Finance Committee on April 28th, 2009

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Then the next step, if need be, would be this quantitative easing. Is the quantitative easing only when it comes to credit?

[Mark Carney]

I didn't catch the last bit.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Is it only for credit? In your opening statement you talked about quantitative easing or credit easing, and it's tough to really understand what quantitative easing would be.

[Mark Carney]

Just to be clear on the definitions, quantitative easing, first and foremost, involves the purchase of assets, and those assets can be either government bonds or private securities. Those purchases, to make it quantitative, are financed by the creation of new central bank reserve, central bank money. It's purchase of assets.

It very well could be government bonds, if we were to do it. We'd only do it if we needed to do it to achieve the inflation target to be consistent with this discussion. The judgment of the bank at that point in the future would be based on where the biggest bang for the buck for overall financial conditions would be.

So if we sat in front of this committee or businesses or all Canadians, and they said, “Well, this rate went down and that one went up, so what's the net impact?”, we'd look at having the biggest impact on overall financial conditions.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Pacetti.

Mr. Kramp, please.

[Daryl Kramp, Conservative, Prince Edward—Hastings, ON]

Thank you, Chair.

Good afternoon, gentlemen.

I'd like to ferret out just a little bit more information on the one point. Even the venerable Mr. McCallum was surprised at the long-term commitment of the low interest rate. I'm wondering where this came from within your department. What do you use for comparables? Have other nations been successful with this, or have they not? What are the potential negative aspects to the Canadian economy that we could ever potentially expect if something went wrong? What are the pitfalls of it?

[Mark Carney]

Thank you, Mr. Kramp.

In terms of the comparables, I will give you two. One, there is a small set of central banks--the Riksbank in Sweden and the Norges Bank in Norway are two examples--that provide a path every time they make a decision for their overnight interest rate, all the way out, if you will.

There are examples of central banks that do that. Their view is that to have the overall impact each time they make a decision, it is where that path as a whole goes in the market. It's, if you will, the ultimate in transparency.

Now the other relevant data point, to answer your question, is what happened earlier this decade when there was concern about potential deflationary pressures in the United States. The Federal Reserve gave verbal guidance that rates would be low for a considerable period. There was a range of verbal phrases that gave guidance to the market in terms of where rates would be, if you still had ambiguity or you had some ambiguity in terms of the exit strategy, some would suggest.

The judgment of the bank and the decision came from the governing council--the six of us, Mr. Jenkins, me, and the four deputy governors--that to provide this clarity was the best thing for markets, given that we were at the zero lower bound, given that we had gone to as low as we could go.

To answer the last bit of your question, on what the risks are, I would say the biggest issue here is that people start to confuse a conditional commitment with a guarantee. It's not a guarantee; it is conditional on the outlook for inflation. Our judgment is that keeping rates at this rate through June 2010 is consistent with achieving our inflation target. I would draw your attention to our outlook for inflation on page 24, where we have probability bands around that outlook for inflation.

So if you want to judge, if you're bullish on inflation or on the outlook, you can see what the relative probability is that we would get there sooner and that we would have to change that commitment.

[Daryl Kramp, Conservative, Prince Edward—Hastings, ON]

Thank you very much.

Do I have another minute?

[The Chair, Conservative, James Rajotte]

You have two minutes.

[Daryl Kramp, Conservative, Prince Edward—Hastings, ON]

Thank you.

What I would like to discuss, then, just for second, are toxic assets. I'm curious as to how you would define what a toxic asset is. What are the benchmarks? What are the parameters?

Obviously this isn't something we can put a universal definition to, but we have to have some means and mechanisms--if we're going to have any intervention at all from governments, whether or not they're going to take equity ownerships into something--as to what we've considered to be a toxic asset. How do you see the definition coming to fruition so that you, or we, as parliamentarians, can make a decision as to whether or not we wish to take that on as a toxic asset?

[Mark Carney]

Very quickly, the term “toxic assets”, at least in this round of financial crises, originated and was applied to a range of structured products. They included those based on subprime mortgages, but much more broadly, they were effectively related to broken markets, structured securitization markets that no longer functioned well. The term has been broadened considerably, and you sometimes see the term “legacy assets” or “troubled assets”. The broadening now includes basically non-performing assets, including non-performing loans, that are affected by the recession in the downturn.

Let me make a general point, because you asked about your role here, that there is not a toxic asset problem in Canada. We don't have these concentrations, nor is there a concentrated pool of troubled assets that reflect difficult economic circumstances. The general point is that when you get into a banking crisis—so it's relevant for the U.S., it's relevant for the U.K., it was relevant for Sweden in the 1990s—you look for concentrations of troubled assets, using the broad definition. It could be real estate lending. And then in order to relaunch the banks, there are different alternatives, but there's a decision to be taken to separate those assets, in a fair way for taxpayers, from those institutions and relaunch those institutions.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Kramp.

