Finance Committee on April 27th, 2010

[The Chair, Conservative, James Rajotte]

Order. Thank you.

I call to order the thirteenth meeting of the Standing Committee on Finance.

We have a very special guest with us here this afternoon, colleagues. We have with us the Governor of the Bank of Canada, Mr. Mark Carney. Pursuant to Standing Order 108(2), he's here to discuss a study on the report of the Bank of Canada on monetary policy. As you all know, he appears twice a year before the finance committee, and we look forward to his presentations and a fulsome discussion of some very pertinent issues.

Governor, Mr. Carney, welcome to the committee. Thank you so much for being with us here today. We look forward to your opening statement, and we'll have questions from members after your remarks.

Please begin at any time.

[Mark Carney, Governor, Bank of Canada]

Thank you very much, Mr. Chair and members of this committee. I'm very pleased to appear before you today to discuss the bank's views on the economy and our monetary policy stance.

Before I take your questions, I would like to give you a few of the highlights from our latest monetary policy report, which was released last Thursday.

Global economic growth has been somewhat stronger than projected, with momentum in emerging-market economies increasing noticeably and moderate recovery under way in most advanced economies. It is now projected by the Bank of Canada that global growth should average slightly above 4% a year through 2012.

In Canada, the economic recovery is proceeding somewhat more rapidly than the Bank of Canada expected in January. It is supported by continued fiscal and monetary stimulus, improved financial conditions, the rebound in global economic growth, more favourable terms of trade, and increased business and household confidence.

This year should mark the turning point when the private sector takes over from the public sector as the primary source of growth. GDP is now projected to grow by 3.7% in 2010 before slowing gradually to 3.1% in 2011 and 1.9% in 2012.

This profile of growth reflects stronger near-term global growth, very strong housing activity in Canada, and the bank's assessment that the policy stimulus resulted in more expenditures being brought forward in late 2009 and early 2010 than expected.

At the same time, the persistent strength of the Canadian dollar, Canada's poor relative productivity performance, and the low absolute level of U.S. demand will continue to act as significant drags on economic activity in Canada.

The bank estimates that GDP in the first quarter of 2010 was about 1% below its peak in the third quarter of 2008, and some 2% below its potential. The economy is expected to return to full capacity in the second quarter of 2011, one quarter earlier than we had projected in January.

The outlook for inflation reflects the combined influences of stronger domestic demand, slowing wage growth, and overall excess supply.

Core inflation, which had been somewhat firmer than projected in January, is expected to ease slightly in the second quarter of 2010 as the effect of temporary factors dissipates, and to remain near 2% throughout the rest of the projection period. Total CPI inflation is expected to be slightly higher than 2% over the coming year before returning to the target in the second half of 2011.

Despite the firming of the global and Canadian recoveries, there are considerable risks around the bank's outlook. There are two main upside risks to inflation. It is possible that the momentum in household expenditures and residential investment could be greater than currently expected. Internationally, a faster-than-expected global recovery could stimulate external demand for Canadian exports and improve the terms of trade.

On the downside, the combination of the persistent strength of the Canadian dollar and Canada's poor relative productivity performance could exert a larger-than-expected drag on growth and put additional downward pressure on inflation.

A second downside risk is that the global economic recovery could be more protracted than currently projected. In this regard, there is a risk that sovereign credit concerns could intensify, leading to higher borrowing costs and a more rapid tightening of fiscal policy in some countries. Either of those factors would restrain global private demand relative to the bank's base-case projection.

Over the medium term, global macroeconomic imbalances continue to pose significant risks to the outlook. While these imbalances narrowed during the recession, sustained improvement over the medium term will require fiscal consolidation in advanced countries, together with stronger domestic demand growth and real exchange rate adjustments in countries with large current account surpluses. In the absence of these measures, the cost to the global economy could be considerable.

The G20 framework is designed to help the global economy move in the right direction. This past weekend in Washington, the G20 reaffirmed its commitment to this important initiative.

In Canada, in response to the sharp, synchronous global recession, the bank lowered its target rate rapidly over the course of 2008 and early 2009 to its lowest possible level. In addition, in April 2009, the bank committed to hold it at that level, conditional on the outlook for inflation. This unconventional policy provided considerable additional stimulus during a period of very weak economic conditions and major downside risks to the global and Canadian economies.

With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus. That is why, on Tuesday, April 20, the bank removed its conditional commitment. This, in and of itself, represents a tightening of monetary policy.

Going forward, nothing is preordained. The extent and timing of any additional withdrawal of monetary stimulus will depend on the outlook for economic activity and inflation and will be consistent with achieving the 2% inflation target.

With that, I would be very pleased to take members' questions.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Carney, for your presentation.

We'll start members' questions with Mr. McCallum, for seven minutes.

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

Thank you, Mr. Chair.

Thank you for being with us, Governor.

