Learn about the objective of Canada’s monetary policy and the main instruments used to implement it: the inflation-control target and the flexible exchange rate.
The objective
The goal of Canada’s monetary policy is to promote the economic and financial well-being of Canadians. Experience shows the best way to achieve this goal is by keeping inflation low and stable. Predictable inflation allows Canadians to make spending and investment decisions with confidence, encourages longer-term investment in Canada's economy, and contributes to sustained job creation and greater productivity. Together, these lead to improvements in Canada’s standard of living.
Canada’s monetary policy framework consists of two key components that work together:
This framework helps make monetary policy actions easy to understand and enables the Bank to demonstrate its accountability to Canadians.
The inflation-control target
At the heart of Canada’s monetary policy framework is the inflation-control target, which is the 2% midpoint of the 1%–3% control range. First introduced in 1991, the target is set jointly by the Bank of Canada and the federal government and is reviewed every five years.
In 2021, the Bank and federal government renewed the monetary policy framework until December 31, 2026. The Bank and federal government agreed that the best way for monetary policy to support Canadians was through price stability, and that monetary policy should continue to support maximum sustainable employment. The Bank can best achieve these joint goals of price stability and maximum sustainable employment by ensuring inflation remains low, stable and predictable over time.
The Bank’s Governing Council, which acts independently of government, is responsible for the day-to-day conduct of monetary policy. The inflation-control target guides the Bank’s decisions on setting the policy interest rate
Inflation targeting is symmetric and flexible
Canada’s inflation-targeting approach is symmetric, which means that the Bank is equally concerned about inflation rising above or falling below the 2% target.
The inflation-targeting approach is also flexible. Policy rate setting decisions are typically based on the Bank’s judgment of where inflation is likely to be over a horizon of six to eight quarters, not what it is today. However, the most appropriate horizon for returning inflation to target will depend on the nature and persistence of shocks affecting the economy.
The 2021 agreement with the federal government specifies that the 2% inflation target remains the cornerstone of the framework. The agreement further notes that the Bank will continue to use the flexibility of the 1%–3% control range to actively seek maximum sustainable employment, when conditions warrant. Given the uncertainty about the level of maximum sustainable employment, the Bank will consider a broad range of labour market indicators.
The Bank will also continue to leverage the flexibility inherent in the framework to help address the challenges of structurally low interest rates by using a broad set of policy tools. The Bank will use this flexibility only to an extent that is consistent with keeping medium-term inflation expectations well anchored at 2%.
Monetary policy tools
Monetary policy actions take time to work their way through the economy and have their full effect on inflation. Monetary policy must therefore be forward looking.
The Bank normally carries out monetary policy through changes in the target for the overnight rate, also known as the key policy interest rate. The Bank also has a range of tools it can use when the policy rate is at very low levels. The potential use and sequencing of these tools would depend on the economic and financial market context.
The Bank’s monetary policy tools affect demand by influencing:
- market interest rates
- domestic asset prices
- the exchange rate
The balance between demand and the economy’s productive capacity—or its ability to supply goods and services—is the main factor that, over time, determines inflationary pressures.
Communication
The Bank is committed to clear and transparent communication. The Bank announces its policy rate decisions on fixed announcement dates eight times a year. A press conference is held after every rate decision. Full updates of the Bank’s outlook for the economy and inflation are published four times each year in the Monetary Policy Report.
The Bank will explain when it is using the flexibility of the inflation-targeting strategy.
The Bank will also communicate to Canadians on how labour market outcomes have factored into its policy decisions.
Monitoring inflation
Inflation is measured as the 12-month rate of change in the consumer price index (CPI). The prices of certain CPI components can be quite volatile in the short run. This can cause large fluctuations in overall inflation. In setting monetary policy, the Bank looks through such temporary movements and focuses on core inflation measures that better reflect the underlying trend of inflation. These core measures act as an operational guide to help the Bank achieve its inflation target. They are not a replacement for CPI inflation.
The Bank’s two preferred measures of core inflation are CPI-trim and CPI-median:
- CPI-trim excludes the components that are the most volatile in a given month
- CPI-median is the weighted midpoint of all components based on their rate change in a given month
Canada’s flexible exchange rate
Canada’s flexible exchange rate, or floating dollar, permits the Bank to pursue an independent monetary policy that is:
- best suited to Canada’s economic circumstances
- focused on achieving the inflation target
Movements in the exchange rate also provide a buffer, helping the economy absorb and adjust to external and internal shocks.
Explainers
Consult these brief articles explaining topics related to our core functions.