It’s possible to imagine a situation where a sharply weaker currency could drive a country’s inflation significantly above target, even with the continued presence of excess capacity in the economy. The greater the divergence of inflation from target, the more skeptical people might become that the divergence would be temporary. In other words, there could be a risk that inflation expectations would become de-anchored.
Managing that risk might even require a tightening of monetary policy that, in the end, would produce below-target inflation. That is not our situation in Canada. The Bank of Canada has almost 25 years of inflationtargeting history, and inflation expectations in Canada are very well anchored as a result.