Tighter trade poses inflation control challenge: Bank of Canada

By Tom James BELLINGHAM, Wash. (Reuters) - Central banks may find it more challenging to maintain inflation targets as the world economy becomes more integrated with increased international trade, the head of the Bank of Canada said on Monday. Policymakers need to acknowledge the risks from these changes and consider how to blunt their potential impact on monetary policy decisions, Governor Stephen Poloz said in prepared remarks for a lecture at Western Washington University in Bellingham, Washington, on Monday night. Increased integration can make economies less sensitive to changes in exchange rates and make domestic inflation more dependent on international developments, Poloz said, citing model simulations by the central bank. "Models that do not recognize rising integration are likely to predict that monetary policy actions will be more effective at stabilizing the economy and controlling inflation than they will prove to be in practice," Poloz said. He did not comment on Canadian monetary policy in the speech. The Bank of Canada aims to keep inflation at 2.0 percent. The annual inflation rate in August sank to 1.1 percent, a 10-month low. Poloz said the evidence of increased international integration is "sufficiently compelling" for central bankers to take seriously as it may affect the models they use to formulate policy. A Bank of Canada simulation found that more aggressive interest rate cuts were needed to cope with a shock in a scenario that assumed a high level of cross-border integration. This is in line with the bank's hypothesis that "a highly integrated global economy will make it more challenging for central banks to stabilize economic growth while pursuing inflation targets," Poloz said. Policy-makers could consider using complementary policy measures to offset the impact, or allow for greater flexibility in a central bank's inflation objective, he said. (Reporting by Leah Schnurr and David Ljunggren; Editing by Richard Chang)