OTTAWA—The Canadian government and Bank of Canada agreed Monday to renew the central bank’s mandate to target 2% annual inflation, with an emphasis on giving the central bank flexibility to address economic challenges and help obtain full employment when conditions warrant.

The mandate was set to expire at the end of the month. Like elsewhere in the world, Canada is dealing with accelerated price increases—annual inflation of 4.7% as of October, or an 18-year high—that is fueling concern among Bank of Canada officials. Strong labor-market gains and elevated inflation prompted the Bank of Canada this fall to move up the timetable for its first rate increase in over three years, and end its large-scale asset-purchase program, also known as quantitative easing, introduced to help stabilize financial markets during the pandemic.