Abstract

Recent Developments in Canadian Monetary Policy

In 1973 Canada, like many other countries, found itself unexpectedly caught up in an inflationary boom of worldwide dimensions. By 1975 the boom in Canada had given way to mild recession, but by then the economy was experiencing a wage and price explosion of alarming proportions. Thus Canada faced the prospect of continuing high inflation for some time to come, substantially higher inflation than that of its major trading partner, the United States. It wasin this environment that the Bank of Canada adopted the practice of setting explicit money growth targets as operating guides for the implementation of monetary policy, and indicated that these targets would have to be lowered gradually over time if there was to be an eventual return to domestic price stability. In Canada, where credit and capital flows both domestically and internationally are relatively free of direct restriction and where a floating exchange rate regime has been in effect since 1970, monetary policy has customarily been implemented through the impact of cash reserve management on short-term interest rates. Essentially the same techniques are now used to resist undesired deviations in the growth rate of the money stock (M1) and thus implicitly in the trend of nominal demand. Since 1975 the Bank’s monetary growth targets have been lowered in two successive steps. The growth of national expenditure has also slackened considerably, and although real economic growth has been weaker than had been hoped, there has been a substantial continuing decline in Canada’s underlying rate of inflation. Although the usefulness for policy purposes of the relationship between money demand and income is subject to limitations of various kinds and is no substitute for the exercise of broad economic judgment in central bank decision-making, Canadian experience suggests that the pursuit of monetary targets can play a useful role in efforts to improve the performance record of monetary policy.