Why is Canada's Price Level so Predictable?
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.
|Date of creation:||01 Jan 2008|
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- Nicoletta Batini & Douglas Laxton, 2007.
"Under What Conditions Can Inflation Targeting Be Adopted? The Experience of Emerging Markets,"
Central Banking, Analysis, and Economic Policies Book Series,
in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 12, pages 467-506
Central Bank of Chile.
- Nicoletta Batini & Douglas Laxton, 2006. "Under What Conditions Can Inflation Targeting Be Adopted? The Experience of Emerging Markets," Working Papers Central Bank of Chile 406, Central Bank of Chile.
- Stephen G. Cecchetti & Junhan Kim, 2003.
"Inflation Targeting, Price-Path Targeting and Output Variability,"
NBER Working Papers
9672, National Bureau of Economic Research, Inc.
- Stephen G. Cecchetti & Kim, 2004. "Inflation Targeting, Price-Path Targeting, and Output Variability," NBER Chapters, in: The Inflation-Targeting Debate, pages 173-200 National Bureau of Economic Research, Inc.
- Benjamin Hunt & Douglas Laxton, 2004.
"The Zero Interest Rate Floor (ZIF) and its Implications for Monetary Policy in Japan,"
National Institute Economic Review,
National Institute of Economic and Social Research, vol. 187(1), pages 76-92, January.
- 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.
- 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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