November 20, 2018 / 5:58 PM / 7 months ago

UPDATE 2-Bank of Canada to review inflation targeting in potential big policy shift

(Adds analyst comment, details)

By David Ljunggren and Fergal Smith

OTTAWA/TORONTO, Nov 20 (Reuters) - The Bank of Canada will review its monetary policies and is open to changes such as dropping decades-old inflation targeting, a top official said on Tuesday, although some economists were skeptical about the central bank’s ability to make major policy shifts.

The deadline for the review is late 2021, when the central bank is due to renew its five-year inflation control agreement with the federal government.

Many major central banks target inflation but some, such as the Federal Reserve, have a dual mandate. The Fed also targets employment.

The inflation target has been 2 percent for the last 23 years, which the Bank of Canada has largely achieved, helping keep prices stable. But in the wake of the 2008 crisis, the bank found it did not have much room to slash rates and help the economy.

Bank of Canada Senior Deputy Governor Carolyn Wilkins said that after 25 years, officials needed to see whether another approach might work better.

“It is time to conduct a thorough review of the alternatives,” she said in a lecture at Montreal’s McGill University, noting that in the decade since the fiscal crisis inflation-targeting had shown it was not perfect.

Royce Mendes, senior economist at CIBC Capital Markets, said moving to a system where the bank for example targeted prices could raise inflation expectations and nominal interest rates.

“I think there is justification to move away but I think there is a high bar,” he said in a phone interview.

Wilkins cited two reasons for looking again at the 2 percent target. Firstly, the bank’s estimate of the nominal neutral interest rate is lower than before the crisis, meaning it has less conventional policy firepower to use in a downturn.

The lower rate also means households and investors could take on excessive risk, leaving the economy exposed to boom-bust financial cycles.

“There are several intriguing frameworks that merit further exploration, although none is perfect,” she said.

Derek Holt, vice president of capital markets economics at Scotiabank, predicted the bank would avoid a major shift after so many years of sticking with the same target.

Wilkins noted some economists have suggested increasing the inflation target to 3 or 4 percent. She said bank research done in 2016 showed this would hit people on fixed or lower incomes and could lead markets to suspect the bank might one day lift the target even higher.

Another option is for the bank to set a target path for the level of aggregate prices rather than an inflation rate. This could make monetary policy more effective but the idea is hard to understand, Wilkins said.

Other possibilities include frameworks that targeted both inflation as well as employment or prices, in a dual mandate. (Additional reporting by Fergal Smith Editing by Tom Brown and Susan Thomas)

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