interest rates. this year, the inflation response was different. as i've already mentioned, we were faced with a series of negative supply shocks just as the economy was reopening. and 2 / 5 bis - central bankers'speeches the effects of these supply shocks on prices and inflation was faster and more pronounced than usual. businesses, flush with customers, weren't worried about raising their prices. so they passed on the higher input costs more quickly to final goods prices. and customers, eager to finally buy what they wanted, paid the higher prices. as a result, the impact on inflation of the energy and agricultural price shocks was faster, larger and more widespread than our models suggested. in sum, since we started inflation targeting in the early 1990s, we have not been hit by large negative supply shocks at the same time as our economy was overheating. the lesson from 2022 is that even if long - term inflation expectations are well anchored, when the economy is in excess demand, businesses raise their prices more quickly and by more when their costs increase. all three lessons are linked, and we have taken them to heart. you don't get 8 % inflation because one thing went wrong. our experience in 2022 is that surprises can combine and interact with each other, resulting in outsized effects on inflation. i'd be pleased to talk more about these lessons and how we are adapting in our discussion, but now i want to look