Learn about the objective of Canada’s monetary policy and the main instruments used to implement it: the inflation-control target and the flexible exchange rate. See also how monetary policy works, how decisions are made and related backgrounders.
The Objective
The objective of monetary policy is to preserve the value of money by keeping inflation low, stable and predictable. This allows Canadians to make spending and investment decisions with more confidence, encourages longer-term investment in Canada's economy, and contributes to sustained job creation and greater productivity. This in turn leads to improvements in our standard of living.
Canada’s monetary policy framework consists of two key components that work together and reinforce each other: the inflation-control target and the flexible exchange rate.
The Inflation-Control Target
At the heart of Canada’s monetary policy framework is the inflation-control target, which is two per cent, the midpoint of a 1 to 3 per cent target range. First introduced in 1991, the target is set jointly by the Bank of Canada and the federal government and reviewed every five years. However, the day-to-day conduct of monetary policy is the responsibility of the Bank’s Governing Council. The inflation-control target guides the Bank’s decisions on the appropriate setting for the policy interest rate, which is aimed at maintaining a stable price environment over the medium term. The Bank announces its policy rate settings on fixed announcement dates eight times a year.
Target for the overnight rate
The target for the overnight rate, also known as the key policy interest rate, is the interest rate that the Bank expects to be used in financial markets for one-day (or "overnight") loans between financial institutions. This key rate serves as the benchmark that banks and other financial institutions use to set interest rates for consumer loans, mortgages and other forms of lending.
Influencing short-term interest rates
To achieve the inflation target, the Bank adjusts (raises or lowers) its key policy rate. If inflation is above target, the Bank may raise the policy rate. Doing so encourages financial institutions to increase interest rates on their loans and mortgages, discouraging borrowing and spending and thereby easing the upward pressure on prices. If inflation is below target, the Bank may lower the policy rate to encourage financial institutions to, in turn, lower interest rates on their loans and mortgages and stimulate economic activity. In other words, the Bank is equally concerned about inflation rising above or falling below the target. Such an approach guards against both high inflation and persistent deflation.
Monetary policy actions take time
Monetary policy actions take time - usually between six and eight quarters - to work their way through the economy and have their full effect on inflation. For this reason, monetary policy is always forward looking and the policy rate setting is based on the Bank’s judgment of where inflation is likely to be in the future, not what it is today.
The benefits
The inflation-control target has helped to make the Bank's monetary policy actions more readily understandable to financial markets and the public. The target also provides a measure of the effectiveness of monetary policy, since it is evident whether or not inflation is near 2 per cent and the target is being achieved. A clear inflation target helps anchor expectations of future inflation. This allows individuals, businesses and governments to make spending and investment decisions that stimulate non-inflationary growth in the economy.
Canada’s Flexible Exchange Rate
Canada’s flexible exchange rate, or floating dollar, permits us to pursue an independent monetary policy that is best suited to Canada’s economic circumstances and is focused on achieving the inflation target. Movements in the exchange rate also provide a “buffer,” helping our economy to absorb and adjust to external and internal shocks.
Backgrounder: The Exchange Rate
A backgrounder explaining the role of the exchange rate in Canada's economy.
Float of the Loonie
Governor Stephen S. Poloz discusses the role of a floating exchange rate in the Canadian economy and in the Bank’s monetary policy framework.
Canada's Experience with Inflation Targets and a Flexible Exchange Rate: Lessons Learned
The Canadian economy has undergone a dramatic transformation over the past decade. And it has emerged as a low-inflation economy, with declining levels of public and foreign debt and a private sector that is more cost-conscious, productive, and efficient, thanks to restructuring and investments in new technology.
Why Canada Needs a Flexible Exchange Rate
This paper explores the arguments for and against a common currency for Canada and the United States and attempts to determine whether such an arrangement would offer any significant advantages for Canada compared with the present flexible exchange rate system. The paper first reviews the theoretical arguments advanced in the economics literature in support of fixed and flexible currency arrangements. A discussion of Canada’s past experience with the two exchange rate systems follows, after which there is a survey of the empirical evidence published on Canada’s current and prospective suitability for some form of fixed currency arrangement with the United States. The final section of the paper examines critically a number of concerns raised about the behaviour of the current flexible exchange rate system.
Decision-Making Process
Find out when decisions are made, who decides and the key stages of monetary policy decision making. You can also read detailed articles on the subject.
Monetary Policy Backgrounders
15 January 2016 Target For The Overnight Rate
Defines this important policy interest rate and describes the role it plays in influencing various market interest rates.28 September 2012 Bank Rate
Explains what the Bank Rate is and its relationship to the target for the overnight rate.29 May 2012 Lending Rates
Outlines the factors that affect interest rates for commercial loans.29 May 2012 How Monetary Policy Works: The Transmission of Monetary Policy
Explains the process by which changes in the policy interest rate work their way through the economy and ultimately affect the rate of inflation.29 May 2012 Monetary Policy
Explains the purpose of monetary policy and describes how it works.7 November 2011 Renewal of the Inflation-Control Target - Background Information - November 2011
Commentary and technical data relating to the 2011 target renewal.1 November 2006 Renewal of the Inflation-Control Target - Background Information
Commentary and technical data relating to the 2006 target renewal.1 May 2001 Renewal of the Inflation-Control Target - Background Information
Commentary relating to the 2001 target renewal.Framework for Conducting Monetary Policy at Low Interest Rates
This document outlines a series of monetary policy measures that could be deployed in a very low interest rate environment.
Monetary Policy Report – July 2016
Canadian economic growth is projected to accelerate from 1.3 per cent this year to 2.2 per cent in 2017.
The Transmission of Monetary Policy - Whiteboard
This video describes, in general terms, the “transmission” of monetary policy-i.e., how changes in the Bank’s policy typically affect the economy and inflation over time.
Large Value Transfer System (LVTS)
The LVTS provides the setting in which the Bank of Canada conducts its monetary policy. Here’s how it works.