Finance Committee on April 28th, 2009

[Mark Carney]

There's no question that the issue of the perimeter of regulation, if I may, catching those institutions that have potentially systemic implications, such as hedge funds in some jurisdictions and such as, as it turned out in Canada, arguably the institutions that created the vehicles of non-bank asset-backed commercial paper, which ended up being quasi-systemic in Canada...that the ability, from time to time, of the financial industry to innovate around the regulatory net has to be addressed.

That is a decision for the G-20 leaders, and it has to be put into practice. It requires coordination. As the bank, we work with the system we have, so we do sit down--well, at least on a quarterly basis, and in fact more frequently, given the nature of the times--with the provincial securities commissions in tandem with the Superintendent of Financial Institutions and the federal Department of Finance to discuss these types of issues to see how we can address them in the current framework. That doesn't mean the framework might not be better if it were to be changed, but we're working within the current framework.

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

But your conversation with those various regulators can only be as strong as those regulators. If, say, in the case of non-bank asset-backed commercial paper, there appears to have been virtually no regulation whatsoever, that it fell between a whole bunch of cracks, how is macro supervision going to address that?

[Mark Carney]

One of the issues that we've advocated--and it was adopted, again in that same communiqué of G-20 leaders--is that regulators have a responsibility as well for the financial system's stability. Therefore, in their actions they must take into account the implications of their actions or regulations for the system as a whole. The first thing you do is to ensure that in the objects of regulation there is that other object, as opposed to simply, for example, a strict micro potential or investor protection responsibility. So it's very important that it's there.

To operationalize that, the question then becomes, how do you as a regulator form that judgment about the macro implications of your actions or regulations? Quite frankly, from a Canadian perspective, I would say that's a conversation about how formal that conversation is with entities that have a macro perspective. How formal that conversation is and how directive it is...different countries will take different views. The Europeans are taking a directive approach that would not...well, it's a European approach, not a Canadian approach.

[The Chair, Conservative, James Rajotte]

Very briefly.

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

Obviously, there's been a lot of conversation about the DBRS, the Dominion Bond Rating Service, and things of that nature. The very nature of what they do is essentially to provide opinion on the quality of the security. Is your proposal going to mine down to that level of, in effect, being a super opinion on the quality of the security?

[Mark Carney]

First, you reference a proposal that we do not have, so by definition you can't read that into it. But if you're talking about a macro-prudential approach, no, one wouldn't focus in on a specific security unless that security itself were a major part of the capital markets, such as, for example, the GSE bonds in the United States. They turned out to be systemically important, in part because of the ambiguity of the guarantees around that and the knock-on effect that had as little as nine months ago. It seems like years ago, but it was less than a year ago. So that would be an example. Macro prudential is really the forest rather than the trees, and individual securities are trees. One wants rating agencies to do their job properly.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. McKay.

Mr. Carney, I want to follow up on your response to Monsieur Laforest's question about the difference in the forecast for economic growth between this time and the last time you were here. You talked about the recovery moving out and flattening, and then you referenced commodity prices. If I recall in your last presentation, you had commodity prices increasing over the long term as one of the factors of recovery. You referred us to page 27, in terms of U.S. demand for Canadian exports. I'm wondering to what extent commodity prices are included in those exports.

On the second reason for the recovery being delayed or the recession being worse, you talk about the more severe synchronized nature of the global downturn. You also reference less ambitious policy actions in other industrial economies, including the U.S. and Europe. I know it's probably a touchy subject to comment on--actions in other countries and other central banks--but I wonder if you could comment on the commodity price aspect and actions in other countries.

I don't know to what extent the bank forecasts commodity prices and what detail they get into, but natural gas is moving forward, for example. It may interest people to know that for Alberta, the price of natural gas is more important than the price of oil.

So perhaps you could comment on commodity prices, and then on actions in other countries, specifically at the monetary policy level.

[Mark Carney]

Thank you for the question.

We do two things with commodities. We differentiate between energy commodities and non-energy commodities. For energy commodities, our forecast is the futures curve for natural gas and oil. You're absolutely right that natural gas is far more important to Canadian growth and activity in Alberta, at least at the current time, than the price of oil. As you well know, natural gas prices are off sharply since January by almost 17% or 18%. That is part of the deterioration in our terms of trade.

The second thing we do, based on our global outlook, is forecast on non-energy commodities. That global outlook has come down in this report versus the last one. As a result, there's a softening in the global commodity outlook.

If you want a very simple shorthand on this, look at table 3, page 19, real gross domestic income, which is a way of aggregating this, plus other factors. There is a sharp reduction in the outlook for 2009 and 2010. So there's an income effect there that has implications.

