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Why is Canada's Price Level So Predictable?

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Author Info

  • Vladimir Klyuev
  • Heesun Kiem
  • Ondra Kamenik
  • Douglas Laxton

Abstract

One of the pioneers of inflation targeting (IT), the Bank of Canada is now considering a possibility of switching to price-level-path targeting (PLPT), where past deviations of inflation from the target would have to be offset in the future, bringing the price level back to a predetermined path. This paper draws attention to the fact that the price level in Canada has strayed little from the path implied by the two percent inflation target since its introduction in December 1994, and has tended to revert to that path after temporary deviations. Econometric analysis using Bayesian estimation suggests that a low probability can be assigned to explaining this behavior by sheer luck manifesting itself in mutually offsetting shocks. Much more plausible is the assumption that inflation expectations and interest rates are determined in a way that is consistent with an element of PLPT. This suggests that the difference between IT as it is actually practiced (or perceived) and PLPT may be less stark than what pure theoretical constructs posit, and that the transition to a fullfledged PLPT regime will likely be considerably easier than what was previously thought. The paper also shows that inflation expectations are a major driver of actual inflation in Canada, which makes it easier to keep inflation close to the target without large output costs.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/25.

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Length: 38
Date of creation: 01 Jan 2008
Date of revision:
Handle: RePEc:imf:imfwpa:08/25

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Related research

Keywords: Inflation targeting; Prices; Interest rates; Price stabilization;

This paper has been announced in the following NEP Reports:

References

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  1. Stephen G. Cecchetti & Junhan Kim, 2003. "Inflation Targeting, Price-Path Targeting and Output Variability," NBER Working Papers 9672, National Bureau of Economic Research, Inc.
  2. Douglas Laxton & Ben Hunt, 2001. "The Zero Interest Rate Floor (ZIF) and its Implications for Monetary Policy in Japan," IMF Working Papers 01/186, International Monetary Fund.
  3. David Longworth, 2002. "Inflation and the Macroeconomy: Changes from the 1980s to the 1990s," Bank of Canada Review, Bank of Canada, vol. 2002(Spring), pages 3-18.
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Citations

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Cited by:
  1. Angelo Melino, 2011. "Moving Monetary Policy Forward: Why Small Steps - and a Lower Inflation Target - Make Sense for the Bank of Canada," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 319, January.
  2. Wolfgang Pollan, 2013. "Inflation Persistence or the Protracted Effects of Commodity Price Changes?," WIFO Working Papers 451, WIFO.
  3. RUGE-MURCIA, Francisco J., 2009. "Do Inflation-Targeting Central Banks Implicitly Target the Price Level?," Cahiers de recherche 16-2009, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  4. Eurilton Araújo & Débora Gouveia, 2013. "Calvo-type rules and the forward-looking behavior of inflation targeting central banks," Economics Bulletin, AccessEcon, vol. 33(3), pages 2042-2051.
  5. A. R. Pagan & Douglas Laxton & Luis Catão, 2008. "Monetary Transmission in an Emerging Targeter: The Case of Brazil," IMF Working Papers 08/191, International Monetary Fund.
  6. Charles Bean & Matthius Paustian & Adrian Penalver & Tim Taylor, 2010. "Monetary policy after the fall," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 267-328.
  7. Clinton, Kevin & Garcia-Saltos, Roberto & Johnson, Marianne & Kamenik, Ondrej & Laxton, Douglas, 2010. "International deflation risks under alternative macroeconomic policies," Journal of the Japanese and International Economies, Elsevier, vol. 24(2), pages 140-177, June.
  8. William B.P. Robson, 2009. "To the Next Level: From Gold Standard to Inflation Targets - to Price Stability?," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 285, March.

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