Monetary policy. This is part of a conference on inflation hosted by the Brookings Institution center on fiscal and Monetary Policy. Its about an hour. And then were going to move to the next segment, which is really important, because it seems to me that theres a question not only about what we should do, but how we should get there. And it may that be we have something to learn from the canadian experience. So i want to introduce john david murray, who was, for 32 years at bank of canada, 32 or 34, john . 4 years at the bank of canada. Last four as deputy governor. He retired three years ago and is now an academic and a board member. Hes going to talk a little bit about how the bank of canada has come to have a much more organized process about reviewing the framework. And then the president of the Federal Reserve bank of boston, who has been thinking about just that question, is going to respond. So, john . Is this mic on . Thank you. There should be a power point that accompanies this. Not that one. [laughter] h. There. You can see what i propose to talk about, and for central bankers in the room, this will usually make them apoplectic. Partnering with the government, but ill explain what i mean, and it relates to davids introduction, the special way that we partner with the government in canada, and perhaps what im going to relay is somewhat unique and specific to canada. The i think youll find it interesting, and beyond that, i also think that there are more general lessons here, so dont want to oversell it. First thing id like to say is that, in fact, standing things on their head a little, when inflation targeting came to canada, it was actually the government that proposed it, not the bank of canada. Now, you might say why would they do that . Three quick reasons come to mind. One of them, the most positive perhaps is that they thought it was a good idea, and they thought the reserved bank of new zealand provided an interesting lead, some encouragement. So thats number one. Number two is that the government was in the process of introducing a new goods and services tax, which was going to boost the headline inflation rate quite significantly, and this coincided with a situation where, unfortunately, they had to negotiate labor contracts with almost all the unions in the federal government. So you could think of them wanting an inflation target as some kind of assurance, some kind of buffer to see them through this difficult period. And the third is sort of a preemptive act that the bank of canada had started on a very sort of aggressive, determined track and was out there talking about the virtues of price stability, which i know isnt anything new for a central bank. But this was in a very direct and determined way. And although no new numeric target was given for this, when asked by a journalist what this might mean, the answer was, for inflation, four is not as good as three. Three is not as good as two. Two is not as good as one. And one is not as good as zero. So effectively, dont want to put words in his mouth, we were talking about price stability. So you can think about this as a preemptive act on the part of the government so, in their view, things didnt go too far. What was the banks reaction to this proposal . Well, it was mixed. There was the positive. They were very receptive to the idea of inflation target. They were less enthusiastic about the way the government wanted to go about it. They wanted to aim for a relatively high rate, not high by that time, but, say, 3 . And they were thinking of something sort of short term. Im going to call it a patch through this difficult period. The banks reaction to this was that it had to be meaningful, and it had to be long term. It had to be serious. And in the event, perhaps a little surprising for some, the bank of canadas view prevailed. And what we got in the end by way of the very first announcement in 1991 was an nflation target of 3 for 1992 going down to 2 in 1995, and there was a 1 ban to either side of these targets. But whats perhaps most interesting is that this was regarded as only a beginning. That after 1995, five years hence, based on experience, this issue would be revisited, but with a strong presumption, a gain that 2 was only an interesting start, and you were going lower. The first renewal of the agreement the bank had with the government in other words, 1995 was to review the experience, but it was related to that, thought of in terms of a one and done, that after five years experience, surely well have enough information that well be able to peg the rate, the optimal level of inflation for it, and thats it. So this was not seen as the beginning of an ongoing process of renewal. Key aspects of the agreement were, this was simply a joint press release by the bank and the government, and it came out as part of the governments february 1991 budget. There is no supporting legislation for this, and indeed, thats been the pattern through time. Its public. And that extent has some force. But it is agreement between parties. Its a partnership with one admittedly more equal than the other ultimately. The government of canada for a long time, its been very clear in the legislation, has the power to issue a directive to the bank of canada. If its unhappy about Monetary Policy, it can tell them what to do. This came about in 1967 as a result of events that i wont go into. But there are three conditions around that ability. One is that they have to be very specific about what they dont like. Two, they have to be very specific about what they want the bank of canada to do. And three, it has to be published. And theres always been a presumption that if it was ever used, the governor at the time would feel compeled to resign. But perhaps as a result of that, its never been used. This nuclear option. What it means is that having that in place is good in two ways in our view. That it does give ultimate responsibility for Monetary Policy to the government, but it also ensures that they cant use it too lightly. And effectively then gives the bank of canada considerable operational independence, instrument independence. Ill speak to this later, hopefully quickly. We actually see the agreement, instead of