The basics of inflation-targeting are similar in Canada and the UK – the Bank of Canada aims to keep annual consumer price inflation at the 2% mid-point of a 1-3% target range. The Canadian approach, however, differs in two important respects, which the Bank of England’s new Governor Mark Carney may wish to import to the UK.

First, while the inflation target is expressed in terms of the total consumer price index (CPI), the Bank of Canada monitors several measures of “core” inflation as an “operational guide” to policy – in particular, “CPIX”, which excludes eight of the most volatile components (fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, inter-city transportation and tobacco products) as well as the effect of changes in indirect taxes.

Previous posts (e.g. here) argued that the Bank of England effectively switched to a core inflation target in 2010, when the present Governor signalled that the MPC would ignore higher inflation caused by “temporary price level factors” – generously defined to include a weaker exchange rate – when setting policy. The Bank, however, has not formalised this shift by adopting a particular core inflation measure as an operational guide – Governor Carney may wish to do so.

A UK measure similar to Canadian CPIX is the CPI excluding energy and unprocessed food and the impact of VAT changes*. Annual inflation on this measure is estimated here to have averaged 2.4% over the past five years – see chart. The Bank of England, in other words, has failed to achieve 2% inflation even on a looser “core” interpretation. (Total inflation averaged 3.3%.) Governor Carney may well judge that policy has been excessively accommodative over this period.

A second difference is that the Canadian approach allows, in exceptional circumstances, for monetary policy to be used to support financial stability, implying temporarily deemphasising the inflation target. In a recent speech, for example, Dr Carney raised the possibility of the Bank of Canada “leaning against emerging imbalances in household debt” while allowing a longer (negative) deviation of inflation from target.

The recognition that monetary policy has a role in promoting financial stability is at odds with the Bank of England’s claimed impotence to prevent the recent credit bubble / bust. It suggests that Governor Carney will be unsympathetic to the UK division of responsibilities between the Monetary and Financial Policy Committees and will seek to coordinate their decision-making to the maximum extent.

*The calculation requires an assumption about VAT pass-through.