Finance Committee on April 30th, 2008

[The Chair, Conservative, Rob Merrifield]

Now we'll commence.

We want to thank our special witness today. We have the Governor of the Bank of Canada, Mark Carney. We want to thank you for coming and attending our committee meetings. This is the second time. We're here to talk about your monetary policy report of April 2008. We want to thank you very much for taking the time to be here. This is very timely. I know there's a considerable amount of interest in the report, and we're looking forward to the opportunity we have with you for the next couple of hours.

So with that, I'll yield the floor to you and allow you to start with opening comments, and then we'll proceed to questions and answers. The floor is yours, sir.

[Mark Carney, Governor, Bank of Canada]

Thank you, Mr. Chair, and thank you, committee members. It's a great pleasure for me to appear today before this committee for the first time as Governor of the Bank of Canada. I'd like to say at the outset that we at the bank appreciate the opportunity to meet with this committee, usually following, as you said, Chair, the release of our monetary policy reports.

These meetings are very important in terms of our accountability to Canadians since they allow us to keep members of Parliament and, through you, all Canadians informed of the bank's views on the economy, the objective of monetary policy, and the actions we take to achieve that objective.

These meetings have also been very valuable for the bank over the years, and Paul Jenkins and I look forward to continuing them during the course of the coming years.

Before we take your questions, I would like to very quickly give you some of the details of our monetary policy report that, as you mentioned, was released last week.

Growth in the global economy has weakened since the January Monetary Policy Report Update, reflecting the effects of a sharp slowdown in the U.S. economy and ongoing dislocations in global financial markets. Growth in the Canadian economy has also moderated. Buoyant growth in domestic demand, supported by high employment levels and improved terms of trade, has been substantially offset by a fall in net exports. Both total and core CPI inflation were running at about 1.5% at the end of the first quarter, but the underlying trend of inflation is judged to be about 2%, which is consistent with an economy that is running just above its production capacity.

The U.S. economic slowdown is now projected to be deeper and more protracted than was expected at the time of the January Update. Our latest projection reflects a more pronounced impact on consumer spending from the contraction in the U.S. housing market and from significantly tighter credit conditions.

The deterioration in economic and financial conditions in the United States will have direct consequences for the Canadian economy. First, exports are projected to decline, exerting a significant drag on growth in 2008. Second, turbulence in global financial markets will continue to affect the cost and availability of credit. Third, business and consumer sentiment in Canada are expected to soften somewhat.

Nevertheless, domestic demand is projected to remain strong, supported by firm commodity prices, high employment levels, and the effect of cumulative easing in monetary policy. We project that the Canadian economy will grow by 1.4% this year, 2.4% in 2009, and 3.3% in 2010. The emergence of excess supply in the economy should keep inflation below 2% through 2009. Both core and total inflation are projected to move up to 2% in 2010 as the economy moves back into balance. There are both upside and downside risks to the bank's new projection for inflation, and these risks now appear to be balanced.

In line with this outlook, some further monetary stimulus will likely be required to achieve the inflation target over the medium term. Given the cumulative reduction in the target for the overnight rate of 150 basis points since December, including the 50 basis point reduction announced last week, the timing of any further monetary stimulus will depend on the evolution of the global economy and domestic demand and their impact on inflation in Canada.

Mr. Chair, Paul and I would now be very pleased to answer your questions.

[The Chair, Conservative, Rob Merrifield]

Thank you very much. I have no doubt there are going to be lots of them.

And we will start with our first round of seven minutes with Mr. John McCallum. The floor is yours, for seven minutes, sir.

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

Thank you very much.

Welcome back for your first time as governor.

If I may, I'd like to talk a little bit about the international credit crunch or asset-backed commercial paper problems. First, I'd like to say I think it's good for the country that the Montreal Accord has passed and congratulate you for any role you may have played in that.

I'd also like to focus on hearings we're likely to hold in the future after the budget implementation bill passes. But since you're here, I thought I might start with you, if I may. What we'd like to focus on is what might have been done to make this crisis less severe than it was in Canada and, just as important, what should be done to reduce the likelihood of such a crisis in the future.

Since we are federal in this room--notwithstanding that I'm sure there's a lot of blame to go around--I'd like to start with federal agencies, and in particular OSFI. Some people have told us that the fact that OSFI encouraged banks to offer conditional liquidity facilities for this paper rather than unconditional may well have exacerbated the crisis and was not a good move.

I wonder if you have a view on that.

[Mark Carney]

Thank you for the question.

We look forward to the hearings you hold on this issue. And if you would like us to appear, if we can be of any service, obviously we would.

