{
  "title": "Strengthening Canada's Economic Toolkit: Improving the Inflation Targeting Framework",
  "publication": "IMF Blog, November 1, 2016",
  "sourceUrl": "https://www.imf.org/en/blogs/articles/2016/11/01/strengthening-canadas-economic-toolkit-improving-the-inflation-targeting-framework",
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  "summary": "For the past 25 years, Canada’s monetary policy framework has been working well.",
  "sections": [
    {
      "heading": "Background and recent performance",
      "content": "- For the past 25 years, Canada’s monetary policy framework has been working well.\n- Headline inflation averaged 1.9 percent, 1994–2015.\n- Long-term inflation expectations have been very well anchored to the 2 percent target.\n- Authors: Maurice Obstfeld, Douglas Laxton, Yulia Ustyugova, Hou Wang.\n- Date: November 1, 2016."
    },
    {
      "heading": "Current challenges to monetary policy",
      "content": "- Unusual global and domestic conditions: low and sub-zero interest rates; significant economic slack; risk that inflation might get stuck below target.\n- Central bank unconventional tools under consideration include ad hoc forward guidance on the policy interest rate, quantitative easing, funding for credit, and negative interest rates.\n- Such unconventional tools have disadvantages and communications risks."
    },
    {
      "heading": "Recommendation: Use conventional forward guidance before unconventional tools",
      "content": "- Systematic transparency about policy intentions increases monetary policy effectiveness.\n- Recommendation: The Bank of Canada should publish the path of the short-term interest rate from the forecast used at its policy meetings.\n  - The Bank holds 8 per year policy meetings.\n  - Guidance should be conventional (routine publication) and include usual caveats: not a commitment and conditional on the Bank’s latest forecast.\n  - Publication of a confidence band for the interest rate path, and alternative scenarios to the baseline forecast, is recommended to clarify conditionality."
    },
    {
      "heading": "Distinction: conventional forward guidance vs. ad hoc forward guidance",
      "content": "- Conventional forward guidance: routine publication of the forecast policy-rate path tied to the Bank’s conditional forecast.\n- Ad hoc forward guidance: a conditional commitment to a very low rate used in past episodes (Bank of Canada in 2009; more extensively by the U.S. Federal Reserve and the Bank of England).\n  - Ad hoc guidance reduced longer-term interest rates but created communications problems about commitment duration and subsequent policy moves."
    },
    {
      "heading": "Rationale: how conventional forward guidance strengthens policy",
      "content": "- Point 1: The current money market overnight interest rate has negligible direct macroeconomic effect by itself; effectiveness depends on influence over expected future short-term rates and medium- and longer-term interest rates faced by households and firms.\n  - Policymakers therefore need a view on the whole medium-term path of the policy rate when making decisions.\n- Point 2: The policy rate path that returns inflation to target is not unique; the chosen path reflects policymakers’ preferences about the short-run output and inflation trade-off.\n  - Only the central bank knows the intended path; without direct guidance, markets must guess intentions.\n- Publishing the forecast interest rate path reveals how the central bank plans to navigate the output/inflation trade-off.\n  - If credible, this will move the term structure of interest rates and the exchange rate in support of policy objectives."
    },
    {
      "heading": "Policy scenario: using conventional forward guidance to avoid a low-inflation trap",
      "content": "- Risk: Further negative shocks when the policy interest rate is near zero could push the economy toward a low inflation trap that is hard to escape.\n- Proposed strategy under conventional forward guidance:\n  - Explicit forecast for the policy rate to stay low for longer.\n  - Allow inflation to temporarily overshoot the target to raise inflation expectations, lower real interest rates, depreciate the exchange rate, and stimulate the economy.\n  - As economic growth improves, raise the desired interest rate and exit from ultra-low interest rates safely.\n- Conventional forward guidance enables the central bank to give a credible public account of this strategy and reinforce confidence in the 2 percent inflation target."
