Inflation Targeting

Canada

Leonard Manalo, Terrance , Gregory Belcher, Renaldo Stultz

 Canada

•GDP = 1.114 Trillion

•13th in the world
•Growth Rate of 2.9% and Unemployment of 6.5 (AUG 2006)
 Inflation Targeting: Definition
• Implemented 1991
• Announcing a numerical goal for inflation
• The Bank of Canada (BOC) uses the total
CPI to measure inflation
– But it looks more closely at the Core CPI
• Removes the eight most volatile elements of the
CPI
• More Consistent measure of inflation
 CPI and Core CPI Percentage Changes

5
4.5
CPI Percentage Change
4
Core CPI Percentage Change
3.5
3
2.5
Percent
2
1.5
1
0.5
0

Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Date
 Goals of Inflation Control
• Allows predictability of average inflation
– Lower market interest rates
– Positive climate of long-term investment
– Prevents significant deflation
– Sets a target range for inflation from 1 to 3
percent
– To achieve this range monetary policy needs
to aim for a 2% target midpoint
 Overnight Rate
• The rate that financial institutions borrow
or lend between each other with the period
on one day.

• Financial institutions need to cover their

daily transactions by borrowing, either with
public banks or the central bank.
 Overnight Rate
• The Monetary Tool of the Operational Band
– Targeted overnight rate is at the center and there
are .25% margins at the top and bottom
• For example:
– As of September 9, 2006 target rate is 4.25%
– Banks borrow from the Bank of Canada at 4.50%
– Banks can earn 4.00% on deposits in the Bank of Canada.

• Under this system, Bank of Canada has

complete control of the overnight rate.
– Banks cannot borrow or lend outside of the
operational band.
 Overnight Rate (Con’t)
• Through the overnight rate, the Bank of
Canada can influence other interest rates
– They can influence economic performance
• Including (at an aggregate level):
– Output
– Price
 Implementation
• When BOC wants to increase the price
level, they will lower target rate.
• Influence money market and reduce the
interest rate of individual financial
institutions
• Lower interest rates >>> increase
investment and aggregate demand moves
upward >>> Price level increases
 Results of the Inflation
Targeting Regime
• Must Sacrifice Price Stability for Employment:
• AW Phillips suggests that policy makers must
scarify the labor market in order to keep prices
stable.
• Core Inflation has been low, and under control

2004Q3 2004 2005 2005 2005 2005 2006 2006

Q4 Q1 Q2 Q3 Q4 Q1 Q2
Unemployment 7.1 7.1 7 6.8 6.8 6.5 6.4 6.2

Core Inflation 1.6 1.6 1.8 1.6 1.6 1.6 1.7 1.8
 Results (Con’t)
•The inflation rate in 1991 was
5.9%
•By December 1993, inflation had
been reduced to 2%
•The government extended the
inflation-control target range in
1998, 2001, and 2006.
 Economic Growth
•Economic Growth due to Inflation Targeting is ambiguous.
•Growth may have to do more with stronger Canadian Dollar.
•Current Growth in Canada is 2.9%.

GDP Growth (Eurostats)

Percentage
2

0
2000 2001 2002 2003 2004 2005
Year
GDP Growth