1980s, we had had trouble containing inflation to 4 per cent. in addition, there were fears at the time that the introduction of the goods and services tax could rekindle inflationary pressures. but inflation quickly fell into line following the announcement of the targets, and has averaged very close to 2 per cent since the end of 1991. since then, we have seen that the economy functions better at a low rate of inflation. but this experience raises the question : would a lower inflation rate lead to further efficiency gains for the canadian economy? there are a number of reasons to think so. lower inflation would reduce the misallocation of resources by reducing price dispersions and making price signals clearer. it would also reduce the costs of updating prices and the economic distortions coming from a non - indexed tax system. we have been researching this issue for some time. back in 1998, the bank published a number of papers that examined the theoretical arguments and the empirical evidence on the potential benefits of lower inflation, most notably a paper by mcgill university's chris ragan and several papers by bank researchers. 3 but it has proven difficult to quantify the expected benefits of lower inflation. in a recent commentary, david laidler of the c. d. howe institute expresses lingering pessimism about finding material efficiency gains. he focuses instead on the distributional benefits of lower inflation, arguing that these will take on increased importance as our population ages and a growing number of canadians rely on fixed incomes. 4 however, advances in modelling offer new ways of quantifying the expected efficiency gains. these have been explored in two recent papers by bank staff : one coauthored with steve ambler – the outgoing special adviser at the bank of canada 5 – the bank of canada. renewal of the inflation - control target : background information ( ottawa : bank of canada. 2006 ). see c. ragan, on the believable benefits of low inflation, working paper 98 - 15 ( ottawa : bank of canada, 1998 ) and d. coletti and b. o'reilly, " lower inflation : benefits and costs. " bank of canada review ( autumn 1998 ) : 3 - 21. d. laidler, better late than never : towards a systematic review of canada's monetary policy regime, c. d. howe institute commentary. ( toronto : renouf publishing, 2007 ). r. amano, s. ambler, and n. rebei, the macroeconomic effects of non -

the central bank would need to bring about temporarily below - trend inflation to return the price level to its target path over time. economic theory suggests that targeting a path for the price level would benefit the economy by adding certainty about prices over the long term. this should support economic efficiency by reducing the risks associated with long - term financial contracts. providing added certainty about future prices would be of particular benefit to people living on fixed incomes. and as i mentioned earlier, price - level targeting might also help central banks avoid some of the difficulties associated with the " zero - bound " issue. if people anticipate that the central bank would take the appropriate measures to achieve the target, expectations about the future price level could become very well anchored. in these circumstances, it would take smaller moves in nominal interest rates to bring about the needed change in aggregate demand, and hence the zero bound is less likely to become a problem. let me explain. if a shock were to bring the price level below the target, the anticipation that prices would return to target over r. amano, k. moran, s. murchison, and a. rennison, trend inflation, wage and price rigidities, and welfare, working paper 2007 - 42 ( ottawa : bank of canada, 2007 ). bank of canada. renewal of the inflation - control target : background information ( ottawa : bank of canada. 2001 ). time would lower real interest rates and help boost demand, thus requiring a smaller reduction in nominal interest rates. put another way, the drop in prices below target would induce buyers to take advantage of the temporarily low prices. this would alleviate the problems posed by the zero bound. there is, however, concern about how a central bank would need to respond to certain shocks under price - level targeting. under inflation targeting as it is now practised, one - off relative price movements or changes in indirect taxes would not trigger a monetary response as long as inflation expectations remain anchored. by focusing on the future trend of inflation, an inflation - targeting central bank accommodates one - off shifts in the price level and need not disturb the balance between aggregate demand and supply. but under pricelevel targeting, persistent relative price shocks would require a monetary policy response designed to bring about offsetting changes in other components of the consumer price index, which may involve shifts in the balance between aggregate demand and supply. it may be possible for a central bank to target the level of a core price index, which is less subject to relative