by Robert Amano, Tom Carter, and Don Coletti (full document, PDF. To read Adobe Acrobat® files, you will need to download and install the free Acrobat Reader® software available from Adobe Systems Incorporated.)
In 2006, the Bank initiated a research program exploring two alternatives to the current inflation-targeting framework: (i) lowering the inflation target and (ii) shifting to a price-level target. This article discusses progress to date, places the Bank's findings in the context of a broader literature, and identifies avenues for future research. Earlier literature and recent studies at the Bank suggest that an inflation target below two per cent is likely preferable to the status quo, though it is unclear how much lower policy-makers should aim and also how much Canadians would benefit from a shift. With regard to the price-level target, evidence is more mixed, with need for study concerning (i) the target's influence on contracting behaviour and inflation expectations; (ii) strategies for ensuring credibility in the commitment to price-level targeting; and (iii) the Canadian economy's vulnerability to shocks that the literature identifies as particularly detrimental to the target's performance.
Topic index: Monetary policy framework ; Inflation: costs and benefits ; Inflation targets ; Inflation and prices ; Central bank research ; Economic models
by Steve Ambler (full document, PDF. To read Adobe Acrobat® files, you will need to download and install the free Acrobat Reader® software available from Adobe Systems Incorporated.)
This article reviews arguments in the literature for and against price-level targeting, focusing on its costs and benefits compared with inflation targeting. Benefits of price-level targeting include the effect on forward-looking inflation expectations; the ability to substitute for commitment by a central bank to its future policies; lessening forecast errors; better economic performance in response to real shocks because of lower wage indexation; and a reduction in the problem of the zero lower bound on nominal interest rates. Strict price-level targeting is not appropriate when inflation expectations are not fully forward-looking, and targeting the overall price level may be harmful if there are volatile movements in some of its components.
Topic index: Monetary policy framework ; Inflation and prices ; Inflation: costs and benefits
by Allan Crawford, Césaire A. Meh, and Yaz Terajima (full document, PDF. To read Adobe Acrobat® files, you will need to download and install the free Acrobat Reader® software available from Adobe Systems Incorporated.)
Many central banks around the world have embraced inflation targeting as a monetary policy framework. Interest is growing, however, in price-level targeting as an alternative. The choice of frameworks has important consequences for financial contracts, most of which are not fully indexed to the price level. Changes in the price level therefore lead to changes in the real value of contracts. Price-level targeting would reduce the size of these changes in real wealth and decrease uncertainty about the future price level. This article assesses the merits of price-level targeting vis-à-vis inflation targeting from a debt-revaluation perspective, with a focus on channels affecting risk premiums, the maturities of nominal debt contracts, and redistribution of wealth. A general conclusion flowing from the analysis is that accounting for the revaluation of nominal debts and assets strengthens the relative merits of price-level targeting compared with inflation-targeting.
Topic index: Inflation targets ; Monetary policy framework ; Inflation: costs and benefits
by Césaire A. Meh and Yaz Terajima (full document, PDF. To read Adobe Acrobat® files, you will need to download and install the free Acrobat Reader® software available from Adobe Systems Incorporated.)
One of the most important arguments in favour of price stability is that unexpected inflation generates changes in the distribution of income and wealth among different economic agents. These redistributions occur because many loans are specified in fixed dollar terms and unexpected inflation redistributes wealth from creditors to debtors by reducing the real value of nominal assets and liabilities. This article quantifies the redistributional effects of unexpected inflation in Canada, providing comprehensive evidence of the nominal assets and liabilities of various economic sectors and household groups. A key finding is that the redistributional effects of unexpected inflation are large even with episodes of low inflation. The main winners are young, middle-income households who are major holders of fixed-rate mortgage debt and the government–inflation reduces the real burden of their debt. The losers are high-income households and middle-aged, middle-income households that hold long-term bonds and non-indexed pension wealth.
Topic index: Inflation: costs and benefits ; Inflation and prices ; Sectoral balance sheet ; Central bank research
