Research Briefing | Aug 26, 2021

Canada | Bank of Canada eyes shift to average inflation targeting

Bank of Canada eyes shift to average inflation targeting - iPad

There’s a close race as the Bank of Canada weighs sticking with its successful flexible inflation targeting (FIT) or switching to average inflation targeting (AIT) when it renews its inflation-control agreement with the government later this year. We think the Bank slightly favours AIT and may in fact move to flexible average inflation targeting (FAIT) as implemented by the US Fed a year ago.

What you will learn:

  • The AIT would not be a dramatic change. The Bank would likely maintain the 2% CPI inflation target and 1-3% control range but would move from a flexible time horizon to an explicit multi-year period for returning inflation to target.
  • Moving to an AIT framework in the current environment would allow the Bank to keep interest rates at the effective lower bound (ELB) and permit an overshoot of its 2% inflation target for a longer period. 
  • As highlighted in a recent Bank paper, allowing inflation to overshoot the 2% target could promote a faster recovery and better support stable inflation and full employment, particularly for vulnerable segments of the population.
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