A Review
First Draft
Mr. Dodge, former Governor of the Bank of Canada, expressed his satisfaction with the Canadian current monetary policy framework in a recent article “ Central Banking at a Time of Crisis and Beyond: A Practitioner’s Perspective” (2008). As he stated, Canada adopted this framework in 1991 that focus only on inflation when the central bank’s objective is also to stabilize output. More specifically, the Bank of Canada implements their monetary policies through set and control the policy interest rate, namely overnight interest rate, with the objective of keeping inflation at 2 percent over the medium term. Mr. Dodge pointed out that from a practitioner’s point of view, experience over the past 40 years provides sufficient evidence that inflation-targeting framework successfully contribute to economy stabilization in Canada and the evident of trade-off between inflation and output growth is insignificant.
However, criticism such as Mr. Curtis explicitly claims that the Canadian economic growth rate fell behind of the US because the Bank of Canada focused their policy responses exclusively on one dimension of economic performance, namely inflation, and did not attempt to stabilize fluctuations in growth rate and unemployment rates (Curtis 2005). In other words, there exists a trade-off between inflation and output growth. To prove this, Mr. Curtis conducted a comprehensive research comparing the US and the Canadian monetary policy and their subsequent economic performance respectively in the 1990s in his paper called “Monetary Policy and Economic Activity in Canada in the 1990s”. Instead of focusing on inflation control alone, the US Federal Reserve set and control its interest rate in response to variation in inflation and economic activity, which seems has been successful because it resulted in economy stabilization and combined with moderate inflation in the last two decades (Curtis 2005). By contrast, in the 1960s and 1970s, Canadian growth rate was higher than the U.S. In the 1980s, growth rate and unemployment rate were similar between those two countries. But in the 1990s, after the introduction of inflation-targeting framework, Canada fell behind of the U.S. He pointed out that further inflation rate reductions were not pursued by the Bank after 1994 since monetary policy put significant emphasis on output and employment stabilization and as a result of this improvements, economic recovered strongly, unemployment rates reduced and inflation was moderate. Thus, Curtis (2005) claims that monetary policy in Canada calls for a further balanced emphasis on both inflation and output as implemented in the US.
Although the seemingly success of the US monetary policy is given a great credit especially during the Greenspan’s era with seven-year expansion according to Mr. Curtis, in a longer term, the after Greenspan’s time when we are facing global financial turmoil today, we inevitably have to wonder if the notable monetary policy adopted by the US results in a better economic stabilization than the Canadian one in a medium to long term. In fact, Canada’s economy has been surprisingly steady while the whole world wrestle with continuous financial turbulences during the past decade, including the Mexican peso crisis in 1995, the Asian financial crisis in 1997, the Russian debt default in 1998, the dot-com bubble burst in 2000, and the 9/11 terrorist attacks and the hurricane-induced shock to energy prices in 2005. A recent review featured the Canadian economic stability during turbulence shows that:
First Draft
Mr. Dodge, former Governor of the Bank of Canada, expressed his satisfaction with the Canadian current monetary policy framework in a recent article “ Central Banking at a Time of Crisis and Beyond: A Practitioner’s Perspective” (2008). As he stated, Canada adopted this framework in 1991 that focus only on inflation when the central bank’s objective is also to stabilize output. More specifically, the Bank of Canada implements their monetary policies through set and control the policy interest rate, namely overnight interest rate, with the objective of keeping inflation at 2 percent over the medium term. Mr. Dodge pointed out that from a practitioner’s point of view, experience over the past 40 years provides sufficient evidence that inflation-targeting framework successfully contribute to economy stabilization in Canada and the evident of trade-off between inflation and output growth is insignificant.
However, criticism such as Mr. Curtis explicitly claims that the Canadian economic growth rate fell behind of the US because the Bank of Canada focused their policy responses exclusively on one dimension of economic performance, namely inflation, and did not attempt to stabilize fluctuations in growth rate and unemployment rates (Curtis 2005). In other words, there exists a trade-off between inflation and output growth. To prove this, Mr. Curtis conducted a comprehensive research comparing the US and the Canadian monetary policy and their subsequent economic performance respectively in the 1990s in his paper called “Monetary Policy and Economic Activity in Canada in the 1990s”. Instead of focusing on inflation control alone, the US Federal Reserve set and control its interest rate in response to variation in inflation and economic activity, which seems has been successful because it resulted in economy stabilization and combined with moderate inflation in the last two decades (Curtis 2005). By contrast, in the 1960s and 1970s, Canadian growth rate was higher than the U.S. In the 1980s, growth rate and unemployment rate were similar between those two countries. But in the 1990s, after the introduction of inflation-targeting framework, Canada fell behind of the U.S. He pointed out that further inflation rate reductions were not pursued by the Bank after 1994 since monetary policy put significant emphasis on output and employment stabilization and as a result of this improvements, economic recovered strongly, unemployment rates reduced and inflation was moderate. Thus, Curtis (2005) claims that monetary policy in Canada calls for a further balanced emphasis on both inflation and output as implemented in the US.
Although the seemingly success of the US monetary policy is given a great credit especially during the Greenspan’s era with seven-year expansion according to Mr. Curtis, in a longer term, the after Greenspan’s time when we are facing global financial turmoil today, we inevitably have to wonder if the notable monetary policy adopted by the US results in a better economic stabilization than the Canadian one in a medium to long term. In fact, Canada’s economy has been surprisingly steady while the whole world wrestle with continuous financial turbulences during the past decade, including the Mexican peso crisis in 1995, the Asian financial crisis in 1997, the Russian debt default in 1998, the dot-com bubble burst in 2000, and the 9/11 terrorist attacks and the hurricane-induced shock to energy prices in 2005. A recent review featured the Canadian economic stability during turbulence shows that:
Source: Turbulent stability: Canada’s economy in 2007 by P. Cross (2008)Canada’s real GDP growth of 2.7% in 2007 surpassed all the other major developed regions, including the euro-zone (2.6%), the US (2.2%) and Japan (2.1%). More significantly, growth in Canada was barely affected by the slowdown in the US, where GDP growth eased from 2.9% in 2006 to 2.2% last year. This was the first year growth in Canada surpassed the US since the recession in the US early this decade after the dot-com bubble burst. It is worth recalling how large the gap between growth in Canada and the US can be when the latter falters: in 2001, Canada’s GDP growth of 1.8% was almost triple the 0.7% in the recession-plagued US, while the 2.9% in 2002 was nearly double the 1.6% gain in the US. The widely-held myth that ‘Canada catches cold when the US sneezes’ was debunked years ago: so far in 2007 and 2008, we have barely sniffled while contagion spread in the US housing and financial markets.
In conclusion, despite the debate of whether trade-off between inflation and output ever exists, current framework of inflation targeting in Canada serves reasonably well and should be considered a great factor contributing to the Canadian economic stabilization. Given the current financial market fluctuation, further modification and agencies that are specialized in the development of both monetary policy and financial stability should improve their functions immediately.
