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Bank of Canada trying to determine why inflation has been on decline

MONTREAL - A senior official says the Bank of Canada is still trying to figure out exactly why inflation has been on the decline since 2012 and fallen below its ideal target of two per cent.

In what he calls his last speech as the central bank's senior deputy governor, Tiff Macklem says the economic puzzle appears to reflect a combination of bad and good disinflation.

He says bad disinflation stems from persistent excess supply in the economy, while good disinflation results from more competition in the retail sector.

Macklem says in theory, monetary policy should work to counter bad disinflation stemming from weak demand.

But in practice, he says it's more like an exercise in risk management, as there's still considerable uncertainty surrounding the bank's measurements and projections.

Macklem says while the fundamental drivers of growth and future inflation appear to be strengthening, inflation is expected to remain well below target for some time, which means the downside risks have grown in importance.

"We need to do our best to determine why inflation is below target, but no matter how hard we try, there will be uncertainty about our diagnosis," Macklem said in remarks prepared for delivery at Concordia University.

"Our work at the Bank of Canada is both to sharpen the analysis as much as we can and, at the same time, to take account of the risks and uncertainties as we determine the appropriate course for monetary policy to achieve our inflation target."

Some uncertainty about the bank's judgments include how long increased competition will depress inflation, he said. Increased retail competition will continue to drive prices lower for about another year.

While there are no signs of a rebalancing towards exports and business investment in Canada, the strengthening of the global economy and the recent depreciation of the loonie should foster a broadening of the composition of growth in Canada, Macklem said.

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