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Changes in domestic interest rates affect the value of the Canadian dollar less than changes in the risk premium do. These variations often occur when a broad shift in risk sentiment occurs in global markets. Ultimately, the value of the currency reflects long-term, slow-moving features of the economies.

The global economic recovery is entering a new phase. In advanced economies, temporary factors supporting growth in 2010 - such as the inventory cycle and pent-up demand - have largely run their course and fiscal stimulus will shift to fiscal consolidation over the projection horizon.

This issue of the Financial System Review reflects the Bank’s judgment that the overall level of risk to Canada’s financial system remains largely unchanged from six months ago. The Bank continues to highlight two key vulnerabilities related to Canadian households: high levels of indebtedness and housing market imbalances. A third ongoing vulnerability is the potential for fragility in fixed-income market liquidity.

This paper assesses the merits of countercyclical bank balance sheet regulation for the stabilization of financial and economic cycles and examines its interaction with monetary policy.

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.

Using turnover ratios, Anderson and Lavoie describe the recent evolution of liquidity in various secondary government bond markets, focusing specifically on the market for Government of Canada securities. They attribute much of the recent variation in liquidity to such cyclical factors as changes in the interest rate environment and investors' appetite for risk, as well as developments in equity markets in the late 1990s. They also examine longer-term structural and policy-related trends, including the rate of adoption of financial and technological innovations and the level of government borrowing and debt-management initiatives.

We propose a framework that allows a portfolio manager to quantify the probability of simultaneous losses in multiple assets of a collateral portfolio. Using this framework, we propose a methodology to conduct stress tests on the market value of the portfolio of collateral when undesirable extreme dependence occurs.

The issue addressed in this article is the extent to which monetary policy in Canada should respond to asset-price bubbles. The article concludes that maintaining low and stable consumer price inflation is the best contribution that monetary policy can make to promoting economic and financial stability, even when the economy experiences asset-price bubbles. In extreme circumstances—when an asset-price bubble is well identified and likely to have significant costs to the economy when it bursts—monetary policy might better maintain low and stable consumer price inflation by leaning against a particular bubble even though it may mean that inflation deviates temporarily from its target. Such a strategy might reduce the risk that a crash in asset prices could lead to a recession and to inflation markedly below target in the longer run. The circumstances where this strategy is possible will be rare because economists are far from being able to determine consistently and reliably when leaning against a particular bubble is likely to do more harm than good. Housing-price bubbles should be a greater concern for Canadian monetary policy than equity-price bubbles, since rising housing prices are more likely to reflect excessively easy domestic credit conditions than are equity prices, which are largely determined in global markets.

Three major developments are affecting the Canadian economy: the protracted weakness in the U.S. economy; ongoing turbulence in global financial markets; and sharp increases in the prices of certain commodities — particularly energy. The first two developments are evolving roughly in line with expectations outlined in the April Monetary Policy Report.