around its target and the variance of output around its production potential. thus, we have chosen an 18 - to 24 - month horizon for achieving the inflation target. we take into account all the relevant information, but we have no simple rule for setting interest rates. that the great problem here is that temporary measures are both difficult to initiate quickly when the need arises and extraordinarily difficult to stop once the need is past. thus, as a practical matter, not a philosophical one, there are some severe limitations to the use of 3 4 discretionary fiscal policy as a stabilizer., my views about this have been reinforced by the way the business cycle in canada has developed over the last 18 months or so. in early 2001, we were expecting that the slowdown in both the u. s. and canadian economies would be modest. in canada, an earlier announced tax cut was fortuitously coming into effect. it was not until the middle of last summer that it became evident that the canadian economy was undergoing a more pronounced slowdown than we had expected. between january and august 2001, we had lowered our policy interest rate by 175 basis points. even the most ardent supporters of discretionary fiscal policy would not have thought about doing anything major until august. with the horrific events of 11 september, economic forecasters marked down their forecasts for 2001 and 2002 significantly. we, like other major central banks, accelerated the pace at which we were cutting interest rates — from september through january 2002, we lowered our policy interest rate by a further 200 basis points. fortunately, the canadian government added only a small amount to spending in its budget announcements in late 2001 — and that consisted mainly of necessary spending for security and border issues. i say " fortunately " because, based on the national accounts published at the end of may 2002, growth in the canadian economy actually rebounded in the fourth quarter of 2001 and accelerated to about 6 per cent in the first quarter of this year. thus, with the benefit of hindsight, it is evident that there was more underlying strength in the economy than we expected. combined with the large amount of monetary stimulus that was applied, this meant that the economy could recover rapidly. therefore, added fiscal stimulus was not necessary to get the economy going. and the monetary stimulus provided is proving much easier to turn around. since mid - april, we have raised our policy rate by 75 basis points. to be sure, other uncertainties have arisen and will continue to arise in the

trend of inflation relative to the target is the best indicator of where demand is relative to potential output, this will be consistent with moving demand back into line with the new path of potential output over the medium term. fiscal policy and automatic stabilization in canada, the main automatic fiscal stabilizers are various types of tax revenues, as well as employment insurance payouts. some of these fiscal stabilizers work almost immediately — for example, personal income tax deducted by the employer. others, such as employment insurance payments, work with a fairly short lag. comparing and contrasting automatic fiscal and monetary stabilizers automatic fiscal stabilizers are very effective in dampening an output cycle. but they offset only part of the change in output. in contrast, monetary policy can fully offset a change in output, but it takes time to work, with the full impact on output normally felt only after 12 to 18 months. discretionary stabilization policy while the automatic or quasi - automatic stabilization provided by monetary and fiscal policies is very desirable, the question remains as to whether there is a role for something further — a discretionary stabilization policy. in the case of monetary policy, the nature of the response is the more or less automatic one described earlier. as i implied then, judgment is key to the process. that is particularly true in times of great uncertainty, such as last autumn. but a clear inflation target means that, in principle, the discretionary choice for monetary policy - makers is limited relative to that of the fiscal authorities. the arguments for and against discretionary fiscal policy as an important element in macroeconomic stabilization in an open economy tend to revolve primarily around lags and around the effectiveness of short - run fiscal policy relative to monetary policy. if the timing were close to perfect, fiscal policy measures that lasted for two or three quarters could, in principle, and under ideal circumstances, shorten the time it takes to move output back to its desired level. thus, in principle, discretionary fiscal policy is a useful tool. but, as a practitioner, i can tell you some commentators have described inflation targeting as " constrained discretion, " in the sense that there is a clear objective and a medium - term framework but no precise rule for varying the policy interest rate ( bernanke et al. 1999 ). that is, there are many possible paths back to equilibrium. at the bank of canada, we have decided that the best way to implement inflation targeting is to have an acceptable trade - off between the variance of inflation