inflation targeting in canada: outcomes, evolutions, and ... · inflation targeting in canada:...

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Inflation Targeting in Canada:Inflation Targeting in Canada:Outcomes, Evolutions, andOutcomes, Evolutions, and

Ch llChallengesChallenges

XI Annual Inflation Targeting SeminarXI Annual Inflation Targeting Seminar

Central Bank of BrazilCentral Bank of Brazil

14–15 May 200914 15 May 2009

Rio de Janeiro

David LongworthDavid LongworthD t GDeputy Governorp y

IntroductionIntroduction

• Brazil celebrates 10 years of inflation• Brazil celebrates 10 years of inflation targeting (IT)targeting (IT)

• IT in Canada has come of age (18)IT in Canada has come of age (18)

• 10 years ago important policy work10 years ago, important policy work d t B Cunderway at BoCy

IT i h i h t d t i• IT regimes have inherent advantages in g gdealing with current stormdealing with current storm

2

22

OutlineOutline

1 Outcomes in Canada1. Outcomes in Canada

2 Evolution: Improvements in IT regime2. Evolution: Improvements in IT regime

3 Challenges for IT Regimes3. Challenges for IT Regimes

3

OutcomesOutcomes

• Inflation: Levels Expectations and• Inflation: Levels, Expectations, and VariabilityVariability

• Interest Rates: Levels, Spreads (vs. U.S.)Interest Rates: Levels, Spreads (vs. U.S.) d V i bilitand Variabilityy

L th d N t f L b d Fi i l• Length and Nature of Labour and Financial gContractsContracts

• Output and Unemployment: Growth Gaps• Output and Unemployment: Growth, Gaps, and Variabilityand Variability

4

33

Outcomes: InflationOutcomes: InflationG h 1Graph 1

C P i I dConsumer Price Index Year-over-year percentage changey p g g

14 14Feb 1991

12 12

Feb. 1991

10

12

10

12

10 10

8 8

6 66 6

4 4

2 2

0

2

0

2

0 0

-2 -2

1955 1965 1975 1985 1995 20051955 1965 1975 1985 1995 2005

• Inflation was low and stable from early 1950s to mid 1960s and again since 19925

• Inflation was low and stable from early 1950s to mid 1960s, and again since 1992

Outcomes: InflationOutcomes: Inflation

• “Low stable and predictable”• Low, stable, and predictable

• Low levels• Low levels

• Predictable: low autocorrelation• Predictable: low autocorrelation,

well anchored expectationswell anchored expectations

• Stable: low standard deviation• Stable: low standard deviation

6

44

Outcomes: InflationOutcomes: InflationGraph 2Graph 2

I fl ti d th T tInflation and the TargetgYear-over-year percentage change Year over year percentage change

5 5Total CPITarget range

4 4Target range

3 3Target midpoint

2 2

g p

2 2

1 11 1Core CPI

0 0Core CPI

0 0

-1 -11

1992 1994 1996 1998 2000 2002 2004 2006 2008

1

1992 1994 1996 1998 2000 2002 2004 2006 2008I fl ti h ll b ithi th 1 3% t t 7• Inflation has generally been within the 1-3% target range


Longer-Term Inflation ExpectationsLonger Term Inflation Expectations7 7

F b 1991

6 6Feb. 1991

6 6

5 5

4 44 4Bond yield differential a

(30 ) Control range

3 3(30 years) Control range

2 22 2C f B d

1 1Conference Board

(2 years)Consensus Economics

0 0

( y )Consensus Economics(6 to 10 years)

0 0

1990 1993 1996 1999 2002 2005 2008a Difference between the yield on Nominal and Real Return 30-year bonds

8• Longer-term inflation expectations well anchored

55


Inflation: Seven-year Standard DeviationInflation: Seven-year Standard DeviationB d Y t h Based on:Year-over-year percentage change

4 44 4Total CPI Feb. 1991 Feb. 1998

3 3

2 22 2

1 11 1Core CPI

0 0

1980 1984 1988 1992 1996 2000 2004 20081980 1984 1988 1992 1996 2000 2004 2008I fl ti h b t bl 9• Inflation has been stable

Outcomes: Interest RatesOutcomes: Interest Rates

• Lower interest rates• Lower interest rates

• Lower spreads vis-à-vis U S rates• Lower spreads vis-à-vis U.S. rates

• Lower variability of interest rates• Lower variability of interest rates

Within month– Within month

Over a cycle– Over a cycle

10

66

Outcomes: Interest RatesOutcomes: Interest RatesG h 7Graph 7

10-Year Government Bond Rate and 90-Day yCommercial Paper Rate% Commercial Paper Rate

