No change to Canada's inflation-control target

The Harper government has decided that when it comes to Canadian monetary policy, if it ain't broke, don't fix it.

The inflation-control regime credited with keeping price gains relatively tame for most of the past two decades is being renewed for another five years, Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney said Tuesday in a joint statement from Ottawa.

The Bank of Canada will release a background document Wednesday morning to explain the finer points of the agreement, which runs until the end of 2016. But the bottom line is that Mr. Carney and his policy-setting team will continue to adjust interest rates to achieve an annual inflation rate of between 1 and 3 per cent, with 2 per cent remaining the optimal target.

Although Canada's inflation-targeting approach has been viewed as highly successful since it was introduced in 1991, researchers at the central bank have been studying ways it could be tweaked or improved. For instance, the bank devoted much effort into exploring whether to adopt a new system that would target a certain level in the consumer price index, rather than the annual rate of change, or whether to cut the target to as low as 1 per cent.

The central bank will "continue its research into potential improvements in the monetary policy framework," according to the statement, but given the uncertain economic climate, top officials including Mr. Carney, Mr. Flaherty and Prime Minister Stephen Harper had long hinted that big changes were unlikely.

Nonetheless, the renewal comes amid a growing sense that pure inflation-targeting is insufficient for post-financial-crisis economic realities. There had been talk for several months that the central bank's mandate might include language confirming that it will pay closer attention to the stability of the financial system, something it largely does already.

Instead, the government and the central bank opted to simply remind Canadians that the central bank's mandate allows it to take a "flexible" approach to inflation targeting, when economic or financial conditions warrant taking longer than normal to return to 2 per cent.

"The experience of the global economic and financial crisis underscored the value of Canada's flexible inflation-targeting framework," the statement said.

Mr. Carney has argued for months that his mandate affords him leeway to lean against economic shocks or dangerous buildups of credit by taking longer than usual to bring inflation to target. On Wednesday, it is expected that he will spell this out – perhaps with examples of when he is most likely to use this flexibility, and for how long.

The central bank's 2006-2011 mandate already allows that, in some situations, taking longer than the typical six to eight quarters to return inflation to 2 per cent "might be considered." Still, at the time the last agreement was being negotiated, few could have imagined how often the central bank might need to take advantage of that.

In recent months, Mr. Carney has touted his flexibility as an important tool for keeping Canada's export-dependent economy fortified against headwinds from abroad. He has left his benchmark interest rate at 1 per cent since the fall of 2010, even during the summer months in the face of hotter-than-expected inflation readings and much criticism from so-called inflation hawks.

"The government agrees with what they've been doing; there's no pushback at all on that front," said Benjamin Reitzes, a senior economist with BMO Nesbitt Burns. "So expect more of the same, at least until global conditions improve meaningfully, which may not be for a few years."

Similarly, Avery Shenfeld, chief economist at CIBC, said the mandate renewal is a reminder that the wiggle room Mr. Carney has been using is appropriate, given the circumstances.

"At the end of the day, they're saying they have a policy of a 2-per-cent inflation target, with an appropriate degree of flexibility to respond to shocks," he said. "This is steady as she goes. I think the evidence showed that any benefits of shifting one way or another did not outweigh the benefits of staying with what has worked."