Monetary Policy Decision Making
at the Bank of Canada
John Murray, Deputy Governor
Canada’s monetary policy framework and the process that the Bank of
Canada follows to make its decisions have evolved over time.
The decision-making process is very information-intensive and collaborative,
drawing on the expertise, judgment and analysis of many people.
This article discusses monetary policy decision making at the Bank, focu-
sing on how the process is organized; the key information that is collected,
shared and interpreted as part of the process; and some common mis-
conceptions about monetary policy and the factors affecting the decision-
making process.
Canada weathered the nancial crisis that erupted in 2007−08 better than
most of its peers, thanks in part to the healthy condition of its banks, prudent
regulation of the nancial industry and the country’s strong scal position,
which allowed the government to implement aggressive countercyclical
measures.
The Bank of Canada’s monetary policy, guided by the ination-targeting
framework put in place over 20years ago, also played a critical role in
Canada’s performance throughout the crisis and the recovery that fol-
lowed. The Bank provided signicant and timely monetary policy stimulus
and, through its hard-earned credibility, helped to anchor household and
business condence during a turbulent time. The decision-making process
underlying its monetary policy actions, in normal as well as exceptional
periods such as the crisis, involves a great deal of consultation, research
and analysis by Bank staff.
This article discusses monetary policy decision making at the Bank,
1
and
touches on three related topics: (i) how the monetary policy decision-making
process is organized; (ii) the information that is collected and interpreted as an
important part of this process; and (iii) common misconceptions about both
monetary policy and the factors affecting the decision-making process.
1 This article updates and extends a May 2012 speech of the same title (Murray 2012). It also draws
extensively from Macklem (2002).
Bank of Canada Review articles undergo a thorough review process. The views expressed in the articles are those of the authors and do not necessarily reect
the views of the Bank. The contents of the Review may be reproduced or quoted, provided that the publication, with its date, is specically cited as the source.
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A Brief Primer on Monetary Policy
Before describing the decision-making process, it will be helpful to provide
some background information on monetary policy itself.
Monetary policy in Canada has one objective—achieving and maintaining a
low, stable and predictable level of ination. This objective was formalized
in 1991 in an ination-control agreement between the federal government
and the Bank of Canada. The agreement identies a specic target for the
rate of ination—the midpoint of an ination-control range—as well as the
price index that is to be used to measure ination. Since 1995, the target
level for the ination rate has been 2 per cent (within a control range of 1 to
3per cent), as measured by the 12-month rate of change in the total con-
sumer price index.
Achieving a targeted ination rate may seem like a rather narrow objective—
a notion that will be revisited later—but experience has shown that this is the
best contribution monetary policy can make to the economic well-being of
Canadians. The greater certainty that low and stable ination provides
regarding the future path of prices allows households and businesses to
make more-informed spending and investment decisions, and minimizes the
inequitable impact of unexpected movements in the overall level of prices.
Keeping ination low, stable and predictable is a means to an end, not an
end in itself.
Under normal circumstances, this objective is pursued using a single policy
instrument or tool—changes to the overnight rate of interest.
2
The Bank sets
the overnight rate, which determines the rates at which banks and other
selected agents are able to borrow and lend at the shortest end of the yield
curve. Movements in the overnight rate also set in motion a number of other
changes throughout the economy that ultimately affect the rate of ination.
The transmission mechanism
Through the monetary policy transmission mechanism (Figure 1), changes
in the overnight interest rate inuence the interest rates that the market sets
on securities further out the yield curve, as well as rates on securities with
different risk and liquidity characteristics (for example, bonds, equities and
mortgages). These changes also inuence the exchange rate—the external
value of the Canadian dollar. The resulting movements in asset prices, in
turn, affect aggregate demand in the Canadian economy by inuencing the
spending and investment decisions of both Canadians and foreigners.
