Keeping Canada Prosperous in an Economically Unsound World

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Canada's central banker credits our continuing prosperity in an uncertain economy to our macro-economic policy framework that protects the economy from both high inflation and the threat of deflation. By continuing to utilize this policy, raising interest rates, and improving the climate for foreign business investment, Canada will continue to prosper. Speech to the Speakers Forum Toronto, Ontario, January 29, 2003.

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I want to talk today about some of the uncertainties surrounding Canada's economic prospects and how the Bank of Canada is dealing with them through its conduct of monetary policy. In particular, I'll discuss what's happening to prices in the economy and how Canada's macro-economic policy framework protects it from the risks of persistent inflation or deflation. Finally, I will update our outlook for the Canadian economy.

Two weeks ago, I was in Basel, Switzerland, for one of our regular meetings at the Bank for International Settlements. This meeting, as well as others during the past year, have been particularly interesting for Canadians. Other participants always ask us, "How come you Canadians are doing so well, when the rest of us seem to be struggling?"

We have been telling them that one of the reasons why Canada has been less affected by the recent worldwide economic slowdown is that we made extraordinary efforts during the I 990s to get our macroeconomic framework--that is, our monetary and fiscal policies right. We all know it was painful to adjust to free trade and to conquer inflation in the early 1990s, and to eliminate public sector deficits over that decade. Canada paid an economic price for those efforts during the 1990s. But they are now yielding clear economic dividends.

Of course, we've also had some good luck. We are less exposed to sectors that are struggling the most. But Canada's economic strength during the past two or three difficult years for the world economy reflects, for the most part, the fact that Canada stuck to its basic policy framework. As we move forward, this underscores the importance of maintaining that framework especially now, when the near-term world economic outlook is not strong, and the geopolitical climate is uncertain.

With all this economic uncertainty, it is not surprising that we hear concerns these days about both the risks of accelerating inflation and the risks of deflation.

I think it is important to place these concerns into some context, so that Canadians can better understand the risks and implications of price shifts in the economy. That is why I'm going to concentrate most of my comments today on this subject. After all, the goal of the Bank of Canada's monetary policy is to maintain low, stable, and predictable inflation.

For over a decade, following a joint agreement with the federal government, the Bank has operated with a system of inflation targets. We aim to keep the trend of consumer price inflation at the 2% midpoint to 3% range. Because we have managed to keep inflation inside the target range through most of the past decade, Canadians' expectations for inflation have become firmly anchored around the 2% target.

Right off the top, let me assure you that the Bank of Canada will continue to pursue a monetary policy focused on returning inflation to that 2% target, should it deviate in either direction. Canada's inflation-targeting framework operates symmetrically; that is, we minimize the chances of both a sustained upward drift in inflation and the threat of deflation.

Recently, rates of inflation in Ca nada have come in higher than expected. At the same time, a weak global economic environment, the huge drop in equity prices, and declines in the prices of some manufactured goods are raising fears of deflation in other countries. Let's look at both these risks.

The upside risk: inflation

First, let's consider the upside risk of accelerating inflation. …