    },
    {
      "heading": "Interaction with fiscal policy",
      "content": "- Current fiscal stimulus in light of Canada’s economic challenges is fully justified.\n  - Rationale: low government debt-to-GDP ratio and the exceptionally low cost of long-term government borrowing.\n- Making monetary policy instruments more effective would complement fiscal efforts to boost growth, strengthening Canada’s resilience and ability to handle unexpected shocks.\n\nSource: Strengthening Canada's Economic Toolkit: Improving the Inflation Targeting Framework (Maurice Obstfeld, Douglas Laxton, Yulia Ustyugova, Hou Wang), November 1, 2016.\n\n---\n\n Content in this bundle\n\n- How to Improve Inflation Targeting in Canada\n  - How to Improve Inflation Targeting in Canada (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - How to Improve Inflation Targeting in Canada (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\n References\n\n- https://www.imf.org/wp-content/uploads/2016/10/canada-chart1.jpg\n- https://www.imf.org/wp-content/uploads/2016/10/canada-chart2.jpg\n- United States\n\nSource: https://www.imf.org/en/blogs/articles/2016/11/01/strengthening-canadas-economic-toolkit-improving-the-inflation-targeting-framework"
    }
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    "[Markdown version](/en/blogs/articles/2016/11/01/strengthening-canadas-economic-toolkit-improving-the-inflation-targeting-framework/index.md)",
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    "Authors: Maurice Obstfeld, Douglas Laxton, Yulia Ustyugova, Hou Wang",
    "Published: November 1, 2016",
    "For the past 25 years, Canada’s monetary policy framework has been working well.",
    "Headline inflation averaged 1.9 percent, 1994–2015.",
    "Long-term inflation expectations have been very well anchored to the 2 percent target.",
    "Authors: Maurice Obstfeld, Douglas Laxton, Yulia Ustyugova, Hou Wang.",
    "Date: November 1, 2016.",
    "Unusual global and domestic conditions: low and sub-zero interest rates; significant economic slack; risk that inflation might get stuck below target.",
    "Central bank unconventional tools under consideration include ad hoc forward guidance on the policy interest rate, quantitative easing, funding for credit, and negative interest rates.",
    "Such unconventional tools have disadvantages and communications risks.",
    "Systematic transparency about policy intentions increases monetary policy effectiveness.",
    "Recommendation: The Bank of Canada should publish the path of the short-term interest rate from the forecast used at its policy meetings.",
    "Conventional forward guidance: routine publication of the forecast policy-rate path tied to the Bank’s conditional forecast.",
    "Ad hoc forward guidance: a conditional commitment to a very low rate used in past episodes (Bank of Canada in 2009; more extensively by the U.S. Federal Reserve and the Bank of England).",
    "Point 1: The current money market overnight interest rate has negligible direct macroeconomic effect by itself; effectiveness depends on influence over expected future short-term rates and medium- and longer-term interest rates faced by households and firms.",
    "Point 2: The policy rate path that returns inflation to target is not unique; the chosen path reflects policymakers’ preferences about the short-run output and inflation trade-off.",
    "Publishing the forecast interest rate path reveals how the central bank plans to navigate the output/inflation trade-off.",
    "Risk: Further negative shocks when the policy interest rate is near zero could push the economy toward a low inflation trap that is hard to escape.",
    "Proposed strategy under conventional forward guidance:",
    "Conventional forward guidance enables the central bank to give a credible public account of this strategy and reinforce confidence in the 2 percent inflation target.",
    "Current fiscal stimulus in light of Canada’s economic challenges is fully justified.",
    "Making monetary policy instruments more effective would complement fiscal efforts to boost growth, strengthening Canada’s resilience and ability to handle unexpected shocks.",
    "**How to Improve Inflation Targeting in Canada**",
    "[https://www.imf.org/wp-content/uploads/2016/10/canada-chart1.jpg](https://www.imf.org/wp-content/uploads/2016/10/canada-chart1.jpg)",
    "[https://www.imf.org/wp-content/uploads/2016/10/canada-chart2.jpg](https://www.imf.org/wp-content/uploads/2016/10/canada-chart2.jpg)",
    "[United States](https://blogs.imf.org/2015/06/25/u-s-monetary-policy-avoiding-dark-corners/)"
  ],
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      "title": "How to Improve Inflation Targeting in Canada",
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