why_canada_inflation_target

In times of severe economic weakness this extra

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Unformatted text preview: for it. In times of severe economic weakness, this extra spending can prove helpful to the economy. But with an inflation target of zero, the monetary authorities lose the option of stimulating the economy through negative real interest rates because, in this case, real interest rates too cannot fall below zero. Preserving the policy option of negative real interest rates is often cited as the main reason for having a positive inflation target.1 In addition to the risks associated with the ZLB, the following two arguments are frequently made for not targeting an inflation rate closer to zero. 1 This does not mean that monetary policy has no other means of supporting the economy when the room for lowering interest rates has been exhausted. In such circumstances, monetary stimulus can be provided through a conditional statement about the future path of the policy rate and through two other non-traditional tools—credit easing and quantitative easing. The Annex in the April 2009 Monetary Policy Report describes these tools and the principles guiding their use. This text, and other backgrounders on topics related to the Bank of Canada’s work, can be found at: bankofcanada.ca—search for “backgrounders.” U N D E R S Difficulties in measuring inflation accurately Difficulties in measuring inflation accurately are one reason not to aim for zero inflation. As discussed in the measurement bias in the Canadian CPI, the measured rate of inflation tends to overstate the increase in the true cost of living by an estimated 0.5 per cent per year. This means that if the Bank targeted zero inflation (no change in the measured CPI), it would in reality be targeting a systematic, even if relatively small, year-after-year decrease in the true co...
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