Managing the Monetary Policy Mix: The Case for the Monetary Conditions Index Revisited

published under the title ‘Bank of Canada should restore the “Made In Canada” monetary policy instrument,’ Inside Policy, MacDonald-Laurier Institute, June-July 2013: 34-37.

8 Pages Posted: 26 Jun 2013 Last revised: 28 May 2014

Dan Ciuriak

Ciuriak Consulting Inc.; C.D. Howe Institute; Centre for International Governance Innovation (CIGI); BKP Development Research & Consulting GmbH

Date Written: May 21, 2013

Abstract

For some time now, the Bank of Canada has adopted inflation targeting to operationalize its general policy of maintaining price stability in Canada. Inflation targeting has a number of important benefits: it anchors private sector inflation expectations, provides a clear and transparent way to communicate the Bank’s policy, and guards the Bank’s independence from political pressure which might undermine public confidence in the currency as might happen with unfettered discretion. The Bank implements its policy by adjusting its policy interest rate which has some direct leverage over commercial interest rates but more importantly acts a signal to the commercial banks, which usually follow the Bank of Canada’s lead. At the same time, the Bank leaves the exchange rate to be determined by financial markets. In an open economy, the degree of monetary restraint is, however, determined by both the interest rate level and the exchange rate. In the 1990s, the Bank of Canada developed an indicator to capture this feature: the Monetary Conditions Index (MCI). The policy mix matters: the monetary restraint generated by a high exchange rate and low interest rates has dramatically different implications for the economy than the same degree of restraint generated by a lower exchange rate and higher interest rates. Canadian policy has ignored this feature; the result has been a sustained period of ultra-low interest rates and an over-valued currency, which have combined to fuel asset bubbles and a debt build-up, while adversely affecting Canada’s trade, innovation and industrial health. The MCI constitutes a "Made in Canada" solution to what has become a "Made in Canada" problem: the Bank of Canada should restore its use and, combined with inflation targets, navigate towards a policy mix more appropriate to Canada’s needs.

Keywords: Monetary Conditions Index, Inflation targeting, Canada

JEL Classification: E52, E58

Suggested Citation

Ciuriak, Dan, Managing the Monetary Policy Mix: The Case for the Monetary Conditions Index Revisited (May 21, 2013). published under the title ‘Bank of Canada should restore the “Made In Canada” monetary policy instrument,’ Inside Policy, MacDonald-Laurier Institute, June-July 2013: 34-37.. Available at SSRN: https://ssrn.com/abstract=2285034

Dan Ciuriak (Contact Author)

Ciuriak Consulting Inc. ( email )

83 Stewart St.
Ottawa, Ontario K1N 6H9
Canada

C.D. Howe Institute ( email )

67 Yonge St., Suite 300
Toronto, Ontario M5E 1J8
Canada

Centre for International Governance Innovation (CIGI) ( email )

57 Erb Street West
Waterloo, Ontario N2L 6C2
Canada

BKP Development Research & Consulting GmbH ( email )

Romanstrasse 74
München, 80639
Germany

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