I won't characterize your forecast as optimistic, which I did once, but I think I would still say that at 3.7% for the current year it's certainly higher than the consensus among private sector economists and others--and of course, it might be right.

But I want to raise the subject of debt. In your report, you say it's possible that the momentum in household expenditures could be greater than currently expected. I might have thought the contrary, because a lot of people have talked about the unprecedentedly high household debt—145%, according to one authority.

OSFI has said, and I quote, “The ability of households to service their debt obligations in the context of continued growth in credit and an environment of rising interest rates is an emerging source of risk for the medium term”.

Royal Bank, Standard and Poor's, the Certified General Accountants Association--various groups--have all spoken about this issue of rising debt. Rather than thinking that consumer spending might rise more quickly than predicted, I would have thought, especially if we do have rising interest rates, that the debt issue might be a negative factor that would slow down domestic expenditures.

[Mark Carney]

Thank you.

You left one institution out of that list of people who have been warning about the levels of household debt, and that's the Bank of Canada. We began warning about this issue in the fall of last year--

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

Right.

[Mark Carney]

--very clearly supported by quite detailed simulations. I would say that we share the concern that there are cohorts of Canadians, or groups of Canadians, who run the risk of being overextended in their personal finances.

We've used every opportunity, and I'll use this one as well, to encourage people when they consider taking on additional debt to look at that obligation over the fullness of time, or in other words, over the long term, and to think about it in more normal circumstances. We still are in quite extraordinary circumstances with respect to borrowing.

That brings me to your question, which is a very welcome and important one. To be absolutely clear, a large portion of this debt that was recently run up--not all of it, but a large portion of it--has been related to the housing market. It was not purely for housing purchases, but was related to the housing markets in two ways: first, conventional mortgages, and second, personal lines of credit that have been secured against houses, the so-called home equity loans. In fact, the bulk of private consumer debt has been home equity debt in recent years.

We see a marked weakening in housing activity over the course of our projection, starting from the second quarter of this year, and over the balance of the year. In fact, you will note in the detailed breakdown on page 20 of the report where we consider GDP growth by component that housing activity will actually subtract from growth in 2011. That's not the same as talking about specific prices, but in terms of the level of this activity, we see it coming down, and we do expect to see a moderation in debt.

That said, credit growth in this country has continued to be quite strong. In those situations, there is a risk that momentum maintains itself for longer than expected. We're expecting to see a coming off in the rate of credit growth. If it does not and persists for longer, then there is a risk of upside momentum. Now, there is a variety of factors--I won't use up all of your time, but I'm sure we will get into it--in regard to why we expect to see this deceleration.

One final point is that something that does characterize our forecast for this year is the front-loaded nature of the recovery, with a much faster first quarter, second quarter, and then a gradual slowing.

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

Thank you.

I'd like to change the subject completely and ask you what you see as the biggest challenge or risk globally over the medium term. Before you answer, I'd like to give you one candidate and see if you might agree with it.

One concern I have--and that I think many people have--is that the United States deficit is very big, at well over 10% of GDP. That in itself might not be a huge problem, except that I think a lot of people wonder if the United States political process—the Senate, the Congress—is capable of dealing with this kind of thing; we look at their social security problems over decades. So as Canada is so close to the United States, I think this is a concern not only for them but also for me.

Do you see the U.S. President and Congress dealing effectively with this over the coming years?

[Mark Carney]

Well, I think the question was on what we see as the largest risk over the medium term.

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

Globally, yes.

[Mark Carney]

I would generalize it, because we have been clear.... We generalize in global imbalances, but I want to talk specifically about fiscal: very much the risk is getting the balance right on fiscal policy. That means both: accelerating the fiscal adjustment too quickly or delaying it too long, in a number of major economies, the United States perhaps being the most prominent. But this is a common issue in a number of major economies: the need to get the balance right.

Something I did highlight— I won't go into detail about it, but I'll just put the reference in--in a speech a few weeks ago here in Ottawa is that we referenced this issue of the markets and the political process actually accelerating adjustment on the fiscal side too quickly, and that driving deficient demand on a global level with knock-on effects.

With respect to the United States, the fiscal challenge in the United States is considerable, and we would support calls for a sustainable fiscal plan to be outlined and implemented.

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

Thank you.

[The Chair, Conservative, James Rajotte]

You have 30 seconds left.

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

I don't think 30 seconds will do much for me.

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. McCallum

Monsieur Paillé, s'il vous plaît.

[Daniel Paillé, Bloc, Hochelaga, QC]

Thank you, Mr. Chairman. Welcome, Mr. Carney.

It is obvious, and you have indicated so, that your simple presence here and the answers that you provide us with could have a tightening or a non-tightening effect on monetary policy. We are well aware of this.

