Finance Committee on April 30th, 2008

[Mark Carney]

I agree.

[Thomas Mulcair, NDP, Outremont, QC]

We trust you. You are using the levers at your disposal to control a very difficult situation, but what can we do to get the banks to bend in this area?

[Mark Carney]

Mr. Mulcair, you have focussed on a very important question. Bank costs have increased, but there remains a spread for most banking products, with the exception of mortgages. My numbers are somewhat different, but you are absolutely right.

It is somewhat difficult to explain, but there a few factors at play. First of all, securitized mortgage markets bring about worldwide problems. These markets are not always rational because the majority of Canadian bonds, indeed more than 85% of them, are guaranteed by the Government of Canada. There is nevertheless an increase in the spread. That is the first reason.

The second reason is that there now exists an excess supply of mortgages on large banks' balance sheets. Why? It is possible that the cause of that might be the size of CMHC's bonds programs. That is an important issue and I wish....

[Thomas Mulcair, NDP, Outremont, QC]

All of this is very good, but allow me, Mr. Chairman, to ask Mr. Carney to share his numbers with us. He stated that there was a slight difference. I am asking for nothing more, because this is information. It is good, but perhaps the witness could share this with the members of the Committee.

[Mark Carney]

Absolutely.

[Thomas Mulcair, NDP, Outremont, QC]

Recently, under one of the most delicious headlines that one could imagine, the Globe and Mail, under one subtitle, printed the following: “Deep rate cut tests banks' patience“.

“Deep rate cut tests banks' patience”.

Not yours, but that of all of the banks. This attests to the arrogance of the banks, that are registering fabulous profits, in the tens of billions of dollars, and to which the Conservative government granted cuts last fall. The banks are beginning to show a certain impatience. We are counting on you to use the levers at the disposal of the State in the market.

What might we do to reduce the mortgage spread, the difference between the official rate and the five-year rate?

[Mark Carney]

First of all, there could be structural aspects within the market, and that is a challenge for the Bank of Canada.

[Thomas Mulcair, NDP, Outremont, QC]

It is also a challenge for us as elected representatives.

[Mark Carney]

Exactly.

Secondly, we understand this... I will continue in English.

[Thomas Mulcair, NDP, Outremont, QC]

Go ahead.

[Mark Carney]

We understand this issue of the spreads going up, and in how we calibrate monetary policy we are taking it into account. It's one of many factors. We see the costs of the banks going up, and it's illustrated, as you say, on page 19 of the report in terms of the spreads going up for the banks.

But the absolute costs—and this is the important point—for the banks are going down. With the exception of five-year fixed mortgages—and you're absolutely right to flag it—the absolute costs of borrowing, even in the corporate sector and certainly for any borrowings off prime rate by individual Canadians, are going down as well. To the extent to which they do, we have to calibrate and take this into account.

We have left in the report that there will be some additional pass-through of the bank's increased costs, because their actual costs are going up.

[The Chair, Conservative, Rob Merrifield]

Thank you very much, Mr. Mulcair.

Mr. McKay, we're into the second round, of five minutes.

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

Thank you, Governor.

You are asking for a fairly significant change—what appears to be a fairly significant increase in powers—under part 10 of this bill, and I'd like some clarification from you as to some differences in drafting in it.

Proposed paragraph 18(g) in subclause 146(1) of Bill C-50 says you need this “for the purposes of...promoting the stability of the Canadian financial system”. Then further on, in clause 147, proposed section 19 says “unusual stress on a financial market or the financial system”. Is there a difference between a “financial market” and the “financial system”?

Why is the modifier “Canadian” in front of the initial phrase, “Canadian financial system”, and not in the other? This would lead one to conclude that it's not limited to Canadian, that it may well be strains on the international market or international system. I wonder whether you could enlighten the committee as to whether this is a distinction without a difference or is actually of some significance.

The second question, which follows from that, is this. You've put about $10 billion into the system in increased liquidity in the last few months. What is it that this increase in powers enables you to do that you haven't been able to do thus far?

[Mark Carney]

I heard three questions in there, and I'll try to answer them quickly.

In terms of the financial market or financial system, the distinction is that a financial system would include financial markets but would also include, importantly, the clearance and payments system and financial institutions, market participants, the system as a whole.

I'm going to defer on the Canadian modifier for a moment. I'm actually not familiar enough with that aspect of the drafting, but the important question you are asking is why we are asking for this and what is a change. I would say a couple of things.

This is practical. What we think we're asking for is a practical change. When the Bank of Canada Act was originally drafted, there was a prescribed list of securities against which we could undertake these open market operations, to use the generic term. The relevance of a number of those securities to the financial markets has decreased over time because of financial innovation, and so, for example, we cannot buy, for the purposes of resale, money market securities longer than 180 days. We cannot buy corporate bonds. There is a host. We cannot buy term asset-backed securities. We cannot buy municipal bonds, or we cannot buy corporate commercial paper. These are big chunks of the financial market, and the issues we are facing right now are issues of provision of liquidity to core bits of the market.

What we're looking for—we have tremendous flexibility in the overnight market in terms of what we can do, and under the current paragraph 18(g.1) we have tremendous flexibility, unlimited flexibility, if we declare “severe and unusual stress” as exists in the existing legislation. What we don't have is the full modern, if you will, flexibility in the intermediate period, which is the situation we're in right now in terms of purchase and resale agreements. We can do it on securities lending, but there are different types. It gets very technical very quickly, and I only have seven minutes.

