| Citation | Jeremy Kronick and Ambler, Steve and Koeppl, Thorsten. 2025. "Monetary Policy Needs to Remain FIT for Purpose." Opinions & Editorials. Toronto: C.D. Howe Institute. |
| Page Title: | Monetary Policy Needs to Remain FIT for Purpose – C.D. Howe Institute |
| Article Title: | Monetary Policy Needs to Remain FIT for Purpose |
| URL: | https://cdhowe.org/publication/monetary-policy-needs-to-remain-fit-for-purpose/ |
| Published Date: | June 3, 2025 |
| Accessed Date: | November 15, 2025 |
Published in the Financial Post
Toward the end of next year the Bank of Canada and the federal government will renew their agreement concerning the monetary control framework. In the run-up to the renewal, the idea is gaining traction that the Bank should assume a “dual mandate” of both low, stable inflation and maximum output and employment.
In our view, that would be a mistake. As we argue in a recent C.D. Howe Institute paper, both theory and practical considerations favour the current framework of flexible inflation targeting (FIT), in which the Bank focuses on achieving two per cent inflation over the medium term while retaining the flexibility to respond to economic developments in the short run.
A large body of research shows that controlling inflation is very important. High inflation reduces both output growth and economic welfare. Moreover, in the long run using monetary policy to try to reduce unemployment is futile: it just leads to higher and higher inflation. In fact, that’s one of the few things economists actually agree on.
In the short run, however, there may be trade-offs between inflation and growth/employment. To keep output growing, say, you may accept a little extra inflation. But the FIT framework allows for that.
Suppose supply chains are being disrupted, as during COVID, or as now with tariffs. That reduces output but also raises prices. If you increase interest rates to address the inflation, output is likely to fall further. You’ve got to choose: curb inflation or keep output growing.
If you think the disruption is temporary, maybe the higher prices can be safely ignored. That’s the “flexible” part of FIT, where the focus of monetary policy remains on low, stable inflation over the medium run. But if the shocks are permanent or even just persistent, a central bank that doesn’t react risks de-anchoring inflation expectations, leading to persistent inflation. The trick, as we saw in 2021, is to know what’s temporary and what’s longer lasting. It’s not always an easy call. And if it is longer lasting then, as we just argued, there’s not much a central bank can do other than keep focused on low and stable inflation.
The target of an inflation control regime like FIT is clear: inflation. In contrast, dual mandates rely too heavily on hypothetical concepts such as “maximum sustainable employment.” Unlike the inflation rate, maximum sustainable employment can’t be measured directly. It’s also likely to change over time. Trying to hit what amounts to an invisible moving target could lead to monetary policy that steers inflation well off course and ends up undermining its own credibility.
Then there’s the “one-stone, two-bird” problem. The Bank of Canada, like most central banks, uses a single instrument — the overnight interest rate — to implement its policy goals. Other tools, like quantitative easing or forward guidance, influence the entire term structure of interest rates and can be useful, but they are only a variation on the overnight rate in that they simply change expectations about the rate’s future level. As Nobel Laureate Jan Tinbergen pointed out in 1952, for every separate policy target you want to hit you’ve got to have a separate policy instrument. In other words, you generally can’t hit two birds with one stone. Possessing only the one stone, the Bank has to choose its over-riding goal.
Executed properly, a dual mandate would require specifying the relative importance of the two goals, especially if there is a trade-off between them. And with maximum employment hard to define, this would potentially leave a central bank open to pressure from the government to concentrate on boosting output at the cost of inflation. Although the Bank of Canada Act gives the federal government authority to issue directives to the Bank, this power has almost never been used. But a dual mandate could give the government added justification to intervene in the conduct of monetary policy, threatening the Bank of Canada’s operational independence. In this regard, the Trump administration’s recent interactions with the Federal Reserve, which some might characterize as browbeating, should give pause.
The Fed has had a dual mandate since 1948. In the fall of 2021, it delayed its response to rising inflation and waited for the economy to reach maximum employment. As a result, unlike Canada the United States has yet to see inflation return to its two per cent target.
In the nearly 30 years since two per cent became the Bank of Canada’s inflation target, Canadian inflation has averaged … 2.1 per cent. This remarkable success of FIT has led to superior economic outcomes for households and businesses. In short, FIT works. It has allowed the Bank to maintain a clear, credible and accountable framework that has served Canada well. If FIT ain’t broke, don’t fix it.
Steve Ambler is professor emeritus of economics, Université du Québec à Montréal. Thorsten Koeppl is professor of economics at Queen’s University. Both also have positions with the C.D. Howe Institute, where Jeremy Kronick is vice-president, economic analysis and strategy.
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