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How to Improve Inflation Targeting at the Bank of Canada

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  • Nicholas Rowe

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 02-23.

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Length: 43 pages Abstract: This paper shows that if the Bank of Canada is optimally adjusting its monetary policy instrument in response to inflation indicators to target 2 per cent inflation at a two-year horizon, then deviations of inflation from 2 per cent represent the Bank's forecast errors, and should be uncorrelated with its information set, which includes two-year lagged values of the instrument and the indicators. Positive or negative correlations are evidence of systematic errors in monetary policy. The econometric evidence suggests that, over the past decade, the Bank has, on average, responded optimally to indicators of inflation, being neither too aggressive nor too timid in raising or cutting the overnight rate. While responding optimally on average, however, the Bank has not responded optimally to each individual indicator. The Bank systematically overreacted to some indicators and underreacted to others. Correcting these errors could improve inflation targeting in Canada.
Date of creation: 2002
Date of revision:
Handle: RePEc:bca:bocawp:02-23

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Postal: 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/

Related research

Keywords: Inflation targets; Monetary and financial indicators; Monetary policy implementation;

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References

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  1. Henry, S G B & Desai, Meghnad J, 1975. "Fiscal Policy Simulations and Stabilization Policy," Review of Economic Studies, Wiley Blackwell, vol. 42(3), pages 347-59, July.
  2. W A Razzak, 2001. "Money in the era of inflation targeting," Reserve Bank of New Zealand Discussion Paper Series DP2001/02, Reserve Bank of New Zealand.
  3. Taylor, John B., 2001. "An Interview With Milton Friedman," Macroeconomic Dynamics, Cambridge University Press, vol. 5(01), pages 101-131, February.
  4. William Poole, 1994. "Monetary aggregates targeting in a low-inflation economy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 87-135.
  5. Stephen M. Goldfeld & Alan S. Blinder, 1972. "Some Implications of Endogenous Stabilization Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 3(3), pages 585-644.
  6. Peston, Maurice H, 1972. "The Correlation between Targets and Instruments," Economica, London School of Economics and Political Science, vol. 39(156), pages 427-31, November.
  7. repec:cup:macdyn:v:5:y:2001:i:1:p:101-31 is not listed on IDEAS
  8. Jeffrey C. Fuhrer, 1994. "Goals, guidelines, and constraints facing monetary policymakers: an overview," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 3-15.
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Cited by:
  1. Frédérick Demers, 2003. "The Canadian Phillips Curve and Regime Shifting," Working Papers 03-32, Bank of Canada.
  2. Philip Liu, 2004. "Improving implementation of inflation targeting in New Zealand: an investigation of the Reserve Bank's inflation errors," Reserve Bank of New Zealand Discussion Paper Series DP 2004/06, Reserve Bank of New Zealand.
  3. Kevin Clinton, 2006. "Core inflation at the Bank of Canada: A critique," Working Papers 1077, Queen's University, Department of Economics.
  4. Nicholas Rowe & David Tulk, 2003. "A Simple Test of Simple Rules: Can They Improve How Monetary Policy is Implemented with Inflation Targets?," Working Papers 03-31, Bank of Canada.
  5. David Longworth, 2003. "Implications of a changing economic structure for the strategy of monetary policy : commentary," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 349-360.
  6. Alan Bollard & Claudio Borio & Pierre Duguay & Glenn Stevens, 2004. "Wrap-up Discussion," RBA Annual Conference Volume, in: Christopher Kent & Simon Guttmann (ed.), The Future of Inflation Targeting Reserve Bank of Australia.

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