Weighing the Options : Why the Bank of Canada Should Renew Inflation Targeting

Leading up to the Bank of Canada’s 2021 renewal of its agreement with the government of Canada, this Commentary evaluates alternatives to the Bank’s current inflation-targeting agreement, and recommends that the agreement continue in its present form. The important elements of monetary policy are the central bank’s mandate, its goals, its policy rule, and implementation. The goals, policy rule, and implementation have to fit together in a coherent fashion so that the central bank’s mandate – as written in the Bank of Canada Act in Canada’s case – can be achieved in an efficient manner, in light of frontline economic science. Inflation targeting has served Canada well. The Bank of Canada has been successful, since 1991, in keeping inflation close to its 2 percent target, with inflation falling within the 1 percent to 3 percent bounds, for the most part. And success in hitting the inflation target has been consistent with good macroeconomic performance. Suggested alternatives to the current inflation targeting agreement include: (i) retaining the inflation targeting approach, but increasing the target above 2 percent; (ii) price level targeting; (iii) average inflation targeting; (iv) nominal income targeting; (v) a dual mandate. In this Commentary I argue that none of these changes would provide a clear improvement over inflation targeting at 2 percent. In some cases, the alternatives clearly fall short because: (a) there would be a loss in central bank credibility; (b) macroeconomic performance would be worse; (c) it would be more difficult for Bank of Canada officials to explain policy in an understandable way