The entire monetary policy of Canada, of your bank, is based upon a target inflation rate of 2%. For a very long time now — it was also the case for your predecessor —, it has been a religion to want to control at all cost this 2% target with a lower range. The problem is that, in the private sector, one could already be fearful of the fact that stubbornly relying on a rate of inflation might, for example, bring about a very high exchange rate, very rapid fluctuations of the exchange rate and dollar parity.

You say that Canada's productivity is rather weak, that use is not being made of Canada's full capacity and that American demand is low. Is there not a danger of a too rapid tightening? Furthermore, Mr. McCallum likes to talk of his Royal Bank. This bank increased mortgage rates rather quickly. A form of escalation took place and it seems that things are moving more quickly than you had hoped.

Obviously, one can never correct what one has said, but you indicated, last week, that at the end of the second quarter, the rate would rise. Is there not a danger of acting too quickly in tightening monetary policy? Obviously, I am thinking of Quebec, of the SMEs and the manufacturers of my province.

[Mark Carney]

Mr. Paillé, there is no risk of the Bank of Canada making changes too quickly or too slowly. Our objective is very clear, as you have just stated. It is a rate of inflation measured by an overall CPI of 2%. This is not a religion, but a mandate from the people of Canada, represented by the government of Canada. An agreement between the Bank of Canada and the government of Canada is in place until the end of 2011. The Bank of Canada and the government will then have the opportunity to make changes, if they so wish. It is a matter of choice and not of religion.

In our opinion and in that of the government of Canada, the best contribution of the monetary policy to the welfare of Canadians is an inflation rate that is low, stable and predictable. Inflation has a painful impact on poor and disadvantaged Canadians. You listed several factors that impact upon the level of economic activity in Canada and, therefore, on Canada's inflation prospects.

At the Bank of Canada, we are able to react to these various factors. In my comments, I mentioned that nothing is a done deal. Global activity could change several factors, including the value of our currency, that could impact upon the inflation prospects in Canada. If such is the case, the Bank will react.

[Daniel Paillé, Bloc, Hochelaga, QC]

I am happy that you have provided this clarification. The terms “religion“ and “mandate“ do not mean the same thing. Mandates can change. Some people change religion. But that is another matter.

In the early 1990s and in the first years of the following century, the tightening that occurred was, in the opinion of some, premature. Things went up and then fell back. The exact same thing was done in the early 2000s with the federal funds. I am leery of ten-year timeframes. We are early in the year 2010, and I would not like our successors or myself to be able to say, ten years down the road, that we went too fast in 2010-11. That is one of my fears.

[Mark Carney]

I assure you that the monetary policy will suit Canadian circumstances.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Mr. Wallace now, please.

[Mike Wallace, Conservative, Burlington, ON]

Thank you, Mr. Chair.

Thank you, Governor Carney, for coming today.

I have a number of questions so I'm going to try to be fairly quick about it.

In your opening statement, you talked about the poor relative productivity of our economy. Just for your information, there's a bill in front of the House that I'm completely opposed to: through the tax system, it would pay individuals, as graduates, to go back to their homes whether they have jobs or not. I think it goes completely against the mobility of labour.

That's my question to you. In terms of productivity, does mobility of labour play a role in the productivity of the Canadian economy?

[Mark Carney]

Thank you for the question, Mr. Wallace.

Yes, flexibility of labour markets is an important aspect of productivity. Flexibility in product markets and openness in trade markets are all factors that influence the productivity growth. Canada does have relatively flexible labour markets. It has been to our advantage. Over the course of the decade in the run-up to the recession, we've seen quite large shifts of labour into very productive activities across our country.

[Mike Wallace, Conservative, Burlington, ON]

The rest of my questions are on the monetary policy report, which I read every time you send it out and which I appreciate.

I just want to confirm this. You indicated in the report, if I'm reading it correctly, that the government stimulus package, which has been put out by this government over the last year and a half, has made a difference in restarting the economy, in our coming out of recession, and in providing economic growth. Is that what this report tells me?

[Mark Carney]

It's not the theme of the report, Mr. Wallace, but certainly fiscal policy has been important, and it particularly is important in 2010. The contribution of government, federal and provincial, is an important contributor to growth in 2010. We would say that our expectations on fiscal policy thus far have been met; in other words, the contributions have been consistent.

I would draw members' attention to page 13, where there's a somewhat busy chart, but an instructive one, which shows the levels of activity in the recession. In effect, relative to where their levels were going into the recession, you see a very sharp fall-off, for example, in business investment, and in exports, less of a contribution. Government expenditure and personal expenditures are the only activities that rise following the start of the recession.

[Mike Wallace, Conservative, Burlington, ON]

You would also.... I'm not going to ask you to agree or not agree, but maybe to comment. The government has done its share--some people think more or less than it should have--in terms of stimulus, but at the end of the day, we need the private sector to come to the table to make sure that this economic recovery is sustainable. Would you agree with that comment?