If strong aggregate demand pressures appeared likely to push output
above the economy’s capacity limits and lift ination above the 2 per cent
target, the Bank would respond by raising the overnight rate. This would
put upward pressure on other interest rates and the exchange rate, all other
things being equal, dampening aggregate demand and stabilizing ination
at the 2 per cent target. The process would be reversed if demand were too
weak and ination seemed likely to fall below 2 per cent. The overnight rate
would be lowered, boosting aggregate demand and increasing ination. It is
important to note that the Bank takes a symmetric approach to the pursuit
of its monetary policy objective; it is as concerned about undershooting
2 In exceptional circumstances, central banks have several other, unconventional monetary policy tools
at their disposal, including quantitative easing, credit easing and conditional commitments concerning
the path of future interest rates (sometimes referred to as “guidance”). These tools have been used by
a number of central banks in the past ve years as a means of providing additional monetary policy
stimulus once the overnight interest rate approached zero and hit its effective lower bound. For more
information, see Bank of Canada (2009) and Santor and Suchanek (2013).
Achieving a targeted
ination rate is the best
contribution monetary policy
can make to the economic
well-being of Canadians
2
MONETARY POLICY DECISION MAKING AT THE BANK OF CANADA
BAnk oF CAnADA REViEW • AutuMn 2013
the 2per cent target as overshooting it. Keeping actual output at or near
potential is the only way that ination can be maintained at a low, stable and
predictable level.
Establishing an explicit ination target and consistently achieving it helps to
build credibility, anchor the ination expectations of businesses and house-
holds, and make monetary policy more effective. An explicit ination target
improves the transparency and effectiveness of the Bank’s communications
and also provides a direct means by which the Bank’s performance can be
judged, thereby improving accountability.
The Bank’s job would be easy if, having achieved the target rate of ination,
it could simply leave the overnight rate of interest where it was and allow the
economy to run. In reality, this is impossible. The economy is constantly
being buffeted by shocks of varying size and duration from both internal and
external sources. By their very nature, these shocks are difcult to antici-
pate. Indeed, it is often difcult to identify the nature and potential intensity
of a shock until well after it has occurred. Moreover, monetary policy affects
the economy with long and variable lags. Adjustments to the policy rate
made now would typically take four to six quarters to have their full effect on
economic activity, and six to eight quarters to have their full effect on ina-
tion (essentially, two years). Policy therefore has to be forward looking, and
policy-makers must make their decisions in conditions of considerable
uncertainty.
Fixed announcement dates
Before December 2000, the Bank had no xed or pre-announced schedule
for its interest rate decisions. Instead, it stood ready to move whenever
action was deemed appropriate. While this approach may appear sensible,
and certainly allowed for a great deal of exibility, experience in Canada and
elsewhere showed that it also added uncertainty to what was already a very
unpredictable operating environment. Businesses, households and market
participants never knew when the Bank was going to move rates. The
unscheduled approach also made coordinating the Bank’s forecasting and
policy decision-making activities difcult.
To avoid these problems and make the process more predictable, the Bank
moved to a system of xed announcement dates (FADs). The Bank now
makes its interest rate decisions on eight pre-announced dates throughout
the year, with an interval of six to seven weeks between each one. In
exceptional circumstances, the Bank reserves the right to change the policy
rate on dates that fall outside this schedule. This has occurred on only two
Policy has to be forward
looking, and policy-
makers must make their
decisions in conditions of
considerable uncertainty
Shocks
hitting
economy
Financial shocks:
foreign interest rates,
portfolio shifts
Shocks to aggregate demand:
foreign demand, commodity
prices, scal policy
Shocks to
potential
output
Shocks to ination:
indirect taxes,
energy prices
Exchange rate
Overnight
interest rate
Aggregate
demand
Output
gap
Ination
Longer-term interest rates Ination expectations
Figure 1:
The monetary policy transmission mechanism
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MONETARY POLICY DECISION MAKING AT THE BANK OF CANADA
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occasions over the past 13 years—on 17 September 2001, following the
terrorist attacks in the United States, and on 8 October 2008, as part of a
synchronized policy easing with other central banks during the nancial crisis.
The timing of the FADs corresponds to the release of key economic infor-
mation used for the Bank’s forecasting and monitoring exercises. Four of
the FADs occur shortly after the publication by Statistics Canada of the
quarterly National Accounts, which report on Canada’s gross domestic
product and its various subcomponents. The other four FADs occur midway
between these dates and are also timed to coincide with the availability of
important economic information.
Decision-makers at the Bank of Canada
The major participants in the decision-making process are the Governing
Council, the Monetary Policy Review Committee (MPRC) and the four eco-
nomics departments at the Bank.