We'll go to Mr. McCallum again.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you.

I think you've seen an all-party consensus in favour of your one-year-plus interest rate drop. Rare.

I'd like to pursue the question of inflation. You know the old metaphor of the punch bowl, that the job of the central bank is to take the punch bowl away before the party gets going. I think in a crisis the job is to force-feed the world with this punch bowl, and then when inflation possibly rears its head, you have to quickly take it away.

I'm with you, with your view, and not with Mr. Flaherty's view. As long as we have output below potential and high unemployment, I don't believe you're going to have an inflation problem, which is what you're essentially saying. But I also think it's kind of an unprecedented and delicate operation, and quite critical in terms of timing, to take this monetary ammunition away just at the right time—not too much, not too little, not too late, not too soon. So you're kind of into uncharted territory, in a way--or at least not chartered for a long time, if ever.

My question is, how do you figure out an operation of such delicacy?

[Mark Carney]

Thank you for the question.

We really do look to apply our inflation-targeting framework. We look at the lags on monetary policy, which tend to run from four to six quarters out. We look at the scale of the difference between the potential of the economy and where the economy is operating. I think in that regard it's very important, Mr. McCallum, that we are disciplined in our judgment about the potential of the economy, because one of the mistakes one can make in these situations is to overestimate the speed limit of the economy in a severe recession.

The reality is, and it's an unfortunate reality, but in this adjustment process, capacity is lost, investment is delayed, productivity is slower than it otherwise would be, and so those inflationary pressures could come back sooner than otherwise. We've made an important revision to our potential output in this forecast, as Mr. Wallace was referencing.

I should say as well that we've made the commitment that given the relative importance of this forward-looking fan chart on inflation and the link to the conditional commitment, we will revisit that in our October monetary policy report as well.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. McCallum.

Mr. Dechert.

[Bob Dechert, Conservative, Mississauga—Erindale, ON]

Thank you, Mr. Chair. Thank you, Mr. Carney and Mr. Jenkins.

Mr. Carney, in your report earlier today you mentioned that as the Canadian economy begins to improve, hopefully later this year and early next year, we should see the end of the stock adjustments in Canadian and U.S. residential housing. I think we've seen some good news in the U.S. recently in that regard. I spent some time yesterday with representatives of the Mississauga Real Estate Board, which is in the city I represent. They tell me that real estate prices are stabilizing in Mississauga and sales are improving.

Are you seeing anything similar across Canada? Maybe you could comment on the U.S. as well.

[Mark Carney]

I'll start briefly. We are expecting a relatively significant price adjustment in houses in Canada this year, in the high single-digit order of magnitude. It's under way, and it's concentrated largely in western Canada. A lot of progress has been made there. What we've seen is a slowdown in starts in Canada such that they're running below.... Currently the demographic rate of household formation would be around $170,000 to $175,000. So you're getting that stock adjustment happening in Canada.

What you've seen in the United States, as everyone is painfully aware, is that housing starts, after running above trend, have dropped to a level significantly below trend, below 600,000 units. When you think about that gap that started to open up, even with the overhang of foreclosures and the difficult financing conditions.... Now that U.S. authorities are starting to make real progress on lowering mortgage rates there--I referenced 3% earlier, and they're trying to get things down below 5%--they are having some success. In our opinion, that's going to start to impact increasingly house purchase activity in the United States as the year goes on and into 2010, and it will provide a measure of stabilization there.

I would make a basic point about the United States that is sometimes easy to ignore. The first thing is for housing starts in the U.S. to stop falling. It's been subtracting a percentage point from growth for some time in the United States. We're now getting down to extraordinarily low levels, and we'll start to see that adjustment. We also expect to see some adjustment in the auto sector.

If I could draw committee members' attention to page 21 of the report, in chart 17 there the blue line shows U.S. GDP outlook; once it gets into the dots, it's our forecast. The green line, which is trade-weighted activity in the U.S., is important. For the sectors of the U.S. economy that are important for Canada, you see the big gap that opens up, 2007 into 2008, and then you see our view as you start to get some of these stock adjustments. The U.S. growth doesn't get up too much, but U.S. activity in housing, autos, while not skyrocketing, starts to come back towards equilibrium and outside impact on Canada. That's one of the reasons we see 2.5% growth in Canada next year as opposed to a lower level.

[Bob Dechert, Conservative, Mississauga—Erindale, ON]

I have another question on forecasting. Obviously, we've seen the forecast change dramatically month to month, even week to week. Would you suggest that the government change its fiscal and monetary policy with those forecasts as they change week to week or month to month, or would you suggest they stick with the plan, implement the plan, and then adjust it at an appropriate time down the road?

