VANCOUVER (Reuters) - The Bank of Canada seriously considered raising its inflation target to give it more flexibility to cut interest rates, but decided unconventional measures provide more room to maneuver than previously believed, Governor Stephen Poloz said on Tuesday.
In a speech that defended the central bank’s decision to renew its inflation target at 2 percent, Poloz said a higher target was considered because rates in many economies have been at or near historic lows.
“The idea is that interest rates would generally be higher if we had a higher inflation target, so we would have more room to lower rates in the future before we hit that effective lower bound,” he said in prepared remarks.
“However, we have learned from recent experience that there are unconventional monetary policies that give us more room to maneuver than previously believed.”
The bank said in October it considered cutting interest rates but held policy steady at 0.5 percent. It cut rates twice in 2015.
Arguing in favor of the renewal of the inflation target at the midpoint of a 1-to-3 percent range, Poloz said pushing inflation up to 3 percent “might be quite difficult to do, and might require some significant economic fluctuations, given how well inflation expectations appear to be anchored at 2 percent.”
He also said that while a higher target would mean higher nominal rates and more room to maneuver, on average, it would impose a higher inflation tax on the economy.
“I think of this as paying dearly, every day, for insurance against the low-probability risk that another very large macroeconomic shock could occur in the future,” he said.
Poloz also said it makes sense to separate monetary policy from efforts to stabilize the financial system because government policy is better suited to address threats like a hot housing market or high household debt than the “very blunt tool” of moving interest rates.
Reiterating that the bank must focus on inflation risks rather than risks to the financial system, Poloz said macroprudential measures such as tighter mortgage rules are a better way of addressing risks to financial stability than using interest rate policy.
In a speech to a business audience in Vancouver, where high house prices have sparked fears of a bubble, Poloz said government moves to make it harder for consumers to take on too much debt to get into housing have mitigated risks.
Reporting by Leah Schnurr and Andrea Hopkins; Editing by Tom Brown