CHAPTER 18 The Conduct of Monetary Policy: Strategy and Tactics 487 was achieved by the end of the decade However, the inflation rate accelerated, and by the end of the 1970s, it was almost at the same level as when monetary gradualism was introduced in 1975 What went wrong? Why did the inflation rate remain high? The answers to these questions lie in a series of financial innovations that reduced the demand for M1 balances In particular, the introduction of new kinds of bank deposit accounts, and the development of cash management techniques for corporate accounts, motivated individuals and firms to move out of demand deposits part of M1 into new chequable savings deposits part of M2 This increased the growth rate of M2 and reduced the growth rate of M1 at the same time that M1 growth was being targeted, thereby rendering what seemed like tight anti-inflationary policy one that was in fact accommodating inflation By 1978, only three years after monetary targeting had begun, the Bank of Canada began to distance itself from this strategy out of concern for the nominal exchange rate, which had been depreciating In particular, when interest rates in the United States increased sharply in late 1979, the Bank of Canada had to choose between allowing Canadian rates to increase to prevent an outflow of financial capital or allowing the exchange rate to depreciate to accommodate the spread in interest rates between the two countries The Bank responded with an extremely restrictive monetary policy to resist depreciation of the Canadian dollar and the possible inflationary shock from import prices Not surprisingly, M1 growth was negative in 1981 even though the target range was for growth between 4% and 8% (see Table 18-2), and Canadian interest rates increased to unprecedented levels (see Figure 18-6) The cost was the very deep 1981 1982 recession, the most severe since the 1930s Because of the conflict with exchange rate goals, as well as the uncertainty about M1 as a reliable guide to monetary policy, monetary targeting was formally abandoned in November 1982 The Checklist Approach, 1982 1988 The period following 1982 was one of groping With the abandonment of M1 targets, the Bank of Canada switched its focus to a range of broader monetary aggregates, such as M2 and M2+, but no aggregate was found that would be suitable as a guide for conducting monetary policy As a result, the Bank adopted what came to be called the checklist approach to policy, meaning that it looked at a list of factors in order to design and implement monetary policy The Bank s checklist included the interest rate, the exchange rate, and with less weight attached to it, the money supply The goal of monetary policy was inflation containment in the short term and price stability in the long term The Bank s anti-inflation policy during the 1982 1988 period can be viewed as one where the interest rate became the operating target and the exchange rate was the intermediate target Throughout most of the period the Bank targeted interest rates, resisting depreciation of the Canadian dollar (fearing that depreciation would worsen inflation) The Bank s policy, however, had been undertaken against the backdrop of a persistent federal budget deficit that led to higher interest rates, making it difficult for the Bank to control money growth and inflation In fact inflation had begun to increase again and the Bank responded with a dramatic reversal of its ad hoc monetary strategy It announced early in 1988 that short-term issues would henceforth guide policy less and that price stability would be the Bank s long-term objective of monetary policy Inflation Targeting, 1989 Present The adoption of inflation targets in Canada followed a three-year campaign by the Bank of Canada to promote price stability as the long-term goal of monetary policy Beginning with the Hanson Lecture at the University of Alberta in January 1988,