mark carney : flexibility versus credibility in inflation - targeting frameworks remarks by mr mark carney, governor of the bank of canada, at the 7th bis annual conference, lucerne, switzerland, 27 june 2008. * * * it is an honour for me to participate in this panel alongside martin feldstein and stanley fischer. just as central bankers are forward looking in the conduct of monetary policy, it is entirely appropriate that the bis coordinate a session that looks beyond price stability to the challenges ahead. with the challenges that we currently face, it is understandable that some may desire greater flexibility in the conduct of monetary policy. however, the value of this greater flexibility depends on the extent to which it detracts from monetary policy credibility. i will concentrate my brief remarks today on the themes of flexibility and credibility. i would like to state at the outset that what follows is a discussion of ideas worthy of consideration. it should not be seen as having any bearing on the current conduct of monetary policy in canada. the bank's current inflation - control agreement with the government of canada will remain in effect until the end of 2011. changes to our agreement with the government, if any were desired by both parties, would only come into effect thereafter. arguments for greater flexibility there are two broad classes of arguments for greater flexibility in the design and application of monetary policy frameworks. the bis has done a great deal of useful work on asset - price targeting in particular and on the complicated interplay between monetary policy and financial stability in general. my fellow canadian, bill white, framed the discussion about flexibility for inflation targeters with his paper " is price stability enough? " in this paper, bill argues that policy - makers should respond flexibly to shocks that create persistent financial imbalances. in particular, he suggests that policy - makers should extend the inflation horizon and pre - emptively tighten policy when faced with such shocks. this would have the practical consequence of purposely deviating from the inflation target temporarily in order to avoid more costly deflationary busts down the road. others argue that globalization creates similar imperatives. for instance, throughout this decade, there has been a secular disinflation ( relative to target ) in goods prices, reflecting the efficiencies from creating global supply chains and outsourcing some production to emerging markets. some suggest that these same emerging markets are creating persistent commodity - price inflation. 1 finally, the current international monetary order – wherein a large dollar block coexi

subject to wide swings in important relative prices, such as world commodity prices. something that seemed to work well in a simple rational - expectations model with a single good might have severe negative consequences in practice. the research would also try to document in a more convincing way the potential benefits of price - level targeting. monetary stability versus financial stability the third issue that needs to be highlighted involves the difficult trade - offs that can at times exist between monetary stability and financial stability. authors such as claudio borio and william white at the bank for international settlements warned as early as 1998 that the single - minded pursuit of price stability could come at the expense of system - wide financial stability. however, the prevailing view in 2006 – indeed, right up to the crisis and slightly beyond – was that financial - stability issues were best left to regulators. central banks had one primary monetary policy tool at their disposal – adjustment of an official short - term interest rate – and experience suggested that this was best directed at achieving price stability. the extreme version of this view rested on three basic tenets : ( i ) asset bubbles and other forms of potentially serious financial dislocation were difficult, if not impossible, to spot in real time ; ( ii ) adjustment of the official interest rate was a very blunt and inefficient instrument with which to counter asset bubbles, and would likely inflict considerable collateral damage on the rest of the economy ; and ( iii ) a more realistic strategy was to focus simply on cleaning up as quickly as possible once an asset bubble had burst. this was the best a central bank could do. 6 the more nuanced view of most inflation targeters, including the bank of canada, was that central banks should lean against any suspected financial instability to the extent that it might threaten aggregate economic activity and the achievement of the inflation target over the medium term, even if this implied appearing to deviate from the target in the short term. in other words, central banks were expected to pursue inflation targeting in a flexible, forwardlooking manner, and could delay achieving their target if such an action would minimize the possibility of more ominous outcomes in the future. but the pursuit of financial stability through monetary policy measures should not go any further. 7 see berg and jonung ( 1999 ) for a description of the swedish experience with price - level targeting. eggertsson ( 2007 ) contends that the united states also successfully pursued price - level targeting during the 1930s, but their experience has largely gone unreco