25

%

2525 25Feb. 1991

20 2090-Day CP Rate

15 1510-Year Bond Rate

15 15

10 10

5 55 5

0 0

1971 1975 1979 1983 1987 1991 1995 1999 2003 200711• Both s-t and l-t interest rates have declined


10-Year Government Bond Rate Spread and10-Year Government Bond Rate Spread and90-Day Commercial Paper Rate Spread 90-Day Commercial Paper Rate Spread

(Canada minus U S )(Canada minus U.S.)6

%66 6

Feb. 1991

4 44 490-Day CP Spread

10 Y S d10-Year Spread

2 2

0 0

-2 -22 2

4 4-4

1971 1975 1979 1983 1987 1991 1995 1999 2003 2007

-4

1971 1975 1979 1983 1987 1991 1995 1999 2003 2007

I t t t d h d 12• Interest rate spreads have come down

77


2-Year Yields12-Month Average of Monthly Standard Deviation

in Percentage Points*%

0.30%

0.30

0.25 0.25Canada

United States

0.20 0.20

0.15 0.15

0 100.10 0.10

0 05 0 050.05 0.05

0.00 0 000.00

1993 1996 1999 2002 2005 2008

0.00

* Daily data

13• For 10 years, 2-year intra-month volatility similar in Canada and United Statesy , y y


10-Year Government Yields 12-Month Average of Monthly Standard Deviation

in Percentage Points*%

0.18%

0.18

C dFeb. 1991

0.16 0.16Canada

U it d St t

0 14 0 14United States

0.14 0.14

0.12 0.12

0 10 0 100.10 0.10

0.08 0.08

0.06 0.06

0.04 0.040.04

1990 1993 1996 1999 2002 2005 2008

0.04

* Daily dataB t 10 i t th l tilit l i C d 14• But 10-year intra-month volatility lower in Canada

(better anchored inflation expectations?)(better anchored inflation expectations?)

88


Canadian and U.S. 2-Year Government Bond RateSeven-Year Standard Deviation*

3 0%

33.0 3Feb. 1991 Feb. 1998

2.5 2.5

U it d St tUnited States

C d2.0 2

Canada

1 5 1 51.5 1.5

1.0 1

0.5 0.5

1984 1988 1992 1996 2000 2004 2008

* Monthly data • Within-cycle variability for the 2-year rate lower in15

• Within cycle variability for the 2 year rate lower in Canada, as policy rate has been less variabley


Canada and U.S. 10-Year Government Bond RateSeven-Year Standard DeviationSeven Year Standard Deviation

3 0%

3 03.0 3.0

F b 1991 Feb 1998

2 5 2 5

Feb. 1991 Feb. 1998

2.5 2.5

2 0 2 02.0 2.0

1 5 1 51.5 1.5

1 0 1 0United States1.0 1.0United States

CanadaCanada

0.5 0.5

0.0 0.0

1980 1984 1988 1992 1996 2000 2004 2008

16* Monthly data • Within-cycle variability for the 10-year rate has declined in C d d i i il t th t i th U it d St tCanada, and is similar to that in the United States

99

Outcomes: ContractsOutcomes: Contracts

• Longer labour contracts• Longer labour contracts

• Fewer cost-of-living clauses• Fewer cost-of-living clauses

• Longer financial contracts• Longer financial contracts

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Outcomes: ContractsOutcomes: ContractsGraph 15Graph 15

Wage Settlements: Private SectorWage Settlements: Private SectorAverage Length (Months) and ProportionAverage Length (Months) and Proportion

ith C t f li i Adj t t Clwith Cost-of-living Adjustment Clause60 60

F b 1991Feb. 1991

50 5050 50Average length

(months)

40 40(months)

40 40

30 3030 30

20 2020 20Proportion with COLA clause

10 10

COLA clause (per cent)

10 10

1978 1982 1986 1990 1994 1998 2002 200618• Contracts have become longer; fewer with protection against inflation

1010

Outcomes: ContractsOutcomes: Contracts Graph 16

R ti f L t B i C ditGraph 16

Ratio of Long-term Business Creditto Total Business Credit

Percentage75 75

g

Feb 1991

70 70

Feb. 1991

70 70

65 65

60 6060 60

55 5555 55

50 50

45 4545 45

40 40

1971 1975 1979 1983 1987 1991 1995 1999 2003 2007

L t fi i l t t h b th 19• Longer-term financial contracts have become the norm

Outcomes: OutputOutcomes: Output

• Less variable output growth• Less variable output growth

• Less variable output gap• Less variable output gap

• Lower and less variable unemployment rt• Lower and less variable unemployment rt.

