Finance Committee on April 30th, 2008

[Mark Carney]

The Canadian economy has a number of strengths. The U.S. economy is going through a number of challenges. Those challenges will have implications for the Canadian economy, as I indicated in my opening remarks. We're vigilant to those. We are focused, in the end, on achieving our mandated target of 2%. That's how we'll manage the falls.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you.

I have nothing further, Mr. Chair.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move to Mr. Turner. The floor is yours. You have five minutes.

[Garth Turner, Liberal, Halton, ON]

Thank you.

Hi, Governor. I have a question for you that's sort of on the heels of Mr. Del Mastro's question about the economy in general. Is this a good time to buy a house with nothing down?

[Mark Carney]

I don't think it's wise for the governor to get into investment advice for Canadians. I would say a general point is that we have some concerns--we referenced this in the report--with the increased prevalence of very long amortization and very high loan-to-value mortgage products, and that development in the market. That's underlined in our report.

[Garth Turner, Liberal, Halton, ON]

Could you articulate that a bit more? Some people, maybe myself included, view the 40-year amortization as kind of a Canadian subprime equivalent to the extent that it allows people who wouldn't qualify under normal financing to actually qualify. Of course, as we've seen in the United States, that has had a pretty significant impact. It's not the only thing, but it's one factor.

Does it concern you at all that we may be going down that road?

[Mark Carney]

I would say that we are concerned about the development in these innovations and their increasingly widespread application. I wouldn't go as far as the way you've posed the question in terms of making any direct comparison to the situation in the United States.

Really, the CMHC and the mortgage insurers are best placed to speak to this, but our understanding is that the vast majority of people who are taking these longer amortization mortgages qualify under a traditional 25-year amortization mortgage. That said, they add to momentum in the housing market, and if everyone has a 40-year amortization mortgage, then we just have higher house prices and the same affordability.

[Garth Turner, Liberal, Halton, ON]

Right, but Governor, is that not happening now? We're seeing an absolute majority now, within the space of two years, since this committee had a look at 40-year amortizations when they first came in through budget 2006. Within that period of time, it has actually become the majority borrowing instrument.

Does this not accelerate asset inflation of the kind that we saw create the problem in the U.S.?

[Mark Carney]

We're seeing, as I'm sure you're aware, some moderation in house price increases in Canada. As we've said in our report, we expect further moderation, in part because of the softening. We see the conditions in the housing market as being not comparable to the situation in the United States--vastly different. We can choose our adjective, but they're not comparable in terms of the risk factors.

It is something that we are watching closely and will continue to watch closely, because it's an important segment of the economy.

[Garth Turner, Liberal, Halton, ON]

Could you clarify that, Governor, because the Canadian Real Estate Association last week said that resales across Canada are down 13%, down 22% in Toronto, down 35.9% in Calgary. Certainly, the listings are mushrooming. It certainly would appear that we have gone through an asset inflation where real estate prices are about 70% greater than they were eight years ago, somewhat similar to what happened in the run-up in the United States.

What exactly is different?

[Mark Carney]

There are a number of differences. One is on a variety of affordability measures. In fact, the IMF's affordability measure showed that Canadian housing is the cheapest, along with Austria, in a 20-odd country comparator of all the major economies. That's one example.

Secondly, the debt service ratio of Canadians is still very achievable, or very modest, at around 7.5% to 8% relative to historic averages.

Another difference is that the level of unoccupied housing is still low, with the odd market exception, but it is still low and below historic averages, and certainly below any other period when we've seen things come off.

The fourth thing that is different, because the original question mentioned the subprime situation in the United States, is that the structure of our housing finance is entirely different from the structure in the United States. The implications of any adjustment in house pricing, up or down, for our financial institutions, our financial system, and then reverberating more broadly back in the economy, is not possible in our system of the U.S. magnitude.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

Mr. Dykstra, five minutes.

[Rick Dykstra, Conservative, St. Catharines, ON]

Yes, through you to the governor, I was kind of intrigued by three things, actually. I'll try to get them all out here so my five minutes gets used as well as possible.

One of the things you mentioned at the outset was the continued growth of the Canadian economy. While there's a bit of a slowdown here in 2008, it's 2.4% in 2009 and 3.3% in 2010. I wonder if you would very briefly elaborate on what you think the foundation of that growth will be built on.