[Mark Carney]

I'll speak for us. When the outlook changes, we can change policy. We do that in a transparent way. Since we last met in January, as it became apparent the situation had deteriorated, we adjusted policy in March. Fiscal policy is not as nimble as monetary policy is, so the timeline of adjustment of forecasts is necessarily different.

As the Bank of Canada, we do not look to adjust our forecast on a weekly basis in real-time updating. But the senior deputy governor and I can assure the committee that we will adjust policy if the outlook has changed, consistent with achieving our inflation target.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Dechert.

We'll go to Mr. Mulcair.

[Thomas Mulcair, NDP, Outremont, QC]

We're going to continue on the theme addressed in your last sentence because that's the subject I wanted to raise following the conversation we had earlier, Mr. Chairman: adjusting policy.

You control a lot of policy. And you've been very generous with us today, talking about everything from the appropriateness of government intervention in the automobile field to your own experience. As we come to grips with some of the policy changes that we have to come up with over the next couple of years to avoid the problems of the past, what role do you see for the Bank of Canada?

I'll share with you an observation. It seems, as we've gone through this, that always there's somebody who was seeing the right thing. Whether it was the people who made their presentations on what Madoff was up to in New York...and there were people who saw right through Madoff, but there was nobody to talk to.

We had this absolutely Kafkaesque conversation with the people from the Dominion Bond Rating Service about how they were able to give the evaluations they did of non-bank ABCPs. It was an extraordinary experience. So there are people out there who are seeing things.

Now, you're very crucial, for us, in this whole process, because you have this point of view that allows you to see much further than most people, and much deeper. What role is the Bank of Canada going to play as we come to grips with this?

I gave a couple of examples before of what we're going to be looking at over the next couple of weeks, everything from credit cards to pensions. The subject here, of course, is the liquidity or the availability of credit. How do we make sure, with the structures we put in place, that we don't go the other way and wind up needlessly hamstringing things?

I will allow myself an opinion: that in the wake of Enron and a couple of other debacles, some of the accounting rules that were invented in the United States as sort of the wall of protection actually wound up being far worse than the malady they were put in place to remedy.

How do we avoid some of those traps? What are some of the courses that we should be on? And how can the Bank of Canada help us in that?

[Mark Carney]

It's an extremely important question.

I'll give you, in a moment, a couple of examples of issues to consider, but let me start by saying, in response to an earlier question, that we can analyze and do research, and then it's our responsibility to make public that analysis in a constructive way so that those who are responsible for either regulating or for legislating these issues can make informed judgments.

In that regard, I think it's our responsibility, through our financial stability report, through speeches, and through other mechanisms and appearances, to raise with you the issues that, in our judgment, rise to a macro level; they'll have an impact on the economy.

What are some of those issues right now? One of them is the procyclicality of capital standards. We saw it on the way up. We're seeing some of the issues on the way down, now, in that institutions have capital buffers that they can't necessarily use. In other words, they can't necessarily expand lending to the extent to which they might otherwise, because the floor is not the minimum; it's a higher level.

There are a variety of aspects that are technical--but important in terms of treatment of markets and measurement of risk in markets--that add to that procyclicality. Firms will hold more capital in a recession, or strive to hold more capital in a recession, than they might necessarily have to do, which will make the recession worse. That's one example.

The second thing that's extremely important, and you referenced it obliquely, is the securitization market. It is extremely important globally that securitization gets relaunched properly. Given the challenges with the credibility of public ratings--the agencies are trying to address it, but there are still challenges--careful thought needs to be given to potential credit enhancements or other mechanisms, including transparency, to relaunch securitization as a matter of urgency; less so in Canada, more so globally, but there's no reason why Canada shouldn't lead on an issue such as this, which would be net helpful for our system.

The third issue, which we're looking at in great detail, is core funding markets, repo markets. As one example, how do you ensure...? One part of it is what's our role as a liquidity provider in those markets? But there are also regulatory tax and other accounting issues around it. You have to make sure that those markets stay open, because that's how you avoid a crash on that.

On pension issues, accounting, Mr. Jenkins can talk at length and in a very informed manner. There are clear issues.

The last thing, and I'll end with this, is that with regard to our role, as I said, it's our job to do some analysis and highlight what we see as the most important issues. We're happy to share that analysis. We'd be more than pleased to. It's also our job to work effectively with the other agencies, both federal and provincial, to ensure that changes are taken.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Mulcair.

I'll go to Mr. McKay.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Chair.

At this G-20 meeting there was a commitment to increase regulation and oversight over financial institutions, instruments and markets, including the hedge funds, and to focus regulators on macro-prudential risk. I think it's generally agreed that the biggest hole in our financial architecture is the absence of a securities regulator, and to the government's credit, they've actually moved some distance on that issue.

If in fact no securities regulator gets produced, does this macro-prudential role effectively become a back-door way of achieving some control over these hedge funds and financial institutions, instruments, markets, and things of that nature?