Blogs & Comment

C.D. Howe on monetary policy

The C.D. Howe Institute released a study today by University of Toronto economics professor Angelo Melino on the Bank of Canadas monetary policy, which declared a preference for a modified version of the inflation-targeting regime in force for almost twenty years under an agreement with the Dept. of Finance. With 5 years elapsed since the last review, the agreement is again up for renewal at the end of this year.
The main competing alternative to the existing inflation-targeting regime is a price-level-targeting regime. The basic difference between the two is that a central bank operating under inflation targeting does not have to offset deviations from the inflation target (2%) — it just has to return inflation to its target. Under price-level targeting, the central bank has to offset deviations from target by pushing inflation past the target to the required extent.
It can be seen that price-level targeting imposes greater discipline and keeps inflation expectations in check more. The price level is prevented from straying off course over medium- to long-term periods and generating uncertainties about the direction of inflation – as could happen under inflation-targeting.
Melino thinksinflation targeting has served Canada well and a radical departure is not warranted. Besides, his modified inflation-target approach would have similar effects to price targeting but within a more flexible framework. Specifically, he recommends:
the inflation target for the next renewal period should be lowered to 1.5%
inflation targets in subsequent renewal periods should be set to correct past deviations
consider the credit cycle in choosing the policy rate (regulation should be used to deal with the credit cycle first, but the Bank may on occasion need to use its policy rate)
try price-level targeting at the zero lower bound for the policy rate
Its not quite what I envisionedas a solution to the error in monetary policy. But at least its a step in the right direction. The end result should be some reduction in the likelihood of financial bubbles and panics in Canada. Now if only the Federal Reserve would get a little more serious about heading off the bubbles once the U.S. economy gets off life support.