What we are asking for is one of the first steps that our international peers did following the start of this crisis. They were able to expand the list of securities they went against.

The last point, for absolute clarity, is that we have not pumped $10 billion into the market. It's very important to be clear that we are running term purchase and resale facilities. They mature, and when they mature we have to take a decision about whether to roll them, so on the $4 billion in $2 billion tranches, you see an announcement that says, okay, we're doing another $2 billion. It is rolling the maturing amount that was out there for 28 days, and that's because the situation still remains somewhat strained.

I'll give you time.

[The Chair, Conservative, Rob Merrifield]

Thank you very much. You may have another opportunity, because we have the governor here for a considerable amount of time.

Monsieur Laforest, the floor is yours.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Thank you, Mr. Chairman.

Good morning, gentlemen.

My question is one of understanding. The Bank of Canada makes short term predictions, adjustments and monetary policies in accordance with its reading of all of the sectors of the economy. I imagine that you also do this for the medium term and perhaps for the longer term as well.

To what extent do you scrutinize the orientation of the economy overall?

[Mark Carney]

We scrutinize it for the medium term and for the longer term. I might begin by mentioning a few points.

For 15 years now, Canada's average annual growth has been of approximately 3.3% in real terms. We are facing a demographic challenge. I believe that the Committee has studied this issue. During this period, Canadian growth has been of 3.3%. Two thirds of this growth were attributable to the increase in job opportunities. The last third was attributable to the rise in productivity. Because of the demographic challenge, we must do the reverse, in other words increase productivity by 2.2 to 3.3% per year. It is quite the challenge.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Perhaps my question was not very well put. When you make medium or long term predictions, you take into account the state of the economy. I imagine that you also consider the major trends. I am referring here to a very precise element, the environmental trend. More and more, citizens are worried about the future of the planet. We are seeing an increase in greenhouse gas emissions, and this is a concern for people. There is also a will to establish carbon exchanges.

When you make economic predictions and adjust your monetary policy, do you take into account these situations for the medium and long term?

[Paul Jenkins]

In a sense, yes. As the governor mentioned, the productivity growth rate and the potential growth rate for the Canadian economy are very important elements with regard to the implementation of the monetary policy. The medium and long term trends impact upon the potential growth rate. This may be because of investments in the environment or other types of investment. This has a direct impact on the implementation of the monetary policy. However, there are timeframes for the enforcement of the monetary policy. If we decide to change the interest rate, the impact upon the economy will be felt after 12 months or two years. That is the most important timeframe for the Bank of Canada. Long term trends impact upon the various factors over this period.

[The Chair, Conservative, Rob Merrifield]

Your time will be gone, so we'll now move on to Mr. Del Mastro.

You have five minutes.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you, Mr. Chair.

Thank you, Governor Carney, for appearing here today.

When the finance minister was here I had the opportunity to ask him about his recent meetings with our international partners. I asked him about Canada's position of continuing to run budgetary surpluses and paying down debt. He pointed out, as we know, that we are the only member of the G7 that is currently doing that. I know the position of the Bank of Canada is also very strong; you're reporting total and core inflation at 1.5%.

Can you contrast that to what we're seeing in other economies, like the U.S., and emphasize why that demonstrates the strong position the Bank of Canada is in right now?

[Mark Carney]

I'll make a couple of comments on that. Thanks for the question.

First, you are correct, the headline inflation in Canada is 1.5% on total and slightly less on core inflation. In the report--I won't use up all your time going through the details--we have illustrated some adjustments that would suggest that the trend of inflation is closer to 2% right now, because there have been some one-off effects with the GST cut and some things that are happening in the price of automobiles. That is actually our target.

I would stress that--this is my second point--our target, as mandated, is 2% total consumer price inflation. We care as much about inflation being below the target as above the target. That's part of the reason we're reacting when we see some of the softness.

The third point I'd make, though, to answer your international comparison question, is that a number of our peers internationally are seeing much stronger impacts from food price inflation and from commodity inflation, and that is influencing, obviously, their conduct of monetary policy.

I'll leave it at that.

[Dean Del Mastro, Conservative, Peterborough, ON]

Okay.

You're projecting for the Canadian economy 1.4% growth this year, 2.4% growth in 2009, and 3.3% in 2010. How do these compare with projections that the feds might have for the U.S. economy?

[Mark Carney]

I can give you what we are projecting--this is probably a little fairer, actually--for the United States, which is 1% in 2008, 1.7% in 2009, and then back to 3.4% in 2010, and with a very different composition. The other point I would make is that whereas in Canada, as we discussed earlier, there's real strength in domestic demand and a drag from the external sector or from the trade sector, in the U.S. there is a material contribution from exports given the past depreciation of the U.S. dollar. There is a fair degree of softness in domestic demand in the United States that can be expected to continue.

[Dean Del Mastro, Conservative, Peterborough, ON]

Just to highlight what you said, there is a saying--I'm sure you're familiar with it, and I certainly heard it when I was at university studying finance and so forth--that when the U.S. gets a cold, Canada or the Canadian economy catches pneumonia. What we're seeing now is that the U.S. economy may well have caught a cold, and it seems that the Canadian economy has a sniffle.

We're going to continue to outperform the U.S. economy, based on your projections, over the next several years. It sounds like Canada is going to continue to be in a very strong position.