The Bank of Canada is studying whether it should make changes to the framework that has underpinned its policy decisions — such as interest-rate movements — for nearly four decades.
In a speech Tuesday, senior deputy governor Carolyn Wilkins said the current inflation-targeting approach has improved the economic and financial well-being of Canadians since it was established in 1991.
But after a decade in the post-financial-crisis environment, she said it has become clear the bank’s mandate of helping inflation stay close to its target of 2% has its down sides.
“Even a well-functioning monetary-policy framework deserves an open-minded discussion, particularly in the post-crisis world we live in,” Wilkins said in prepared remarks of her address at McGill University in Montreal.
“There are a couple of challenges facing our framework that mean it may not serve the economic and financial welfare of Canada in the future as well as it has in the past.”
One key issue, she noted, is that interest rates are no longer expected to rise as high they had before the crisis, which means there will be less room — or “conventional firepower” — for the bank to cut rates in an economic downturn.
The bank, which is on a rate-hiking path, has said it expects its benchmark interest rate to eventually settle somewhere between 2.5% and 3.5%, about two percentage points lower than it was in the early 2000s.
Another concern, Wilkins said, is that lower rates may entice Canadians and investors to take on excessive risk — leaving the economy exposed to the ups and downs of financial cycles. Long-running low-rate conditions have encouraged Canadian households to amass record levels of debt.
She said the Bank of Canada is conducting research on alternative frameworks, including a higher target for inflation and a more-flexible, dual mandate that would extend the bank’s focus to also incorporate labour and other economic indicators.
The work, which is an effort with the federal Finance Department, is underway in the lead-up to the Bank of Canada’s next five-year renewal of its inflation-control agreement with the government. The next renewal is set for 2021.