I would say that with respect to ABCP, the non-bank asset-backed commercial paper issue, multiple factors caused the problem. And I would start by underlining the responsibility of all market participants for their actions in creating the problem and being party to the problem.

I would highlight three issues specifically.

First, on disclosure, and this is an issue for the relevant securities commissions, it appears that under the current disclosure requirements, these so-called exempt securities were sold without a full disclosure of the risks that were included, including importantly--which drove the dynamic of this situation and made the Montreal Accord so difficult--the fact that derivative counterparties to the structures, and it's slightly complicated, were senior to the noteholders. And this was a very important factor that drove the negotiating dynamics and did not appear--I won't be conclusive about it--to be adequately disclosed. That's the first issue around disclosure.

The second issue does relate to the liquidity arrangements that were associated with this paper. You made a reference to the fact that there was a so-called general market disruption clause related to most liquidity lines that were there. This issue was flagged by third parties--including twice by the Bank of Canada--and it was ignored, by and large, by noteholders who held the paper and, by and large, by those who structured the paper. And that is an issue I would encourage you to look into.

In terms of OSFI and liquidity, I really think it's best addressed by OSFI. My understanding, though, of the situation--and I know you will speak directly to OSFI about this--is that the bank capital treatment related to these liquidity facilities in Canada was not different from the globally accepted standard. What was different is that a market was allowed to develop that took advantage of one treatment of that capital standard. And that market developed based on ratings, based on structuring advice, based on sales, and based on the willingness--and this goes back to responsibility--of investors to take that paper in the face of warnings to the contrary.

The third issue, which is a broader issue that I think has affected a variety of structured products, is the alignment of incentives between the various principals who structure and sell the products and the end investor. I think whether it's the non-bank asset-backed commercial paper in Canada situation or the subprime mortgage situation in the U.S., one thing that is abundantly clear from these situations is that it is risky to purchase a structured product where there is not clear alignment of the originator or the packager of the original assets and the end investor. So if there's no tail responsibility, whether legal or economic, to the structurer, as an investor one should take a pause and decide whether or not to invest.

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

Thank you.

I just have a couple of minutes. So just more generally, as the crisis has unrolled and we've seen a number of bank failures are rescued, could you give us some sense as to...? I know you can't be precise, but are we near the end or at the beginning of the end? In terms of risks, not in Canada but internationally, how much more of this is likely to happen before we're at the end of the tunnel?

[Mark Carney]

I tried to say in a speech in Toronto on March 13 that we were at the end of the beginning, because I think we collectively had a much better understanding of the causes of the crisis. One of the issues there, in terms of moving from understanding the causes to resolving them, is disclosure.

I suspect you all have, but I would encourage you to read the report of the Financial Stability Forum adopted by G7 ministers, because at the heart of that and in the annex of that is a very prescriptive, detailed disclosure requirement for financial institutions. Those requirements, and the prospect of implementing those requirements, are going to enhance disclosure. And it's already happening. We're seeing that it will indicate the need, or not, for additional capital, and that is part of what is prompting to get more capital in the system.

I know your time is short, but I have a very quick point. The basic issue here is that the unregulated or the non-bank financial sector is coming, by and large, into the regulated bank sector, and leverage levels in that sector need to go down from where they were before. So it's a combination of assets coming on and a need for capital. That's the process we're working through, which will take time, but at least we're in that process now.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move on to Monsieur Crête. The floor is yours.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Thank you, Mr. Chairman.

Good morning, gentlemen.

Mr. Carney, I wish to begin by thanking you for having accepted my suggestion of holding a training day and of gathering together the critics from each party as well as the governor of the Bank of Canada. I believe that this event has been set for May 30. This fits into the logic of the new approach that you want to implement, namely greater openness with regard to the various influences. I thank you for that.

In the summary of your April, 2008 Monetary Policy Report, you state the following:

Given the cumulative reduction of 150 basis points in the target for the overnight rate since December, the timing of any further monetary stimulus will depend on the evolution of the global economy and domestic demand, and their impact on inflation in Canada.

Today, you stated the following to us:

The deterioration in economic and financial conditions in the United States will have direct consequences for the Canadian economy.

Given the statements made yesterday by President Bush and the rise in the price of gas, could you tell us if, between your tabling of the document and today, you have already predicted that the next step will require yet another significant drop in the rate?

[Mark Carney]

I wish to begin by thanking you, sir. I found your suggestion excellent. You talked of openness and it is in this spirit that we will be meeting.

