Outcomes are annualized growth rates (%) of seasonally adjusted M1 between the base period and the next
announcement of new targets. For example, the outcome corresponding to the November 1975 announcement is the
annualized growth rate of M1 between April and June 1975 and August 1976.
Ben Bernanke and Frederic Mishkin, Central Bank Behaviour and the Strategy of Monetary Policy:
was achieved by the end of the decade. However, the inflation rate accelerated,
and by the end of the 1970s, it was almost at the same level as when monetary
gradualism was introduced in 1975. What went wrong? Why did the inflation rate
remain high? The answers to these questions lie in a series of financial innovations
that reduced the demand for M1 balances. In particular, the introduction of new
kinds of bank deposit accounts, and the development of cash management tech-
niques for corporate accounts, motivated individuals and firms to move out of
demand deposits
part of M1
into new chequable savings deposits
part of M2.
This increased the growth rate of M2 and reduced the growth rate of M1 at the
same time that M1 growth was being targeted, thereby rendering what seemed like
tight anti-inflationary policy one that was in fact accommodating inflation.
By 1978, only three years after monetary targeting had begun, the Bank of Canada
began to distance itself from this strategy out of concern for the nominal exchange
rate, which had been depreciating. In particular, when interest rates in the United
States increased sharply in late 1979, the Bank of Canada had to choose between
allowing Canadian rates to increase to prevent an outflow of financial capital or
allowing the exchange rate to depreciate to accommodate the spread in interest rates
between the two countries. The Bank responded with an extremely restrictive mon-
etary policy to resist depreciation of the Canadian dollar and the possible inflationary
shock from import prices. Not surprisingly, M1 growth was negative in 1981 even
though the target range was for growth between 4% and 8% (see Table 18-2), and
Canadian interest rates increased to unprecedented levels (see Figure 18-6). The cost
was the very deep 1981 1982 recession, the most severe since the 1930s.
Because of the conflict with exchange rate goals, as well as the uncertainty about
M1 as a reliable guide to monetary policy, monetary targeting was formally abandoned
in November 1982.
The period following 1982 was one of groping. With the abandonment of M1 targets,
the Bank of Canada switched its focus to a range of broader monetary aggregates,
such as M2 and M2+, but no aggregate was found that would be suitable as a guide
for conducting monetary policy. As a result, the Bank adopted what came to be called
the checklist approach to policy, meaning that it looked at a list of factors in order
to design and implement monetary policy. The Bank s checklist included the interest
rate, the exchange rate, and with less weight attached to it, the money supply. The
goal of monetary policy was inflation containment in the short term and price stabil-
ity in the long term.
The Bank s anti-inflation policy during the 1982 1988 period can be viewed as
one where the interest rate became the operating target and the exchange rate was
the intermediate target. Throughout most of the period the Bank targeted interest
rates, resisting depreciation of the Canadian dollar (fearing that depreciation
would worsen inflation). The Bank s policy, however, had been undertaken
against the backdrop of a persistent federal budget deficit that led to higher inter-
est rates, making it difficult for the Bank to control money growth and inflation.
In fact inflation had begun to increase again and the Bank responded with a dra-
matic reversal of its ad hoc monetary strategy. It announced early in 1988 that
short-term issues would henceforth guide policy less and that price stability would
be the Bank s long-term objective of monetary policy.
The adoption of inflation targets in Canada followed a three-year campaign by
the Bank of Canada to promote price stability as the long-term goal of monetary pol-
icy. Beginning with the Hanson Lecture at the University of Alberta in January 1988,
C H A P T E R 1 8
The Conduct of Monetary Policy: Strategy and Tactics
487
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