Inflation Targeting: A Canadian Perspective By Prof Inflation Targeting: A Canadian Perspective By Prof. Angelo Melino – University of Toronoto April 2011 Presenting second half of paper: Engr. Hasan AlSayegh 5 December 2011 Special Topics in Economic Policy Dr. Nayef Alshammari

Can, should, framework of Bank of Canada be improved? Currently using: flexible inflation targeting (IT) Continue to use inflation targeting? Use alternate: price-level path targeting (PLPT)? What about condition of Zero Lower Bound (ZLB)?

Under Inflation Targeting Past deviations from inflation target do not affect path of policy rate There is no “catch-up” or “cool-off” for past price fluctuations Author confident Bank has not secretly targeted price level despite close correlation Best explanation: Bank has error-correction behavior built into it to account for interest rate smoothing

Under Inflation Targeting Murchison (2010) states interest rate smoothing IT incorporates many aspects of PLPT Thus uses some history-dependence to choose path for policy rate to avoid large changes Since empirical estimates of Bank’s Taylor rule fit better when we allow for interest rate smoothing; it is built into Bank’s ToTEM

Price-Level Path Targeting Set monetary policy according to future price-level, not inflation Should produce better anchor to reduce medium and long horizon price level uncertainty, still would have tail risk Masson & Shukayev (2011) argue major events could “reset” price level target path, such as war May not eliminate long horizon inflation uncertainty due to large shocks to price level

Zero Lower Bound It was thought that ZLB would limit monetary policy, but ZLB events were not expected April 2009 ZLB occurred: Bank outlined series of actions Only one used: Conditional commitment to keep policy rate fixed at effective ZLB until end of June 2010 Potential advantages of PLPT appear when economy is at ZLB

Target Rate of Inflation Should it stay at 2%? Friedman argues that the opportunity cost of holding money by private agents should be equalized to the social cost of producing it. In the end 2% works

Conclusion Bank of Canada may use additional sources of data to predict future events Difficult to predict “seismic” economic events, such as events of 2007: Financial stability Otherwise, system works greatly as is

Questions?