[Paul Jenkins]

That's a very good question. It comes back to a theme we were talking about earlier. The domestic demand that we're seeing in the Canadian economy is going to be the main driver, if you like, as we look out over this three-year period.

As to the growth rates that you were quoting, if you look at the contribution that we're anticipating from what we call domestic demands of consumption, housing investment, those are going to be the main sources of growth. In fact, what we call net exports, which is the balance between what we export and what we import, is going to be a drag on the Canadian economy. That largely reflects the weakness in the United States, a reduction in exports this year because of that weakness. So we have this negative development U.S., but we have this strength of domestic demand, the domestic demand component being the strongest.

[Rick Dykstra, Conservative, St. Catharines, ON]

Thank you.

The other question I had relates, Mark, a little bit to the comment you made around the concern we have of inflation being higher than 2% but the justified, or just as valued, concern of it being lower than 2%. Could you expand on that a little bit? I think it's a pretty important point for us to understand, especially right now.

[Mark Carney]

Thank you for asking that. It is quite important.

We have a clear mandate. I think one of the strengths of our system is that Paul Jenkins, I myself, and the Governor in Council have a very clear mandate in terms of inflation. It is total consumer price inflation, it's 2% per annum, and we're measured against that mandate. I'm pleased to say--I had nothing to with this--my predecessors hit that mandate bang on over 15 years--2.0% average inflation over that period.

The advantage of it being symmetric is, first, its clarity; people can understand it. You can write a contract, whether it's a wage contract, a business contract, whether you're buying a financial asset or other, you can count on 2%. It's not as if we're aiming for 2% but we'd really like to get down to 1%. We'll be absolutely clear, we plan to get 2%.

The second thing is that in extreme situations--and many of us will remember the deflation scare of a few years ago--it's the absence of that symmetry that can create a self-fulfilling prophecy or self-fulfilling activity. It fortunately did not happen. It was a strong action by some foreign central banks to avoid that, but it runs a greater risk. However, if it's absolutely clear what you're shooting for, people take action over the whole course of their time, not when things drift farther and farther away from the target.

[Rick Dykstra, Conservative, St. Catharines, ON]

Mr. Turner has his pet hobby horse of the housing industry; mine is the Canadian penny. I'd be interested in hearing your comments on whether you think we should keep it or not, based on the revenue it produces.

But before you get to the most important penny question, you made a half-point reduction in the Bank of Canada rate--a significant cut. For us and the folks watching, I wonder if you could give a very brief overview as to why you believe it was the right thing to do at this time.

[Mark Carney]

You don't really want me to answer that penny question. It's not our domain--it's that of the government and the minister--but our research indicates that we would not expect an inflationary or dis-inflationary effect from the elimination of the penny. So rounding up or rounding down will have no impact. It's not going to affect the 2% target.

On the 50 basis point adjustment we made last week, given the amount of time I would say a couple of things.There have been two major shocks to the global economy that have implications for Canada, and my colleague referenced them earlier. There has been the slowdown in the United States and turbulence in the financial markets. When we acted on March 4, we highlighted the downside risks that importantly included those two shocks.

With further information and developments, when we took our decision and published this associated report, we incorporated those shocks fully into our base case projection. So the projection you see and the numbers we quote are balanced.The risks are on the upside, the risks are on the downside, as opposed to a projection where there are a lot of downside risks--which is where we would have been in March.

So that's an important thing to understand. We've incorporated things. We've had time to work it through. We've calibrated accordingly. As we say, further stimulus will depend on the evolution of the global economy and domestic demand.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

There are lots of pets around the table. We'll see if Mr. Pacetti has one.

You have five minutes.

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

Thank you, Mr. Chairman.

Thank you for appearing, Mr. Governor.

I want to try to focus on the growth of the GDP and the fact that you revised your number down to 1.4%. What was your previous number?

[Mark Carney]

It was 1.8%.

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

Was that forecast in January?

[Mark Carney]

Yes.

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

So in the span of four months you revised your number from 1.8% to 1.4%. In its budget documents, the present Conservative government has forecast 1.7%. Now it's down to 1.4% in a matter of two months. What are the chances that GDP growth will go from 1.4% to 1%?

[Mark Carney]

As I said in response to the previous question, this is our base case projection. The risks are balanced around it. I wouldn't want to ascribe a probability to that. This is our mean projection.