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1111

Outcomes: OutputOutcomes: OutputG h 20Graph 20

GDP Growth: Seven year Standard DeviationGDP Growth: Seven-year Standard Deviation QBased on: Quarter-over-quarter percentage change at annual rates

51998Q11991Q1 1998Q1

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33

2

1

00

1980 1984 1988 1992 1996 2000 2004 20081980 1984 1988 1992 1996 2000 2004 200821• Output growth has been more stable

Outcomes: OutputOutcomes: OutputG h 21Graph 21

Convential Measure of Output Gap:Convential Measure of Output Gap: Seven-year Standard DeviationSeven year Standard Deviation

2 52.51991Q1 1998Q1

2 02.0

1.51.5

1.0

0.5

1980 1984 1988 1992 1996 2000 2004 200822

1980 1984 1988 1992 1996 2000 2004 2008• The output gap has also been more stable• The output gap has also been more stable

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Outcomes: Output UROutcomes: Output, URG h 19Graph 19

Unemployment RateUnemployment Rate P tPer cent

14 14Feb 1991Feb. 1991

12 12

10 1010 10

8 88 8

6 66 6

4 44 4

2 22

1965 1971 1977 1983 1989 1995 2001 2007

2

1965 1971 1977 1983 1989 1995 2001 2007

23•• Until recently, unemployment in the IT regime declined steadily

Outcomes: Output UROutcomes: Output, URG h 22Graph 22

Unemployment Rate:Unemployment Rate: Seven year Standard DeviationSeven-year Standard Deviation

2.5Feb. 1991 Feb. 1998

2 02.0

1.5

1.0

0 50.5

0 00.0

1980 1984 1988 1992 1996 2000 2004 200824• The unemployment rate has also been more stable

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EvolutionEvolution

• Fixed Announcement Dates introduced• Fixed Announcement Dates introduced

• Increased transparency regarding• Increased transparency regarding economic outlookeconomic outlook

• Changes when IT agreement renewedChanges when IT agreement renewed i 2001in 2001

Ch h IT t d• Changes when IT agreement renewed g gin 2006in 2006

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Evolution: FADsEvolution: FADs

• Prior to Dec. 2000, decisions taken anytimePrior to Dec. 2000, decisions taken anytimeI i l ft th t t li ti d t• Impression left that our monetary policy tied to Federal Reserve’sFederal Reserve sDesired benefits of Fi ed Anno ncement Dates• Desired benefits of Fixed Announcement Dates– Reduced uncertainty in financial marketsReduced uncertainty in financial markets

Greater attention on situation in Canada– Greater attention on situation in Canada– Greater emphasis on medium termp

Increased transparency accountability public– Increased transparency, accountability, public dialoguedialogue

• Studies have shown that these benefits haveStudies have shown that these benefits have transpiredtranspired

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1414

Evolution: TransparencyEvolution: Transparency

• Monetary Policy Report Update introduced inMonetary Policy Report Update introduced in F b 2000February 2000

• Increased transparency of economic projection• Increased transparency of economic projection– Core inflation, total CPI inflation, oil price (April 2003)( )

– Annual foreign output growth (April 2004)Annual foreign output growth (April 2004)

Annual contributions to Canadian GDP growth (April 2004)– Annual contributions to Canadian GDP growth (April 2004)

– Quarterly growth of GDP (October 2005)

– More explicit assumptions about exchange rate, p p g ,

non-energy commodity prices terms of tradenon-energy commodity prices, terms of trade

• Forward-looking statements about monetary g ypolicypolicy

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Evolution: 2001 RenewalEvolution: 2001 Renewal

G t h i t t id i t• Greater emphasis on target midpointp g p• Length of agreement extended to 5 yrs from 3• Length of agreement extended to 5 yrs from 3• Role of core inflation made more preciseRole of core inflation made more precise

D fi iti f i fl ti h d• Definition of core inflation changed– Excludes 8 most volatile elements– Excludes 8 most volatile elements

• Accountability when persistent deviations from y ptargettarget

• Discussion of appropriateness of 2 % target pp p % g

28

1515

Evolution: 2006 RenewalEvolution: 2006 Renewal

Elaboration of the Targeting Framework:Elaboration of the Targeting Framework:

T t H i• Target Horizon

• 6-8 quarters still generally appropriate• 6-8 quarters still generally appropriate

• But specific occasions may arise when longer, shorterp y g

• Asset Prices• Asset Prices

• No explicit recognition in target index (beyond housing p g g ( y gin CPI)in CPI)

Mi ht b i t t d i ti l• Might be appropriate to respond in exceptional circumstancesc cu s a ces

Issues warranting further research:• Issues warranting further research:

• Lower inflation targetLower inflation target

P i l l t ti• Price level targeting29

ChallengesChallenges

• Asset price booms• Asset price booms

• Commodity price boom• Commodity price boom

• Financial crises• Financial crises

Zero lower bound• Zero lower bound

Can e do better?• Can we do better?

