in canadian monetary policy. explicit inflation - control targets were jointly introduced by the bank and the government of canada in 1991. since 1995, the goal has been to hold the trend of inflation inside a target range of 1 to 3 per cent, with emphasis on the midpoint of 2 per cent. inflation targets provide an anchor for policy and an anchor for people's inflation expectations. they supply the bank with an effective mechanism for assessing and dealing with demand pressures in the economy in a way that reduces fluctuations in output. here's how this'stabilizer'feature of the targets works. if total demand was pressing on the economy's capacity to produce, so that the future trend of inflation looked likely to move towards the top of the target range, the bank would tighten in order to reduce demand and inflation pressures. equally importantly, in a symmetric fashion, if demand was weak and future inflation looked likely to move towards the bottom of the range, the bank would ease, providing more room for the economy to expand. the basic point here is that the focus on inflation control allows the bank to support growth when the economy is weak and to prevent overheating when the economy is strong and is pushing against capacity constraints. the other important element of our monetary policy approach is a flexible exchange rate. a floating exchange rate allows our economy to adjust to economic disturbances such as a sharp change in foreign demand for our products or a sharp movement in the relative price of our exports compared with our imports. in cases like these, movements in the relative value of the canadian dollar help our economy to adjust with less fluctuation in output and employment than if the exchange rate did not move. and when our currency moves in response to those shocks, the inflation target helps to anchor expectations regarding its value in world markets. so the inflation target and a flexible exchange rate work well together — indeed they reinforce each other — under our current monetary policy framework. effective two - way communication in an increasingly interconnected world subject to all kinds of shocks and uncertainties, delivering a monetary policy that is credible and effective has become quite a challenge. the bank believes that greater openness and clear, two - way communication are important ways in which it can influence the economy, particularly at times of increased uncertainty. put another way, our actions will likely be more successful if those we seek to affect — the financial markets and the general public — understand what we are up to and why. the bank has made considerable progress in this area, and

characterized by significant stock adjustments in the financial and real sectors of major industrialized economies. a key lesson of japan's lost decade is that an economy will not grow until the excesses that built up during the bubble have been removed. 6 in japan, these included commercial real estate, physical capital, and a highly leveraged corporate sector. financial imbalances and losses from a deteriorating economy quickly overwhelmed the capital buffers of the japanese banking sector. the resulting negative feedback loop between the real and financial economies took nearly a decade to break. there are some striking parallels in the united states. earlier this decade, there was substantial misallocation of investment ( much of which was financed from abroad ) into private real estate. in addition, key industries such as autos invested in capital stock that became increasingly misaligned with prospective demand. there are also important differences. unlike japan, excess debt in the united states is concentrated in the household and financial sectors, and the deleveraging of the financial sector was a trigger rather than the result of the recession. with u. s. banks now raising significant capital to cushion their losses, the negative feedback loop between the financial and real economies has been slowed, though not yet reversed. more capital will be required globally ; the toxic assets in core banks still need to be addressed ; and a host of vital financial markets, such as private - label securitization, must be relaunched. as a result, stabilization of the global financial system remains a precondition for a sustainable recovery, both globally and in canada. this process of financial stock adjustment is mirrored by an adjustment process on the real supply side of the economy. in the last quarter of 2008, it became clear that levels of inventories, employment, and capital were not commensurate with the level of global demand. each, in turn, fell roughly in the sequence one would expect, given relative adjustment costs : first, inventories ; next, employment, which is quasi - fixed ; and last, capital, as investment fell below the rate of replacement. although global demand and trade levels appear to be approaching bottom, and inventory and labour adjustments have already been substantial, there is still more to come. unemployment will likely rise further across the g - 7, with the sharpest increases still to come in those economies with the least - flexible labour markets. uncertainty over the employment outlook will weigh on consumption in most major economies for some time. the capital stock adjustment process will take longer, and