October 22, 2024 – The Bank of Canada’s monetary policy framework has gradually evolved over time. The shift in the Bank’s policy response has contributed to the delayed interest rate hikes that exacerbated post-pandemic inflationary pressures.
In “Bumps in the Road: The Ever-Evolving Monetary Policy in Canada,” Ke Pang and Christos Shiamptanis analyze how the Bank’s response to inflation and the economy has evolved since the adoption of the inflation-targeting framework. Using newly available Bank of Canada Staff Economic Projections (SEP) data, the authors offer an in-depth look at how real-time historical forecasts available to policymakers at the time influenced key monetary decisions.
“We find a shift in the Bank’s policy response over the past two decades. It gradually increased its response to the state of the economy and shifted its response from temporary to more persistent inflation deviations,” says Shiamptanis. “We also find that the Bank responded differently to positive and negative future inflation deviations. This asymmetric response led to a delay in interest rate hikes after the Covid-19 pandemic, which kept inflation above target for longer than anticipated,” says Pang.
The report highlights the importance of real-time data in understanding the Bank’s decision-making process. Pang and Shiamptanis argue that the Bank’s growing focus on the output gap and negative inflation deviations played a role in the prolonged inflationary pressures experienced post-pandemic. They note that while this evolution of the Bank’s policy may have been appropriate in certain economic conditions, it contributed to delayed interest rate increases when inflation was rising rapidly after the pandemic.
Pang and Shiamptanis emphasize that the Bank’s asymmetric approach – emphasizing negative inflation deviations (below-target inflation) over positive ones – led to a delay in necessary policy adjustments. While appropriate in other economic periods, this approach ultimately resulted in sharper and more aggressive rate hikes in 2022 than might have been necessary with earlier intervention.
“It’s evident that a more symmetric approach – responding equally to both positive and negative inflation deviations – could have mitigated the severity of the policy tightening required,” says Pang.
The report also finds that there is some delay in the recent rate cuts. “The policy rate cuts in June, July and September could have been introduced earlier in this year,” says Shiamptanis.
For more information, contact: Ke Pang, Associate Professor, Wilfrid Laurier University; Christos Shiamptanis, Associate Professor, Wilfrid Laurier University; Percy Sherwood, Communications Officer, C.D. Howe Institute, 416-407-4798, psherwood@cdhowe.org.
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