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How to Improve Inflation Targeting at the Bank of Canada

  • Nicholas Rowe

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp02-23.pdf
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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
Contact details of provider: 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/

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  1. Taylor, John B., 2001. "An Interview With Milton Friedman," Macroeconomic Dynamics, Cambridge University Press, vol. 5(01), pages 101-131, February.
  2. 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.
  3. 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.
  4. 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.
  5. repec:cup:macdyn:v:5:y:2001:i:1:p:101-31 is not listed on IDEAS
  6. 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.
  7. 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.
  8. William Poole, 1994. "Monetary aggregates targeting in a low-inflation economy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 87-135.
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