Mark Carney, the next governor of the Bank of Canada, stressed the importance of the central bank’s role in ensuring financial system stability, and defended an independent currency, in his opening remarks to the House of Commons Standing Committee on Finance today.

Carney spoke in favour of the bank’s inflation-targeting policy framework, saying, “The Bank’s exemplary record of inflation control has meant that we have avoided the destructive effects of high inflation prevalent in earlier decades — effects that were disproportionately felt by poorer Canadians, and which reduced our output and increased our unemployment.”

That said, he allowed that the Bank of Canada has launched a research program to examine whether and how the monetary policy framework in Canada might be improved. “The program is focusing on the potential costs and benefits of targeting a lower rate of inflation, of pursuing a price-level target instead of an inflation target, and the challenges of communicating these potential changes to Canadians,” he revealed.

He also noted the importance of a floating exchange rate, calling it “a key element” of the monetary policy framework. “It allows Canada to pursue an independent monetary policy appropriate to our own economic circumstances,” Carney said. “Although there is no target exchange rate for the Canadian dollar, the Bank does care why the exchange rate is moving and what the potential impact will be on output and inflation.”

Carney added that the challenge for the Bank is to understand the reasons behind currency movements, incorporate those with assessments of other data, and set a course for monetary policy that works to keep total demand and supply in balance and inflation on target.

Despite this challenge, Carney argued that it would be a mistake to peg the Canadian dollar to the U.S. dollar. “It would mean that, de facto, Canada would adopt U.S. monetary policy, despite the reality that the structures of our economies are very different and, as a consequence, often require different types of adjustments in response to global developments,” he said.

Looking ahead, Carney said that monetary policy will be challenged by four underlying trends: globalization, the resolution of global imbalances, the pace and direction of financial innovation and integration, and the evolution of potential growth in Canada.

“These underlying economic and financial trends complicate the pursuit of our inflation target, not only because none is likely to proceed at a steady, predictable pace, but also because they are all interrelated,” he noted. “The strength of our financial system will help determine the ultimate impact of these trends, since each has the potential to affect asset-price volatility and the stability of growth and employment.”

He also allowed that recent credit market turmoil has highlighted questions about the Bank’s role in ensuring stability. As a result, the Bank is currently examining whether some market failures might be best addressed if the central bank had a facility that would provide liquidity at terms longer than overnight, possibly secured with a wider range of securities.

The response to the recent turbulence in financial markets should reaffirm that market participants are fundamentally responsible for their actions, Carney stressed. “The market is beginning to lead many of the necessary changes, as institutions are improving their liquidity management and credit discipline, and originators and distributors of new loans are beginning to adjust their products to standardize terms and align incentives. At the same time, accurate and timely information about underlying risks is essential for the market to differentiate and properly price risk. Thus, as Governor Dodge highlighted in September, enhanced disclosure and transparency are crucial,” he said.

These recent events have also underscored the importance of continued close co-operation among authorities in Canada, and within international bodies, Carney added.