Policy Rules and the Conduct of Monetary Policy in Canada Pierre Duguay Deputy Governor

Outline Introductory Comments Targeting Rule vs. Instrument Rule General vs. Specific Targeting Rule Bank of Canada Inflation-Control Strategy IFB Instrument Rule as a practical answer in large scale forward-looking model Approaches to deal with uncertainty

Lars’ Framework Targeting Rule vs. Instrument Rule Response to determinants of aggregate demand and inflation vs. response to outcomes Drawback of Taylor Rule: Time-varying neutral rate General vs. Specific Rule Transparency about horizon and implications for output gap

Bank of Canada Inflation-Control Strategy Model-Based Staff Economic Projection Numerical solution to optimal-control problem A Process to Deal with Uncertainty Range of information Multiplicity of models Search for robust rule Search for leading indicators Communication and Transparency Less is more

Model-Based Staff Economic Projection Monetary Policy is endogenous Object of projection is to derive recommended path for policy instrument Alternative Scenarios Alternative assumptions about key variables Alternative interest rate path Robust Taylor rule Constant interest rate for a period of time Evaluation of Forecasting Performance

IFB Rule in QPM A Plausible Numerical Solution to Complex Optimal-Control Problem Brings inflation close to target over acceptable horizon Avoids excessive secondary cycles Selection of Parameters Based on trade-off between variances of output and inflation Made by Governing Council

IFB Rule in QPM rsl t =.3 rsl t (ygap+ygap t-1 )/ (infgap t+6 + infgap t+7 )/2 Use of term spread mitigates trade-off between target and instrument Trade-off between variance of output and inflation Improved by weight on output gap Worsened by interest rate smoothing

Communications Less is more: Keep story simple Outlook for output and output gap, core and total CPI inflation Broad direction of interest rates Factors that will be watched closely Not wanting to preempt private sector forecasts Focus on the logic of central bank decisions Highlight uncertainty

Conclusion Monetary Policy as commitment to a Targeting Rule using all relevant information Decision process factoring uncertainty Communication focusing on the logic of central bank decisions and highlighting uncertainty