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The financial system makes an important contribution to the welfare of all Canadians. The ability of households and firms to confidently hold and transfer financial assets is one of the fundamental building blocks of the Canadian economy.

Governor Tiff Macklem discusses how inflation targeting became a leading strategy for maintaining price stability and how the Bank of Canada is ensuring its monetary policy framework is fit for future challenges.

Over the last 10 years, the level of inflation has been much lower than in the previous two decades. At the same time, the behaviour of inflation has changed profoundly. By surveying the data and the economic research, the author first examines changes in the variability, growth rates, and behaviour of some of the major macroeconomic variables during the 1980s and 1990s. He then looks at how these changes are linked to a shift in the approach of monetary policy over the period. Lastly, he reviews the economic benefits that these changes have had for Canada.

We identify the drivers of unsecured and collateralized loan volumes, rates and haircuts in Canada using the Bayesian model averaging approach to deal with model uncertainty. Our results suggest that the key friction driving behaviour in this market is the collateral reallocation cost faced by borrowers.

In recent months, much has been said, and written, about developments in financial markets. The turbulence in global credit markets, which had its roots in developments in the market for subprime mortgages here in the United States, has been a focal point of attention for market participants and policy-makers around the world.

The fourth generation of Bank of Canada projection and policy analysis models seeks to improve our understanding of inflation dynamics, the supply side of the economy and the underlying risks faced by policy-makers coming from uncertainty about how the economy functions.

Although the current inflation-targeting regime has served Canadians well, sound public policy demands the continuous exploration of possible improvements in the monetary policy framework.

Inflation in Canada remains high but should come down quickly to around 3% in the middle of this year because of lower energy prices, improved supply chains and restrictive monetary policy. The Bank projects that inflation will reach the 2% target by the end of 2024.

Cover page

French Provincial Issues in Canada

The coins pictured on the cover are part of the National Currency Collection, Bank of Canada.
Photography by Gord Carter, Ottawa.

This issue of the Financial System Review reflects the Bank’s judgment that high household indebtedness and housing market imbalances remain the most important vulnerabilities. While these vulnerabilities remain elevated, policy measures continue to improve the resilience of the financial system. A third vulnerability highlighted in the FSR concerns cyber threats to an interconnected financial system.