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1616

Challenges: Asset PricesChallenges: Asset Prices

• Canada fortunate that housing servicesCanada fortunate that housing services i l d d i CPIincluded in CPI

Feeds off new house price index• Feeds off new house price index

• Have not changed our view since 2006• Have not changed our view since 2006

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Challenges: Financial CrisesChallenges: Financial Crises

M i iti t i b tt d ti l• Main mitigant is better macroprudential g ppolicy (regulators)policy (regulators)

• Scope to ease monetary policy quickly• Scope to ease monetary policy quickly

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Challenges: Zero lower boundChallenges: Zero lower bound

• Inflation targeters have distinct• Inflation targeters have distinct d t f t i th i t liadvantages of tying their monetary policy g y g y p y

decisions to achieving their inflation targetdecisions to achieving their inflation target• Number of quarters at effective lower• Number of quarters at effective lower

b d b ti d t i fl ti j tibound can be tied to inflation projectionp jActions in terms of credit and q antitati e• Actions in terms of credit and quantitative qeasing need to be tied to principleseasing need to be tied to principles

icovering:g• Objective Impact Neutrality Prudence• Objective, Impact, Neutrality, Prudence,

Exit StrategyExit Strategy

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Challenges: Doing BetterChallenges: Doing Better

• Lower Inflation Target?• Lower Inflation Target?• Many theories would suggest itMany theories would suggest it

B t t f t iti ld b tl• But costs of transition could be costly• Effective lower bound for interest rates• Effective lower bound for interest rates

• Price Level Targeting?Price Level Targeting?W ld h l i h ff i l b d• Would help with effective lower boundp

• Much theory and calibration would favour it• Much theory and calibration would favour it• But doesn’t perform well with persistentBut doesn t perform well with persistent

terms of trade shocksterms-of-trade shocks

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1818

ConclusionsConclusions

• Good economic performance aided by ITGood economic performance aided by IT

• Significant changes in last 10 yearsSignificant changes in last 10 years• Great increase in transparencyp y

S k h ll t d d i f t• Some key challenges today and in futurey g y

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36

1919

A diAppendixAppendixG h 3Graph 3

O fExpected and Observed Inflation Rates7 7%

Feb 1991

6 6Conference Board

Feb. 1991

6 6(2 years)

5 5

4 4

3

4

3

4

3 3

2 2

1 11 1Overall CPI*

0 0

-1 -11

1984 1987 1990 1993 1996 1999 2002 2005 2008

1

1984 1987 1990 1993 1996 1999 2002 2005 2008* The low point in 1994 reflects a cut in taxes on tobacco products.

37• Since 1992, expectations influenced little by actual inflation


Annual Standard Deviation of Wage SettlementsAnnual Standard Deviation of Wage Settlements Private SectorPrivate Sector

P t i tPercentage points

3.5 3.5Feb 1991

3 0 3 0

Feb. 1991

3.0 3.0

2.5 2.52.5 2.5

2.0 2.0

1.5 1.5

1 0 1 01.0 1.0

0 5 0 50.5

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

0.5

• Variation of wage settlements across contracts has declined

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

38• Variation of wage settlements across contracts has declined

2020


Canadian and US 90-Day Commercial Paper RateSeven-Year Standard Deviation

%

5%

5

Feb. 1991 Feb. 1998

4 44 4

3 3

United States

2 2

United States

Canada2 2

1 1

0 00

1980 1984 1988 1992 1996 2000 2004 2008

0

39

A diAppendixAppendix Graph 14Graph 14

Wage Settlements: Average Length (Months) andWage Settlements: Average Length (Months) and Proportion with Cost of living Adjustment ClauseProportion with Cost-of-living Adjustment Clause50 50Feb. 1991

40 40

30 30A l thAverage length

(months)

20 20( o t s)

20 20

10 10Proportion with 10 10COLA clause (per cent)

0 0

(per cent)

0

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

0

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

• Contracts have become longer; fewer with protection against inflation40

• Contracts have become longer; fewer with protection against inflation

2121


Quarterly GDP Growth at Annual RatesQuarterly GDP Growth at Annual Rates Per centPer cent

12 121991Q11991Q1

8 8

4 4

0 00 0

-4 -4-4 -4

8 8-8

1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

-8

O t t th h b l l til i 1991

1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

41• Output growth has become less volatile since 1991


E ti t d O t t GEstimated Output GapDifference between actual estimated and estimated potential output

4 44 41991Q1

2 22 2

0 00 0

2 2-2 -2

-4 -4

-6 -6

1971 1977 1983 1989 1995 2001 2007

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