Mark Carney spoke to a packed house on 11 December 2012, addressing 1,250 CFA Society Toronto members and guests at a luncheon in Toronto. As Carney got ready to take the reins of the Bank of England, he took the time to share his insights with a record number of members who listened as the outgoing Governor of the Bank of Canada discussed central banks’ use of guidance as a communication tool and answered questions about what he thinks lies ahead for the Canadian economy. In this article, we summarize some of the key messages from Carney’s speech and the discussions that followed during the Q&A session.

Carney began by pointing out the importance of guidance as a communication tool for central banks in extraordinary times, but he also stressed that it should be used only sparingly in normal times. The Bank of Canada regularly communicates to industry and the public through their eight scheduled meetings a year, which provide an explanation of interest rate decisions, and through the release of their quarterly Monetary Policy Report, which provides supplemental economic details. Transparency in central bank communications is considered extremely important to ensure effective and successful monetary policy implementation.

Carney noted that clear and open communications need to be provided on both the Bank’s policy objectives and the mechanisms and tools used to achieve these objectives. As an example of a successful case of Bank of Canada policy, Carney said it established an explicit inflation target in 1991. This target gave Canadians confidence in the bank’s attainment of the two percent inflation target over time. With confidence in asset prices, interest rates, and exchange rates, households and companies were able to make sound decisions on savings and investment. With a highly credible inflation-targeting framework established, Carney explained that the Bank could respond aggressively to economic shocks through changes in the overnight target rate over a typical six to eight quarter period without fear of dislodging the inflation expectations of the public.

“[Carney] also expressed comfort in some recent indications that the housing market is moderating…”

In cases where nominal rates are at zero, or there is a need to introduce additional economic stimulus, central banks might consider using unconventional policy tools, said Carney. Such tools include extraordinary forward guidance, quantitative easing, and credit easing. For example, in April 2009, during the “great recession,” additional economic stimulus was considered necessary, and the Bank of Canada used the unusual forward guidance approach to provide a commitment to hold the low policy rate through to Q2, 2010, conditional on the outlook for inflation. Carney also explained that the Bank of Canada had extended the $30 billion exceptional liquidity programs over the same period to ensure policy growth objectives were achieved.

In a recent issue of Financial System Review, said Carney, the Bank of Canada identified increased household borrowing in Canada as an evolving risk to the economy. Central bank guidance communications included encouraging households to reduce their debt levels and reminding them that interest rates might rise if the central bank was to withdraw monetary stimulus. He also said that the timing and degree of such a withdrawal would be weighed carefully against global and domestic development. Carney explained that in 2012 the percentage of new fixed-rate mortgages had almost doubled to 90 percent, reflecting the combination of attractively priced fixed-rate mortgages available and successful communication of the Bank of Canada message on the coming rate hikes. He also expressed comfort in some recent indications that the housing market is moderating in the wake of the CMHC rule changes.

Finally, Carney discussed the different approaches adopted by other central banks seeking to adopt the optimal path for their own local economies. For instance, in September 2012, the U.S. Federal reserve Board (the “Fed”) indicated that it would maintain a low policy rate (near zero percent) until mid-2015, contingent on inflation and substantial improvements in the labor market. In addition to using enhanced forward guidance, the Fed had also made several large-scale asset purchases.

Taking questions after his speech, Carney was pressed on a number of points, including the use of numerical targets in his interest rate policy. He said that adopting a nominal GDP target might be a more flexible approach than a nominal inflation targeting approach, especially if the policy rate was in the zero percent range. Under a nominal GDP targeting framework, the central bank would be required to make up for past misses.

Responding to questions about the strength of the financial crisis post-2008, Carney expressed confidence. Despite a challenging macro environment side, substantial progress was made on the regulatory side as additional capital of about $600 billion was raised by banks globally. Processes are also underway to move interest rate derivative trading clearance to exchanges, and there are other derivative regulations under review he said.

At the same time, Carney noted that Canadian banks have a competitive advantage over other international banks in implementing the Basel III capital rules on January 1, 2013: six years ahead of requirements. In the U.S., stress testing undertaken by the bank regulators indicated that the 19 largest banks, accountable for 90 percent of total U.S. banking assets, had met Basel III standards. The Basel III rules are currently under parliamentary review in Europe and are headed for implementation, he concluded.