The Bank of Canada should improve its monetary policy program to more effectively meet the goals of stabilizing the value of money and minimizing the volatility of output, a new report by the C.D. Howe Institute suggests.

The report, by University of Western Ontario economics professor emeritus Michael Parkin, says that although monetary policy in Canada has been successful, the financial crisis has highlighted areas where the policy falls short.

Parkin calls for the Bank of Canada to engage in price-level targeting, by targeting the path of the consumer price index rather than the inflation rate and ensure that it rises by 2% a year on average. The central bank should commit to lowering this rate of increase over the coming decade until true price-level stability is achieved, which would ensure a more predictable long-term value of money, Parkin says.

For Canadians saving for retirement, this system would reduce the systemic risk that arises from uncertainty about the future value of money, the report explains.

Second, Parkin recommends that the central bank create clear-cut interest rate rules, to boost transparency on its decision-making procedures.

“Decisions based on simple, mechanical rules bring greater clarity and predictability to decisions and put the onus on policymakers to explain departures from the rule,” Parkin says.

The Bank of Canada could also improve its communications by reporting monetary policy performance in the form of a Taylor curve graph, which shows the tradeoff between output and inflation volatility.

“The Taylor curve is a handy way to describe the best that monetary policy might achieve, to describe what it has achieved, and to make cross-country comparisons,” Parkin says.

He adds that the bank should compare Canada’s monetary policy performance with that of other countries.

Lastly, reflecting on the credit crisis and the market volatility of recent months, the report recommends that the Bank of Canada play a greater role in ensuring financial stability.

“Monitor financial stress indexes, asset prices, and the price of risk, and when judgment suggests financial instability is present or likely, consider modifying the interest rate to avoid financial crisis, then explain in detail both the concern and the reason for action,” the report suggests.

The C.D. Howe Institute is urging the Bank of Canada to consider these recommendations in advance of its monetary policy renewal in 2011.

IE