3
The Governing Council, which is responsible for making the interest rate
decision, includes the Governor, the Senior Deputy Governor and four
Deputy Governors. The MPRC, which plays an important role in the discus-
sions leading up to the decision, consists of the Governing Council plus ve
or six advisers—often supplemented by one or two special advisers—as well
as the chiefs of the four economics departments, the heads of the Montréal
and Toronto regional ofces, and other senior personnel.
The four economics departments are Canadian Economic Analysis;
International Economic Analysis; Financial Stability, which focuses largely
on the activities of Canadian and foreign nancial institutions; and Financial
Markets, which concentrates on domestic and foreign nancial markets.
These participants share their information, analysis, experience and judg-
ment with members of the Governing Council, who make the nal decision.
The Bank makes every effort to minimize the inherent uncertainty and risk
associated with policy-making by drawing on useful information and insights
that are available both inside and outside the Bank. External information
includes data series from agencies such as Statistics Canada; current
analysis and forecasts from other central banks, governments, international
nancial institutions and private sector economists; information obtained
through the Bank’s Business Outlook Survey of rms and our Senior Loan
Ofcer Survey of banks; and academic research. All of this external informa-
tion is combined with the contributions of Bank staff.
The information that ows from all of these sources is comprehensive and
diverse and contributes, at each stage of the process, to the nal decision
on monetary policy.
A Five-Stage Decision-Making Process
The monetary policy decision-making process comprises ve key stages
(Figure 2).
Stage 1. The presentation of the staff projection to the Governing Council
occurs approximately two and a half weeks before the interest rate decision.
This projection has at its centre the Bank’s latest forecasting and policy
3 The exact process varies among FADs. The process described here relates to the quarterly FADs, for
which a full projection exercise is conducted, following the release of Canada’s National Accounts.
The four FADs that occur between these projections involve fewer participants and follow a more
condensed schedule.
The Bank makes every effort
to minimize the inherent
uncertainty and risk associated
with policy-making by drawing
on useful information and
insights from both inside
and outside the Bank
4
MONETARY POLICY DECISION MAKING AT THE BANK OF CANADA
BAnk oF CAnADA REViEW • AutuMn 2013
simulation model, ToTEM II.
4
Results from this model are supplemented by
information drawn from a number of other sources and alternative models,
which examine a specic sector in greater detail (a satellite model) or view
the economy using a different paradigm or set of data.
5
ToTEM II and many of the other models used by the Canadian Economic
Analysis Department rely critically on inputs provided by the International
Economic Analysis Department and its global macroeconomic model,
GMUSE, again supplemented by many other pieces of information and
alternative models.
6
Since Canada is an open economy, international
developments, such as movements in commodity prices, growth in Asian
demand and prospects for the U.S. economy, play a major role in deter-
mining the path of the Canadian projection.
The combined output of all of these models and analyses is blended with
judgment to produce a base-case or most likely scenario, which is pre-
sented at this rst meeting with the Governing Council. A number of key
risks and alternative scenarios are also identied at this meeting. Staff then
work on these scenarios in preparation for Stage 2, the major brieng.
Stage 2. While Stage 1 involves mainly the Canadian Economic Analysis
and International Economic Analysis departments, the major brieng, which
occurs approximately one and a half weeks later, draws importantly on all
four economics departments. There are six key inputs to this meeting:
(i) an updated monitoring of economic developments and risks;
(ii) the Business Outlook Survey, compiled by the Bank’s ve regional
ofces;
(iii) a report focusing on capacity pressures and alternative indicators of
ination;
(iv) an analysis of money and credit conditions;
4 The acronym stands for Terms-of-Trade Economic Model, version II. For more information on ToTEM
and ToTEM II, see Fenton and Murchison (2006); Murchison and Rennison (2006); Dorich, Mendes and
Zhang (2011); and Dorich et al. (2013).
5 For descriptions of alternative models that the Bank uses in its analysis of current economic conditions,
see Binette and Chang (2013) and Granziera, Luu and St-Amant (2013).
6 GMUSE has been the main projection model used in the International Economics Analysis Department
since 2011. It is a macroeconomic model comprising blocs for the United States, the euro area, Japan,
China and the rest of the world. See Blagrave, Godbout and Lalonde (forthcoming) for a discussion
of GMUSE, and Barnett and Guérin (2013) for a description of other models used for monitoring key
foreign economies.