eroding that independence potentially, rather enhancing it, because once youve got the government to sign on, the scope for them to criticize, as long as youre actually doing your job, becomes more limited, so we see tremendous advantage in this public agreement, and as ill mention in a minute, this renewal process thats developed, where its refreshed every five years. Ive talked about the early ambitions regarding ultimate price stability, the origins of the process. Lets see, have i got this right, just to give you a flavor of where this was headed initially, the first bullet doesnt complete all of it, just lays out the specific targets as i described earlier. I think the last two bullets are more interesting for you. Thereafter, that means after 1995, the objective would be further reduction in inflation until price stability is achieved. The last one, based on a lot of work that the bank of canada had done in advance is, a good deal of work has already been done for canada. This work suggests a rate of increase that is clearly below 2 . You might ask, where did that come from . Well, it came from a lot of research, but the three reasons for having an inflation rate above zero at the time for us, were not regarded as that material. We had a measurement bias in the c. P. I. , but it was judged to be very low. Presently probably, and then half a percent or less now, thats not a reason to have a 2 target. We could find some statistical support for this notion of nominal wage rigidity, which would be the second argument, but our work suggests that economically it was not very important or meaningful. And because of the great moderation perhaps, we underestimated the significance of the effect of lower balance. That was something that we thought, if it did occur, surely there would be means to overcome. So thats where we were coming from at the time. In the event the target was renewed with the government in 1993, i wont go through why, instead of 1995, and its since been renewed in 1998, 2001, 2006, 2011, 2016. Its up for renewal in 2021. We referred to earlier, despite all these renewals, theres been no material change. The 2 has been maintained at the mid point, and the language around it has quietly changed. Instead of talking about price stability so often, we talk about low, stable, and predictable inflation as being the good thing. One of the reasons and its perhaps the most important reason the 2 target hasnt changed, is that the economy seemed to perform so well, better than expected, under the 2 inflation target. So thats a rather high bar for doing anything adventurous, especially youll note the dates for some of these renewals coincided with episodes in which the economy, the situation was particularly uncertainty, 2001, right after the tech bubble, 2011, well fallout from the Great Recession. But just to give you a flavor for how much things changed on the inflation front, looking good, we actually did so well that the i. M. F. And others accused us of covertly price level targeting. And you can see why, looking at this graph, that might be a reasonable suspicion. The black line shows you a hypothetical price level that is allowed to grow at 2 a year, and up until about 2012, 2014 even, were doing a remarkably good job. This came as a surprise to us. [laughter] no, not the good part. Not the good performance. We knew we were doing a great job. But when the i. M. F. Pointed this out, accused us of covertly price level targeting, which is itself a little odd, because the major benefit is to advertise it, so you can condition expectations. As we reflected on it, two things, people have referred to luck earlier, and perhaps a sequence of shocks that happened to be offsetting or similar the rick, but another thing thats been mentioned, and we learned to appreciate its importance even more is our reaction function. Like many Central Banks, put it on Interest Rate smoothing. If you think about that, that already introduces quite a bit of history independence, and you are inflation averaging unwittingly. You might as well take credit for it. Quickly, the advantages of a regular renewal process, you may say whats the point if you dont change . But theres a lot going on underneath is what ill maintain. The first, we believe this is a critical part of our accountability, that this is a critical element of our fiduciary responsibility, to canadians, to ensure on a regular basis that we are working under the best possible framework for them. Second, its a way of defusing potential problems. By that i mean, if this is a onceinalifetime event, oh, theyre going to renew the target and things might change, theres a lot of excitement around it. But if theres a regularity to it, this is business as usual. You defuse a lot of that. Were just taking care of business for you. Next, it promotes oh, wait, deliberate and transparent mechanism to engage stakeholders. This is terribly important, the Transparency Part in particular. When the bank of canada renews the agreement with the government, this isnt the product of some sort of secret discussions between the two. This is something that is initiated quite early on, and the bank of canada is very careful to lay out the issues it proposes to address. The changes that it might consider, and to invite feedback from the public, from the government, of course, from academics, and its the beginning of a sequence of often conferences as part of this process. So the transparency to our mind is very important in terms of the credibility and buyin, and thats a way of promoting Public Awareness and understanding. Its a driver. Kristin mentioned this, a driver for more focused Research Effort within the bank. And something new has actually been learned on every occasion. Its not as though we find it as deepening our understanding of the economy or the Monetary Policy process. Nothing has changed. But things are going on underneath. Possible disadvantages, some have argued by renewing every five years, perhaps youre not going to anchor expectations if the market thinks every five years theres a possibility youre going to change. Inflation expectations might not be well anchored. Ill show some counter evidence in a minute. Theres increased scope