It’s friday at noon. in a dining room in the Bank of Canada building in Ottawa, the six-member governing council, headed by governor David Dodge, is sitting down to lunch.

Over the meal, the crucial final round of discussions will begin, leading to a decision that will affect virtually all aspects of the Canadian economy — the setting of the key overnight interest rate. That’s the rate banks charge one another for a 24-hour period to cover daily transactions. Talks will continue on Friday afternoon and on Monday. On Tuesday, the council will announce whether it will raise, lower or maintain the current rate.

The Bank goes through this process eight times a year, and it is central to keeping the economy on an even keel.

The Bank uses the overnight interest rate to help keep inflation within a stated range — since 1995, the target has been between 1% and 3% — with 2% the ideal mid-point.

The upcoming announcement of the latest bank rate, scheduled for early September, is eagerly awaited. Economists believe the bank will increase the rate — most suggest by 25 basis points — marking the end of a long period of neutral decisions.

Rate announcements are usually short and sweet. But determining the rate is a long, complex process.

“There is no crystal ball in the middle of the table that we can stare into and see the future,” says Tiff Macklem, a deputy governor of the Bank of Canada. The council consists of the governor, a senior deputy governor and four deputy governors.

“Depending on your experience, on your judgments, which indicators you put more weight on, you can add things up a little differently, come to a slightly different view.
Then it is through the process of debate and discussion that [the council] develops a consensus view,” Macklem says.

Typically, the decision-making process begins several weeks before the announcement, when the Bank’s staff presents its economic projection involving a comprehensive look at the Canadian economy, which it prepares quarterly. (At the
other four meetings, staff presents an update of the projection or a risk scenario based on the previous projection.) The projection also considers global economic conditions, with special emphasis on the U.S. situation.

At that meeting, a projection model is presented that traces a link between the current overnight rate through a number of economic variables to the rate of inflation.
The model is also used to predict the outcome of various economic developments, should they arise.

“The model itself has a policy reaction function, which will produce a path for interest rates that brings inflation back to target. That rule, that reaction function, has certain properties we look at and we think it’s a good baseline rule,” Macklem says.
“Policy doesn’t follow that rule mechanically, but [it] has some reasonable properties and provides a good starting point for the discussion.”

That afternoon, following the staff economic projection, the council meets to discuss the presentation, the baseline model, what the staff sees as the risks of that course of action and the council’s interpretation of the risks.

About a week before the announcement, and under a media blackout, the staff and council meet again for what is called the “major briefing,” which usually lasts two hours.

Analysis and projections

The council first hears an analysis of the risks identified at the projection meeting and the consequences of alternative paths. That is followed by reports from the Bank’s regional offices, including a national forecast created from the regional ones. The third stage is an analysis of the money and credit situation in Canada, which holds some predictive properties for analysing future spending.

“It’s not perfect — nothing is perfect,”
Macklem says of the money and credit analysis. “That’s why you look at a lot of different things.”

Finally, the council hears about what market expectations are concerning the bank’s probable course of action. All this information is intended to provide a different perspective and complement the staff’s economic projection.

At the Friday morning meeting, the council
hears from the bank’s monetary policy review committee: the chiefs of the four economic departments (international, research, monetary and financial analysis, and financial markets), six economic advisors and the two directors of financial markets for Toronto and Montreal, respectively.

The meeting, lasting anywhere from 90 minutes to a couple of hours, begins with an update of economic and financial information since the economic projection.
One of the chiefs of the four economic departments leads the discussion.

@page_break@At this point, the council doesn’t offer its own analysis. Instead, it listens to the perspectives and final recommendations of each committee member.

Then, beginning at the Friday lunch and continuing in the afternoon, the council, accompanied only by the communications director and an economic advisor, starts its deliberations.

The council slowly works toward a common view of the outlook for the Canadian economy, the trend in inflation and the major risks around the baseline projection. Each governor gives his or her viewpoint.

The council meets again on Monday and, sometime that day, it reaches a decision about the overnight rate.

No written records or transcripts of the deliberations are kept. The chief of the communications department helps the council to draft a carefully worded press release, in both official languages.

The next morning, media are invited to a “lockup” at the Bank of Canada building.
They are allowed in an hour early and given the press release containing the decision and the explanation of it. They can’t leave or communicate that news until 9 a.m. At that time, the markets find out what the decision is.

Four times a year, the Bank also releases its monetary policy report or monetary policy report update a week after the fixed announcement date. The report summarizes the Bank’s view of the economy and why it made its policy decision.

Craig Wright, chief economist at Royal Bank of Canada, believes the Bank of Canada’s consensus approach has a key advantage.
As each of the governors will have to support the council’s decision after the
announcement, Wright believes that encourages committee members to make sure their opinions are heard during deliberations.

“It’s a view they all have to support. They all sing from the same songbook,” Wright says, adding that the consistency of the message has a stabilizing effect on the market.

There’s a long lag between setting the rate
and its effect on the economy, Macklem notes. “If we change the overnight interest rate today, it will take 18-24 months before you see an effect on inflation. That means we have to be forward-looking,” he says.
“The reality is no matter how good the process is, there will be surprises. The challenge is to adjust, to react appropriately and deal with events as they unfold.”
IE