Stage 1
Staff projection
Stage 2
Major brieng
Stage 5
Release date
Stage 3
Staff recommendation
Stage 4
Governing Council decision
F S S M T W T F S S M T W T F S S M T W
Figure 2:
The ve-stage monetary policy decision-making process
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MONETARY POLICY DECISION MAKING AT THE BANK OF CANADA
BAnk oF CAnADA REViEW • AutuMn 2013
(v) the Bank’s Senior Loan Ofcer Survey; and
(vi) an overview of nancial market conditions and monetary policy expecta-
tions in Canada, the United States and the rest of the world.
Stage 3. The nal policy recommendations of staff are typically presented
on a Thursday, two days after the major brieng. A senior member of
the Canadian Economic Analysis Department or International Economic
Analysis Department summarizes and updates the outlook and risks that
have been presented in stages 1 and 2, and provides a recommendation
regarding any policy action to be taken. The overview and recommenda-
tion serve as the starting point for an extensive discussion by the entire
MPRC. Tactical and communications issues associated with various policy
options are then reviewed, based on a note prepared by the Financial
Markets Department. The meeting concludes with each member of the
MPRC, except for the six Governing Council members, providing a policy
recommendation.
Stage 4. The Governing Council decision-making process begins on
Thursday afternoon, immediately after the Stage 3 discussions, and
resumes on the following Monday. Members of the Governing Council
review the information and recommendations that they have received,
exchange views, and explore any outstanding issues and differences in
opinion. Further discussions are held on Tuesday, a decision is reached by
consensus, and a press release is drafted and approved.
Stage 5. The nal stage of the process focuses on the publication of the
press release at 10 a.m. on Wednesday, announcing the Bank’s decision
and explaining the reasons behind it. Four times a year, this message is
reinforced and expanded on with the synchronous release of the Monetary
Policy Report, which provides a more detailed account of Canadian and
global economic developments, the Bank’s projections, and the major
upside and downside risks that could affect the ination outlook.
In addition to the Monetary Policy Report, two other publications are
released four times a year, approximately one week before the interest
rate decision. The Business Outlook Survey summarizes the results of
the quarterly interviews that the Bank’s ve regional ofces conduct with
a representative sample of businesses across the country. This survey
is an important complement to the other material that the MPRC and the
Governing Council rely on and serves as a “reality check” on regional
economic developments. The second publication is the Senior Loan Ofcer
Survey, which is based on interviews conducted with major banks and
nancial institutions in Canada to determine whether lending conditions for
businesses have eased or tightened in the previous three months.
7
The nal elements of the Bank’s communication effort around the four
issues of the Monetary Policy Report are a press conference by the
Governor and the Senior Deputy Governor, as well as their appearances
before the House of Commons Standing Committee on Finance and the
Senate Standing Committee on Banking, Trade and Commerce.
The Bank places a great deal of importance on communication. It is a
critical part of our accountability to Canadians and enhances the effective-
ness of monetary policy by increasing the public’s understanding of the
economy and our actions.
7 These publications are part of the information presented at the major brieng. See the key inputs to
Stage 2.
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MONETARY POLICY DECISION MAKING AT THE BANK OF CANADA
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Five Common Misconceptions About Monetary Policy
Despite the Bank’s emphasis on communication and the considerable time
that is devoted to these activities, there is often some confusion about the
objectives that underlie the Bank’s decision-making process and about the
constraints that some observers mistakenly assume limit the Bank’s scope
for independent action. Following are ve of the most common misconcep-
tions and the Bank’s response to them.
Misconception 1: Monetary policy in Canada is essentially determined in the
United States by the Federal Reserve. As a relatively small open economy,
highly dependent on trade with its southern neighbour, Canada has no
choice but to follow the Federal Reserve’s lead.
The Bank pursues an independent monetary policy that is tailored to the
conditions prevailing in the Canadian economy in order to achieve the
2 per cent ination-control target. This independence is possible because
Canada has a separate currency and a exible exchange rate. If we had a
common currency and/or a xed exchange rate, this would not be the case.
There have been notable differences in Canadian and U.S. interest rates
over time, reecting the varying economic circumstances in each country
and differences in the appropriate monetary policy settings.
Misconception 2: Monetary policy in Canada is largely guided by exchange
rate considerations.
