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In this issue, Bank researchers discuss the muted recovery from the 2007–09 financial crisis and possible causes. There are also discussions about the Bank’s new Canadian survey of household expectations, measuring both durable goods and housing prices in the CPI and how regulatory changes may affect monetary policy operating frameworks. In the final article, improvements to the management of Canada’s foreign exchange reserves are introduced.

The consumer price index (CPI) is the most commonly used measure to track changes in the overall level of prices. Since it departs from a true cost-of-living index, the CPI is subject to four types of measurement bias—commodity substitution, outlet substitution, new goods and quality adjustment. The author updates previous Bank of Canada estimates of measurement bias in the Canadian CPI by examining these four sources of potential bias. He finds the total measurement bias over the 2005–11 period to be about 0.5 percentage point per year, consistent with the Bank’s earlier findings. Slightly more than half of this bias is caused by the fixed nature of the CPI basket of goods and services.

This issue of the Financial System Review reflects the Bank’s judgment that household indebtedness and housing market imbalances–the most important vulnerabilities for the Canadian financial system–have moved higher over the past six months. However, the financial system remains resilient, and macroeconomic conditions continue to improve. Other vulnerabilities discussed in this FSR are fragile fixed-income market liquidity and the capacity of an interconnected financial system to mitigate cyber threats.

Developments are underway to replace Canada’s two core payment systems with three new systems. We use a discrete choice model to predict migration patterns of end-users and financial institutions for future systems and discuss their policy implications.

Deputy Governor Sylvain Leduc discusses how upgrading Canada’s core payment systems will contribute to financial stability and help the Bank keep inflation on target.

Éric Chouinard and Graydon Paulin review the progress to date in implementing Basel III, the new framework of global regulatory standards for the banking sector developed by the Basel Committee on Banking Supervision. The report highlights the expected net benefits of implementing Basel III, as well as the challenges in ensuring international consistency in measuring the risk-weighted capital of banks. It includes a discussion on how implementing Basel III has affected the banking system in Canada and other important jurisdictions, and demonstrates the need for ongoing assessment of the effects on the financial system and the macroeconomy.

There is a close link between prices of equity options and the default probability of a firm. We show that in the presence of positive expected equity recovery, standard methods that assume zero equity recovery at default misestimate the option-implied default probability.

In the Doug Purvis Memorial Lecture, Governor Stephen S. Poloz shows how changing the mix of monetary and fiscal policies can yield the same outcomes for growth and inflation, but lead to different results for public sector and private sector debt levels, which can impact financial stability.