As for our comments contained in the Monetary Policy Report, it is our hope that the shelf life of this document will be longer than just one week. I believe that we have stated clearly in the document that we are now predicting that the slowdown will be deeper and more protracted — and this latter characteristic is also important — than initially expected. However, neither the data nor the recent comments of the American President have changed this opinion.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Today, there is much concern on the part of businesses and workers because the slowdown, especially in Quebec and Ontario, is very obvious, very definite. It is occurring at a rather astounding speed. In your view, is there hope that we will be able to round the bend at a speed that will prevent us from skidding out of control? It is not at all clear that what the United States are experiencing is anything different than a real and deep recession.

Do you think it is possible, over a rather lengthy period, to avoid having all of the negative impacts of the American recession cancel out the positive effect of domestic demand here in Canada?

[Mark Carney]

I will perhaps begin, and then let Mr. Jenkins take over. Domestic demand in Canada has remained robust. We do face challenges with regard to our exports. Indeed, there would be an absolute reduction in our exports. That is one aspect of the issue.

Furthermore, I would like to stress the fact that we have reacted to this situation. According to the Bank of Canada's predictions, there is now a slowdown in the United States and there is going to be one in 2009. We are reacting now.

[Paul Jenkins, Senior Deputy Governor, Bank of Canada]

I might add a few details. In our predictions for the Canadian economy, we underscore two major international factors. There is, first, the weakness of the American economy, as you mentioned, but there is also a positive force. Indeed, the demand for core products is strong. It is the influence of the price of core products on our terms of trade that is supporting this domestic demand. In the predictions that we set out in the report, we talk of the fact that there is a reduction in core products, but that the prices have remained very high. With regard to domestic demand, that is the most important support. We note in our predictions for the years 2008 to 2010 a very important contribution on the part of domestic demand.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Will the rising cost of gas, which will have consequences for consumption overall, not have a major impact on demand in Canada? We are going to have to continue buying gas, which will significantly reduce our purchasing power for everything else. Is that an important factor that we will have to pay particular attention to?

[Paul Jenkins]

Yes, in the sense that the price of gas is very high. With regard to the growth rate of the all-items CPI, there are several elements that are going down. In our report, we underscore the fact that within the CPI the growth rate in the price of services is of roughly 3%, but that the price of goods has been going down by close to 1.5%. The consumer price index therefore comprises a mix of these trends. Household spending is certainly under pressure because of the price of gas, but this is offset by other factors.

[The Chair, Conservative, Rob Merrifield]

Are you finished? Okay. Merci. We'll move on now.

Mr. Menzies, go ahead.

[Ted Menzies, Conservative, Macleod, AB]

Thank you, Mr. Chair.

Thank you to Mr. Carney and Mr. Jenkins for joining us here today.

Pursuing on from what you were talking about, Mr. Jenkins, many industries and many facets of the Canadian economy are changing and adapting. I guess we all are concerned when we see job losses in the manufacturing sector and of course, most recently, huge losses in the auto industry. Certainly we're all concerned about that. When I look at your report, you don't paint too rosy a picture, but you paint a realistic picture of what the outlook is in manufacturing and in all of these sectors.

Mr. Carney, in your recent speech entitled “Implications of Globalization for the Economy and Public Policy”, you actually referred to Roman times. I didn't hear the whole speech, so I'd be interested to see the connection, but I think your reference was that things are changing. We certainly look at losses in the auto industry as an impact on Canadians' lives, but overall, in the last two years, we have a net gain of over three-quarters of a million new jobs, and over 80% of those are full-time jobs.

So can you share with us your thoughts on how Canada is adapting and if we are capable of weathering these economic times?

[Mark Carney]

I'd be happy to read out that entire speech for you, Mr. Menzies.

[Ted Menzies, Conservative, Macleod, AB]

Maybe some other time.

[Mark Carney]

In terms of the overall employment issue, you've raised a number of important points. Certainly, first of all, there is a very difficult adjustment going on in the manufacturing sector in Canada. I think this committee is aware of it, and we are certainly aware of it at the Bank of Canada. We are watching it closely.

Canada grew manufacturing jobs in the 1990s. We were unique in the OECD, with the exception of Spain, in doing that. We are now losing manufacturing jobs. I think 16% of manufacturing jobs have gone over the course of the last five years. That's about 360,000 jobs over that period that have disappeared in manufacturing.

As you suggested, though, in the wake of that, the economy has created about 1.5 million jobs in the service sector and about another 300,000 jobs in the other goods-producing sectors, which would include construction, importantly, which is very strong. It also includes the natural resources sector and other sectors like that. So we're seeing strength in our economy, and going back to Mr. Crête's discussion, I would say that the relative importance of domestic demand in the economy is the type of force that continues to support this type of employment--service sector, construction, and obviously the natural resources because of the terms of trade, as referenced by Mr. Jenkins.

