November 18, 2014 / 6:53 PM / 4 years ago

Bank of Canada eyes lifting inflation target, but threshold high

CALGARY (Reuters) - The inability to cut interest rates below zero to stimulate the economy in the aftermath of the recent financial crisis has caused the Bank of Canada to begin considering whether it should raise its 2 percent inflation target, the bank said on Tuesday.

Deputy Governor Agathe Cote said another argument in favor of raising the target was that interest rates are likely to be lower than before the crisis, and this increases the likelihood of being constrained by the phenomenon known as the “zero lower bound” for rates.

“These factors suggest that consideration should be given to an inflation target that is above 2 percent,” Cote said in a speech in which she outlined areas the central bank would examine ahead of the late 2016 renewal of its inflation-targeting agreement with the federal government.

However, she said the system was not broken and the bar for change was therefore high.

“While a number of prominent economists have argued for a higher inflation target, there is good reason to be cautious,” she said in the prepared text of a speech she gave in Calgary.

Changing what has come to be perceived as stable and achievable could cause the target to be regarded as temporary and less credible, she said.

Cote contrasted the current issues with the discussions that led up to the inflation-target renewal in 2011, when the central bank considered but decided against cutting the target to below 2 percent.

Its research at the time strengthened the case for lowering the target but also highlighted risks associated with the zero lower bound.

She did not rule out the possibility of cutting the target but her remarks focused on the possibility of raising it.

Cote said the bank would also examine the extent to which monetary policy should be used to address financial stability risks, such as those from increased housing prices and household debt. Such risks have been edging higher in Canada, she said.

While Cote acknowledged concerns about the buildup of financial stability risks in advanced major economies due to years of aggressive stimulus, she pointed out a recent speech by Bank of Canada Governor Stephen Poloz that suggested “the alternative is not attractive.”

Finally, the bank will research whether it should continue to identify one preeminent measure of core inflation as its operational guide.

Writing by Randall Palmer and Leah Schurr in Ottawa; Editing by Andrew Hay and Jeffrey Hodgson

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