The Bank of Canada provides a very transparent view of how and what goes into the monetary policy decision-making process. It is very revealing in describing a procedure that most central banks, albeit with some variation, follow leading up to a monetary policy decision. It is interesting to note that each department has its special input to the process.
Staff Provides Base Case Analysis The process begins with the Bank staff's evaluation of economic performance along with their projections. Their assessment is based on input from various departments within the Bank including the International, Monetary and Financial Analysis, and Financial Markets, as well as input from the Bank's regional representatives. The results are presented to the decision-making body, the Governing Council. At the same time, the staff recommends an appropriate interest rate that would keep inflation within its target range and near the 2 percent midpoint. The projections are organized around the national income accounts (see Chapters 8 and 12) and provide the reference point from which other sources of information are assessed.
Because of Canada's dependency on exports for growth, domestic projections begin with the International Department's assessment of developments and prospects of the global economy. Then the analysis focuses on the short-term status of and prospects for the domestic economy. Economic indicators including, for example, recent car sales, housing starts, employment, manufacturers' shipments, retail sales, and merchandise trade are evaluated and recent data revisions are factored in. Other events that could have an impact on the outlook including labor disruptions, unusual weather, and special sales and financial promotions are also surveyed.
The next step combines this new information into a structural macro-economic model of the Canadian economy that is specifically designed to help trace the link from the interest rate target to inflation. It also highlights the very indirect nature of the Bank's influence on inflation and the fact that this influence becomes apparent only over time.
Governing Council Is Briefed About a week before the policy announcement, the Council is briefed on four topics that could influence their decision: risks and alternatives, regional surveys and forecasts, inflationary and capacity pressures, and money and credit.
■ Risks and alternatives. The economic model evaluates the outlook's risks and uncertainties including alternative assumptions about domestic and U.S. economic growth as well as commodity prices including crude oil. The Council is provided with alternative interest rate scenarios. One alternative illustrates the possible consequences of delaying an interest rate change proposed by the model.
■ Regional surveys and forecasts. Regional bank representatives prepare a bottom-up forecast after surveying about 100 companies. This information provides Council members with an insight into what businesspeople are seeing and planning. The survey asks basic questions about past and expected sales growth, investment intentions, inventories, employment plans, wage growth, and prices four times a year. The survey also includes indicators of activity and capacity in the goods, labor, and real estate markets, as well as various measures of wage and price inflation, and measures of inflation expectations.
■ Money and credit. — Information on various holdings of money and credit provide another view of what consumers and firms are doing and planning to do.
The challenge is to separate the real signals about economic activity and inflation from volatility or noise caused by other factors. The Department of Monetary and Financial Analysis provides a view from the financial side of the economy, including the outlook and risks surrounding it, and makes an interest rate recommendation as well. The evaluation includes factors such as bond market credit spreads and other changes that could affect lending conditions to businesses and households by banks.
The Financial Markets Department assesses market expectations for interest rates and what market expectations are for Bank action. Future Federal Reserve actions are also included in the discussion. The information sources include interest rate futures and expectations implicit in the term structure of interest rates, market commentary, published reports of investment banks, and the Bank's contact with dealers and investors. The market perspective acts both as a reference point against which to compare the staff's analysis and as a guide to the issues that may need to be addressed when communicating the decision.
The Final Briefing Takes Place and the Governing Council Reaches a Decision
At the final briefing, the Governing Council meets with the other members of the Monetary Policy Review Committee, which includes six advisers, the chiefs of the four economics departments, and the directors of the Montreal and Toronto financial markets divisions. This meeting typically takes place on the Friday morning preceding a fixed announcement date (usually the following Tuesday).
The staff updates the Council on any economic or financial information that has become available since they completed their analysis. This is followed by a wide-ranging discussion on the economic outlook, the balance of risks, and the appropriate setting for interest rates. Each Committee member makes a recommendation on the appropriate interest rate setting. The Financial Markets Department chief discusses market expectations regarding the Bank's upcoming decision. This discussion highlights what market participants see as the factors weighing on the decision and how key messages should be communicated.
On the same Friday, the Governing Council begins its own deliberations and develops a consensus view on the most likely economic scenario along with its underlying inflation trend. Only after agreement is reached on the outlook do they begin deliberations on the appropriate path for the key policy rate and the related communications activities.
The Council operates on a consensus basis (as does the European Central Bank). There is no vote. This differs from the Fed and the Banks of England and Japan wherein a specific vote is taken and reported.
The Council reconvenes the following Monday, and by the end of the day reaches a consensus decision. With support from a senior communications staff member, they prepare the press release that outlines the reasons behind the decision. Their decision is announced the following day at 9 A.M. ET. Below is the announcement released on April 25, 2006, announcing a 25-basis-point increase in interest rates.
Bank of Canada raises overnight rate target by 1/4 percentage point to 4 percent
OTTAWA—The Bank of Canada today announced that it is raising its target for the overnight rate by one-quarter of one percentage point to 4 percent. The operating band for the overnight rate is correspondingly increased, and the Bank Rate is now 4 1/4 percent.
The global economy has been growing at a robust pace, exhibiting a little more momentum than had been anticipated. This global strength and the associated higher prices of many commodities, together with strong domestic demand in Canada, have produced solid growth in the Canadian economy at a pace consistent with the Bank's outlook in the January Monetary Policy Report Update. At the same time, global competition and the past appreciation of the Canadian dollar continue to pose challenges for a number of sectors of the economy. All factors considered, the Canadian economy is judged to be operating at, or just above, its production capacity. High energy prices have kept total CPI inflation in Canada somewhat above the Bank's 2 percent target. Core inflation has remained below 2 percent owing to persistent downward pressure from prices of imported consumer goods. Against this backdrop, the Bank decided to raise its target for the overnight rate.
Looking forward, the Bank projects that the Canadian economy will grow by 3.1 percent in 2006, 3.0 percent in 2007, and 2.9 percent in 2008. Total CPI inflation is projected to average close to 2 percent in 2007 and 2008 (excluding the effect of any changes in the GST). The Bank judges that the risks to its projection are roughly balanced, with a small tilt to the downside later in the projection period.
In line with the Bank's outlook for the Canadian economy, some modest further increase in the policy interest rate may be required to keep aggregate supply and demand in balance and inflation on target over the medium term. The Bank will closely monitor evolving developments in the Canadian economy in light of the cumulative increase in the policy interest rate since last September. A full analysis of economic developments, trends, and risks will be provided in the Monetary Policy Report, to be published on April 27, 2006.
Post-announcement Communications Two days after an announcement and four times a year, the Bank releases either the Monetary Policy Report or the Monetary Policy Report Update. These provide details on the Governing Council's economic and inflation outlook, its risks, and the reasons for the recent rate decision. Along with background media briefings by the deputy governors and a press conference by the Governor and Senior Deputy Governor, the Report is also followed by testimony before parliamentary committees and by presentations by deputy governors and other senior staff across the country and in international financial centers. There are no minutes of the Governing Council's meeting.
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