The second point I'd make, and then I'll stop and give you back your time, is on the broader forces. One of the points I tried to make in those comments was that the nature of manufacturing is changing, and people are specializing or becoming increasingly specialized within a global supply chain. It's about finding the right point in that global supply chain. That means fewer jobs in Canada but, we would hope, higher-value-added jobs, so that the overall contribution of manufacturing to our economy remains high. That requires linking into those supply chains. It requires training. It requires a global sense from our manufacturing industries, and they're working towards that. There's no question that they're working towards it. That is difficult, but overall, the employment picture is quite healthy.

My last point is that the employment picture being quite healthy--there is a circularity here--is one of the reasons we still see some strong momentum in domestic demand.

[Ted Menzies, Conservative, Macleod, AB]

Thank you.

Also in that speech you touched on interprovincial trade barriers. That's something I think all governments over the past few years have struggled with, and we've had trouble bringing the provinces onside. Alberta and British Columbia have a landmark agreement, the TILMA, the British Columbia–Alberta Trade, Investment, and Labour Mobility Agreement. I met with Jim Peterson, the former trade minister, who has been tasked with trying to bring a similar agreement between Ontario and Quebec. We see that as an impediment to growing the economy, and we have had witnesses who have also shared that with us.

Can you expand on where you were going with that in your speech?

[Mark Carney]

I am entirely in sympathy with the thrust of the question. The TILMA agreement has much to be recommended, and the recent initiative between the provinces of Quebec and Ontario to explore greater openness and flexibility along that provincial boundary is encouraging. At a time of a slowing economy, it may sound a bit odd to say this, but as a general trend, we are in a longer trend of labour scarcity in this country, which is good news for workers and good news for Canadians. It means better jobs--better, higher-value-added jobs. It also means that we need to provide maximum flexibility collectively, all governments, for our citizens to find those jobs where they are or where they choose to live and deploy their talents.

[Paul Jenkins]

Could I add one additional comment, tying in with your previous question? One of the advantages of having more flexibility, which you gain by removing these interprovincial trade barriers, is that your economy can respond to economic shocks more quickly, and therefore you can attain and sustain a higher level of employment and growth on an ongoing basis. So from the point of view of these adjustments we're going through in our economy in response to these relative price shocks, removing some of these interprovincial trade barriers, adding more flexibility to your economy, does produce significant benefits.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move to Mr. Mulcair.

The floor is yours.

[Thomas Mulcair, NDP, Outremont, QC]

Thank you, Mr. Chairman.

Welcome, Mr. Carney. Since our entrusting ourselves to you, this is our first opportunity to have an in-depth discussion. I believe that this is the first time that elected representatives are able to state such a thing. We had the opportunity to meet with you previously, and you have our full confidence in your ability to fill this important office. I must tell you that you have been truly deserving of this trust since your arrival.

I would like to deal specifically with the repercussions for consumer loans. In a rather cryptic sentence, that I will read into the record in the English version, because the translation, unfortunately, is not very good, we find the following:

Banks have shown a willingness to borrow at these higher spreads in order to secure longer-term financing, but have not yet fully passed these increased spreads on to businesses and households. Nevertheless, the absolute cost of borrowing by banks has declined...

I'm on page 19 of the English.

Let us take a look at the spread that exists between the official rate and a five-year mortgage loan, which is a concrete standard example that is easy to follow. Ten years ago, in 1998, the bank rate varied between 5.25 and 5.75%. I will use the 5.5 rate of October 1998. There was a difference of 1.25%. Thus, with the rate at 5.5%, you could get a five-year mortgage for 6.75%. That was pretty much average at the time.

Let us now go to December 2006, already some 18 months ago. The rate was then of 4.5%. The difference was of 1.95%, close to 2%. That was quite a hefty increase, but it was still within the range. A little bit later, in April 2007, we were still at 4.5% and then, all of a sudden, the difference moved to 2%, 1.99% to be exact. A 2% difference looked more like some kind of a margin for prudence, rather than for modesty. Today, there is no longer any modesty whatsoever. In September 2007, the rate was of 4.75% and, all of a sudden, there was a difference of 2.44%. In March 2008, in other words last month, the rate was set at 3.75%, but there was a difference of 3.44%. Therefore, even with a 1% drop, we are still sitting at 7.19% for a five-year mortgage.

Those are your numbers.