The level and variability of the exchange rate can have important effects on
an open economy such as Canada’s. However, the exchange rate is one
of many variables that the Bank considers when it sets monetary policy.
Most critical from the Bank’s perspective is the combined inuence of all of
these variables on the outlook for economic activity and what this implies
for meeting the 2 per cent ination-control target. The Bank does not have
a target for the exchange rate. Our only monetary policy objective is low,
stable and predictable ination.
Misconception 3: The Bank’s narrow focus on ination ignores more
important objectives such as full employment and a rising standard of living.
Experience has shown that price stability is the most important contribution
that the Bank can make to the economic welfare of Canadians. Since the
introduction of ination targeting in 1991, the low and stable ination
environment has allowed consumers and businesses to manage their
nances with greater certainty about the future purchasing power of their
savings and income. Interest rates have also been lower, in both nominal
and real terms, across a range of maturities. Low, stable and predictable
ination has helped to encourage more-stable economic growth in Canada,
as well as lower and less-variable unemployment.
Misconception 4: Focusing on price stability limits the Bank’s ability to
pursue its other major objective, nancial stability.
While at times there may appear to be tensions between these objectives,
they are inextricably linked; it is impossible to achieve one without main-
taining the other. Although other policy levers, such as bank regulation and
macroprudential tools, are typically the rst lines of defence in promoting
nancial stability, monetary policy can, in exceptional circumstances, play
acomplementary role in achieving this end. Fortunately, there is sufcient
The Bank pursues an
independent monetary
policy that is tailored to the
conditions prevailing in the
Canadian economy in order
to achieve the 2 per cent
ination-control target
Low, stable and predictable
ination has helped to
encourage more-stable
economic growth in Canada,
as well as lower and less-
variable unemployment
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MONETARY POLICY DECISION MAKING AT THE BANK OF CANADA
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exibility in the current monetary policy framework to promote nancial
stability while also meeting our ination target over the medium term. One is
not sacriced for the benet of the other.
8
Misconception 5: If the Canadian economy is operating close to capacity
(i.e.,near full employment) and ination is at, or close to, the 2 per cent
target, interest rates have to be close to their “normal” or “neutral” levels.
If there were no forces acting on the economy to push it away from this
desired state, the statement would be true. However, this is seldom the
case. Headwinds and tailwinds are often present, threatening to push eco-
nomic activity and ination higher or lower.
9
Monetary policy needs to lean
against these forces with opposing pressure from higher or lower interest
rates to stabilize the economy and keep ination on target. Monetary policy
is seldom static; it must respond as these forces ease or escalate.
Conclusion
Canada’s monetary policy framework and the process that the Bank follows
to make its decisions have evolved. The move to ination targeting in 1991
and the adoption of xed announcement dates in 2000 are certainly the
most noteworthy changes, but there have been many other renements in
the way policy is formulated and implemented. The process for decision
making is information-intensive and collaborative. It has also proven to be
very effective. Without doubt, there will be further renements as the Bank
learns from new experiences. The effort to improve the decision-making
process is ongoing.
8 This exibility would involve adjusting, as appropriate, the time horizon over which the 2 per cent target
is achieved. For more information on the Bank’s ination-control framework, see Bank of Canada
(2011a).
9 An example of a headwind would be a persistent reduction in the demand for Canadian exports. An
example of a tailwind would be a persistent nancial shock resulting in unusually narrow risk spreads.
For more information, see Bank of Canada (2011b).
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at Low Interest Rates.” Monetary Policy Report (April): 25–27.
—
. 2011a. “Renewal of the Ination-Control Target: Background
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wp-content/uploads/2011/11/background_nov11.pdf.
—
. 2011b. “Technical Box 2: Headwinds, Tailwinds and the Policy Rate.”
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Barnett, R. and P. Guérin. 2013. “Monitoring Short-Term Economic
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Binette, A. and J. Chang. 2013. “CSI: A Model for Tracking Short-Term
Growth in Canadian Real GDP.” Bank of Canada Review (Summer):
3–12.
There is sufcient exibility
in the current monetary
policy framework to promote
nancial stability while also
meeting our ination target
over the medium term
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Blagrave, P., C. Godbout and R. Lalonde. “GMUSE: The Bank of Canada
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