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We study the formation of price bubbles on experimental asset markets where cash earns interest. There are two main conclusions.

Since the last Report, the Canadian economy has advanced broadly in line with expectations.

At the Bank of Canada, we have worked hard over the past several years to define our goals and our methods for achieving them. We have continued to strengthen our monetary policy framework, and we have established priorities in all areas of our operations to help us meet our strategic objectives. In 2002, the Bank set out a medium-term plan for the period 2003–05. The plan’s clearly defined policy frameworks and priorities were critical in guiding our analysis and our decisions in 2003, a year in which Canadians across the country were affected by a number of severe and unanticipated events.

Most models in finance assume that agents make trading plans over the infinite future. We consider instead that they are boundedly rational and may only form forecasts over a limited horizon.

We develop a model with firm heterogeneity in importing and cross-border shopping among consumers. Exchange-rate appreciations lower the cost of imported goods, but also lead to more cross-border shopping; hence, the net impact on aggregate retail prices and sales is ambiguous.

This Report outlines recent developments in the Canadian economy that affect the rate of inflation and provides an account of the measures taken by the Bank of Canada to control inflation.

In the last half-year, the economic expansion in Canada has become well established, supported by low inflation, highly stimulative monetary conditions, and a strong U.S. economy.

With inflation remaining low for the sixth consecutive year, the Canadian economy recorded a strong expansion of about 4 per cent through 1997.

There have been a number of significant economic and financial developments since the time of the July Monetary Policy Report Update.

This Report presents the Bank of Canada’s assessment of the trend of inflation in Canada and explains the monetary policy actions deemed necessary to keep inflation within the Bank’s inflation-control target range.