The Bank of Canada Review is a quarterly journal-style report on the BOC’s latest research.
The theme in the issue released Thursday is price level targeting rather than inflation targeting. For a quick primer, here is how Investopedia explains price level targeting:
Price level targeting is similar to inflation targeting in that both establish targets for a price index like the CPI. However, where inflation targeting only looks forward (i.e., a 2% inflation target per year), price level targeting actually takes past years into account when conducting open market operations. So, if the price level rose by 2% in the previous year (from a theoretical base of 100 to 102), the price level would have to drop the next year in order to bring the price level back down to the 100 target level. This could mean more forceful action needs to be taken than would be required if inflation targeting were used.
In practice, it could have important implications in a world that’s struggling with low inflation.
If a central bank introduces a 2% price level regime but misses it with only 1% inflation in the first year; it would imply that prices must close that 1% gap in Year 2 and rise another 2%. That may send a powerful signal that helps break the cycle of ultra-low inflation (or deflation).
Something like this could appear first at the BOJ where there are signs that belief in QE is wavering.