for unhelpful interference, and this has been the topic of, sarah, a lot of people today, and thats true. Theres a risk. Its a waste of time and energy. I mean, if nothing really changes in the end, whats the point . And then related to that, trying the publics patience, sort of announcement fatigue, oh, were going to renew, were going renew, oh, 2 , did i mention that . Counter arguments, theres absolutely no evidence from canada, very little, of fragile or unanchored expectations as a result of this. Its actually a mechanism for enhancing the Central Banks independence, we would maintain, and its important confirmation of the frame works 10u7bdness. Fine nothing changes, the fact that you are confirming that, in your view, we are where we should be is important. Inflation expectations, thats to show thaw this is based on two and threeyear inflation expectations. You always get a little movement, but theyre remarkably stable for that term , one to three years. And near the end, quickly, what are some of the issues the bank of canada has examined in the last 27 years . I divide them into two categories, fundamental, and then sort of House Keeping or operational. The fundamental ones, which weve always looked at, should lowered . On target be that operated everything right through the 2011 agreement. Its only in 2016 that the question was turned, and should we raise the inflation target . In the end, we didnt, and i can explain why. Maybe ill do it now very quickly. There had been this predisposition toward lower is better starting at the beginning. And this had sort of receded a little. But there had always been a sense that lower inflation, something close to price stability, would be better. And price level targeting held a lot of attraction for some of us, as a way of achieving a lower inflation rate while dealing with the effective lower bound f. Price level targeting works, it actually reducing the swings in inflation and output and Interest Rates. You need much less by way of Interest Rate movement to stabilize the real economy and inflation. The key is communications and credibility. People have to know what you want to do and believe youre going to do it. Nd that could be a big if. Would price level targeting be better . No, thats kind of good, interesting. How much recognition to give to Financial Stability considerations . Do you want to modify your reaction function in a way and give that recognition your frame work . We asked that as part of the 2016 thing, and the answer was probably not much. Wed already gone on record in 2006 speaking about leaning and its advantages am we refreshed that in 2011 and address it had again in 2016. 2016, we actually stepped back a little, whereas in 2011 wets, oh, it could be a forty line of defense. That if supervisors and regulators werent doing their job. Thats too bad. If macro tools didnt appear to work, if investors werent being provident enough, shame on them. Were institutions. Theres a fourth line of defense, if you really had to, you might lean. But by the time we got to 2016, we had been influenced by the work that shows there actually might be a negative benefit to leaning. You do more damage than good. So dont go they didnt quite run away from that in the latest renewal, but it was sort of easing back. Operational House Keeping matters, c. P. I. , the best index still, thats the one we do target, and we favor that for a number of reasons. Best measure of core inflation, thats changed a little through time. How important this measurement bias, and we confirm every time, that it isnt bigger, indeed, because of some changes that have been made by statistics canada. Its a little smaller. It wasnt big to start with, and its smaller now. Looking ahead, this is my last slide, next renewal set for 2021, bank of canada already mapping out a Research Agenda for the next five years. The final questions have not been determined yet, or else theyd be advertised. But they intend to take a broader sweep this time. Instead of just looking at the objectives or the frame work per se, but to also look at tools in more detail and communication. Old issues will almost certainly be revisited. Other new initiatives will no doubt be added. Here in terms of the undamental issues, while weve done a lot ive retired. I shouldnt say we. While the bank of canada has done a lot of work on lowering inflation its advantages or cost, price level targeting, while we talked about it and did some work, we didnt talk about nominal g. D. P. Targeting, and i think that is going to be revisited in level form as opposed to growth rate. I cant be sure. This isnt based on information or inflation averaging, or instead of, we already inflation average, we happened to pick a 12month period for that. Like australia over the cycle, and as i mentioned earlier, we already do it kind of with our Interest Rate smoothing and the reaction function. So thats some of what will be looked at. But the main takeway i want to give you is that the bank of canada really values this renewal process, and it doesnt become sort of a dogfight between the central bank and the government. Maybe thats an unusual situation. Now, you may argue you may argue that you cant take much comfort from that, because weve never proposed a major change. Why would the government sort of be nasty or push back . And thats a fair argument. But turning it on its head a little, i can say, from my experience, i am not aware of the government ever pushing us to do something or to change something, like wouldnt a little higher inflation be nice for everyone. So the fact that that question was raised in 2016 and examined isnt at the behest of the government or anything, you know, take it easy. No, very much the bank has been carrying the load on the proposals, the proposed changes, and the research, bringing the government in at the end. It is a partnership, and obviously they have final, final say to a degree. But theres a lot thats going on. Ill end with this. What did i mean by a lot going on underneath . Although we didnt change anything major. You can see where we started. There was a strong presumption that we were going lower. We had research to support it. was nowhere near price stability, and pri