Suppose that the economy is operating at its production potential and that inflation is at the 2 per cent target. A downward shift in demand would create excess supply in the economy, putting downward pressure on inflation.
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.