The Bank of Canada has aimed for an inflation rate of 2% since 1991. They have worked hard to keep inflation around this target even when tough events happened in the economy. These events include the dot-com bubble bursting in 2000, the September 11 attacks in 2001, the 2008–09 global financial crisis, and the oil price shock in 2015. Each of these events challenged the Bank in different ways.
Lessons Learned from the Past
In the past, the Bank has learned that changing policies too fast or too slow can cause problems. When the COVID-19 pandemic hit, it created a huge shock to the economy. Many businesses had to close suddenly, and a lot of Canadians lost their jobs. At first, there was a worry that prices would drop quickly, known as deflation.
The Bank remembered what they learned from earlier events and took quick action. They lowered the policy rate to almost zero and started a new program called quantitative easing. This means the Bank bought government bonds to help put money into the economy. By working together with the government, the Bank helped keep Canada’s economy going and prices stable.
The Shift in Focus
When the economy began to reopen, people wanted to buy more than what was available, causing demand to exceed supply. The Bank then had to change its focus from worrying about low prices to dealing with rising prices. Inflation shot up to more than 8%, the highest level in 40 years. In response, the Bank raised its policy interest rate to 5% to help control inflation.
Current Situation and Challenges
Now, inflation has come down to 3.4%, but the road back to the 2% target will be slow and tricky. It’s important to understand that monetary policy, which is how the Bank controls money supply and interest rates, is not perfect. It’s like a blunt tool because it cannot target specific groups or areas.
Limitations of Monetary Policy
Here are some key points to understand about the limitations of monetary policy:
- Time Lag: When the Bank changes the policy rate, it usually takes a year or longer for those changes to affect the economy. The Bank does not react to temporary price changes but aims to keep overall inflation on target over the medium term. For the Bank of Canada, this target is between 1% and 3%.
- Housing Supply Concerns: Many Canadians are worried about housing availability and costs. While changes to the policy rate can influence mortgage rates and demand for housing, they cannot fix the deeper issues that cause a lack of housing.
- Long-term Growth: Having low and steady inflation helps the economy stay stable. By raising or lowering interest rates, the Bank can influence demand in the short term. However, real long-term growth relies on a growing population and improvements in productivity, which do not change quickly with interest rates.
The Effectiveness of Monetary Policy
Even with these limitations, history shows that monetary policy is effective at controlling inflation. The Bank of Canada continues to monitor the economy closely and make adjustments to keep prices stable for everyone. They understand that their job is challenging but crucial for ensuring that Canadians can afford the things they need.
Through careful management, the Bank of Canada is committed to returning inflation to its target while supporting a healthy economy.
