The Bank of Canada must take account of the international environment, where inflation-targeting has become widespread, as it considers Canada’s future options, according to a study released Tuesday by the C.D. Howe Institute.

In the report, author Pierre Siklos examines international experience with monetary policy over the past decade and the consequences of the worldwide spread of inflation-control regimes for Canada’s targeting program, which expires on Dec. 31, 2011.

Since 1989, when inflation targets were introduced in New Zealand, this type of policy framework has spread throughout the world. There are now almost 30 countries that target inflation in a more or less formal fashion, the report notes.

At the heart of all inflation-targeting regimes, says Siklos, is the core belief that a low and stable inflation rate is a desirable goal. Systems differ as to what is targeted, how it is accomplished, and over what time-horizon the objective is to be attained.

The likely source of inflation targeting’s success, Siklos states, is that this strategy is better able to anchor inflationary expectations, making monetary policy more consistent.

The report points to the need to deal explicitly with some questions about the Canadian economy’s performance under inflation targeting, especially in light of the large shocks that have hit the Canadian economy in recent years.

“For example, the Bank of Canada could be more explicit about how it might pre-empt the consequences of stresses in the economy and the financial system to avoid the accusation that it is an effective enabler of asset price bubbles,” the report states.

“The principal lesson is that the Bank must take careful account of the international environment in which it has been and will be operating. The Bank’s failure to emphasize international matters in 2006, when it set out its remit for reviewing the program, was a serious omission,” the report says.

“Given the high degree of international integration of such markets, the best response to such issues for one inflation targeting country is unlikely to be independent of measures taken elsewhere,” the report concludes.

IE