To bring inflation back to 2 per cent over a period of 18 to 24 months, the Bank of Canada would lower its target for the overnight interest rate. Through its effect on market interest rates and the exchange rate, this action would increase the level of output in the economy, moving it back towards production potential.
Inflation would, therefore, return to the target shortly after the excess supply disappeared from the economy. An upward shift in demand would, of course, generate symmetric responses. While the theory is clear about the appropriate response to demand shocks, the magnitude and persistence of shocks—and hence the size and timing of interest rate adjustments—are always difficult to judge.