Policy Rules and the Conduct of
Monetary Policy in Canada
Pierre Duguay
Deputy Governor
Outline
• Introductory Comments
• Targeting Rule vs. Instrument Rule
• General vs. Specific Targeting Rule
• Bank of Canada Inflation-Control Strategy
• IFB Instrument Rule as a practical answer in large scale
forward-looking model
• Approaches to deal with uncertainty
Lars’ Framework
• Targeting Rule vs. Instrument Rule
• Response to determinants of aggregate demand and
inflation vs. response to outcomes
• Drawback of Taylor Rule: Time-varying neutral rate
• General vs. Specific Rule
• Transparency about horizon and implications for output
gap
Bank of Canada Inflation-Control Strategy
• Model-Based Staff Economic Projection
• Numerical solution to optimal-control problem
• A Process to Deal with Uncertainty
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Range of information
Multiplicity of models
Search for robust rule
Search for leading indicators
• Communication and Transparency
• Less is more
Model-Based Staff Economic Projection
• Monetary Policy is endogenous
• Object of projection is to derive recommended path for
policy instrument
• Alternative Scenarios
• Alternative assumptions about key variables
• Alternative interest rate path
Robust Taylor rule
Constant interest rate for a period of time
• Evaluation of Forecasting Performance
IFB Rule in QPM
• A Plausible Numerical Solution to Complex
Optimal-Control Problem
• Brings inflation close to target over acceptable horizon
• Avoids excessive secondary cycles
• Selection of Parameters
• Based on trade-off between variances of output and
inflation
• Made by Governing Council
IFB Rule in QPM
rslt = .3 rslt-1 + .25 (ygap+ygapt-1)/2
+ 3.5 (infgapt+6 + infgapt+7)/2
• Use of term spread mitigates trade-off between
target and instrument
• Trade-off between variance of output and inflation
Improved by weight on output gap
Worsened by interest rate smoothing
Communications
• Less is more: Keep story simple
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Outlook for output and output gap,
core and total CPI inflation
Broad direction of interest rates
Factors that will be watched closely
• Not wanting to preempt private sector forecasts
• Focus on the logic of central bank decisions
• Highlight uncertainty
Conclusion
• Monetary Policy as commitment to a Targeting
Rule using all relevant information
• Decision process factoring uncertainty
• Communication focusing on the logic of central
bank decisions and highlighting uncertainty