The sharp downturn in Q1--the 7.3% annualized contraction in Canada--and the slightly sharper downturn in Q4 than we previously forecasted have an implication, in that firms have a lot more inventories than they wanted. That provides some of the drag to growth in Q2 and Q3, as they don't produce us much and need to work those inventories off. That has short-term implications. So those factors are important.

On the U.S. activity variable you referenced, commodities play a role, but given the weight of manufacturing exports to the U.S., the response to the earlier question stands.

[The Chair, Conservative, James Rajotte]

What about the less ambitious policy actions in other countries, as noted on page 7 of your report?

[Mark Carney]

Ah, the less ambitious. There are two aspects to that. Global fiscal policy moved less rapidly and was less ambitious than the 2% target of the G-20. We will now probably get there in other countries--at least there's an announced intent. But implementation is important, and it's getting pushed out into 2010, as opposed to earlier.

The most important issue is that efforts to stabilize banking systems have taken longer. There has been less implementation than expected in the United States. The last time we were here was the day of the announcement of a component of the plan, as opposed to the entirety of the plan in the United States. That has had some implications.

We have had considerable discussions with our colleagues in the U.S. and Europe, most recently in some detail over the weekend. We take some comfort from those discussions, in that the will is certainly there and the plans are in place. There are real implementation challenges, but they're seized with the importance of the situation.

[The Chair, Conservative, James Rajotte]

Okay, we appreciate that.

We'll go to Mr. Pacetti, please. I'm sorry, Ms. Hall Findlay, first.

[Martha Hall Findlay, Liberal, Willowdale, ON]

We are going to do our best to share this time. Thank you, Mr. Chair.

Mr. Governor, you've talked about the possibilities of quantitative easing and/or credit easing. There are two parts to my question. Can you give us some real world examples of what might happen economically over the next months to cause you to do that, understanding that your goal is 2% inflation? Within that, what is your preference for quantitative versus credit easing, and when might either one of those be your preference?

[Mark Carney]

The easiest shorthand for the real world examples is to look at the risks to our projection. These include a deeper global recession than envisioned, so that the famous second derivative is not as positive as we'd like and the bottoming out—to some extent the slowing of the decline—that is expected in the second quarter and into the third quarter and then up does not materialize. Clearly there are delays in progress on the stabilization of the financial system. There is a lot that needs to be done. Nobody is going to wave a flag and say it's over, but I think we'll know when we see major hiccups. The lack of progress will be clearer than the presence of progress. It will be slowly built up, in that regard.

I would say those are the two fundamental issues. While we see at this point some choppiness in the data, for example, in the U.S., where there is some positive and some negative and the negative still outweighs the positive, we see some stabilization in upticks in some of the softer data—the survey data, consumer confidence, business confidence, purchasing managerial indices around the world—but I would caution that they are coming from very low bases and this is a very recent improvement. So there is a lot still to be done in order to establish that return from what is a deep recession.

[Martha Hall Findlay, Liberal, Willowdale, ON]

In which circumstances is quantitative versus credit preferred?

[Mark Carney]

In which circumstances? I think the important thing is that we get some sort of shock that pushes the outlook for inflation down in a persistent fashion so that we need to provide additional stimulus. At that point, the bank would need to make a judgment about which of these—and within these strategies there are various ways to put them into effect—would have the biggest impact on overall financial conditions. It's a judgment at that point in time.

If I may, I would point out that, for example, in the credit markets, markets that were constrained or not very active in January have considerably improved to this point. So the strategy that might have been necessary in January might well be different from the strategy now. It's hard to predict where things would be at a point in time. Particularly, on my last point, if the reason for the revision and the outlook was—I hesitate to talk in conditionalities. In fact, I probably should just end this answer here, so I will.

[Martha Hall Findlay, Liberal, Willowdale, ON]

Thank you.

[Mark Carney]

You sucked me in.

[Voices]

Oh, oh!

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Mr. Menzies, please.

[Ted Menzies, Conservative, Macleod, AB]

Thank you, Mr. Chair, and thank you to our two witnesses, Mr. Carney and Mr. Jenkins.

I would like to go back to something that we haven't spent a lot of time on here, and it may not be in your field of expertise, but I think both of you understand it better than many of us. What do we do with these impaired assets or toxic assets that got a lot of institutions into a lot of trouble? You talk about $4.1 trillion worldwide. Where does it go? Is it simply discounted and sold off? How do we make sure that we don't see those toxic assets finding their way back in to create the same problem all over again?

[Mark Carney]

Thank you, Mr. Menzies.

There are a couple of things. One is that, just to be absolutely clear, the $4.1 trillion is the estimate of the IMF—we're not necessarily endorsing it. But I'd make two comments, and I'm not trying to be cute. Part of the reason they're called “toxic” assets is that their presence affects or poisons existing management of the institutions that hold them. So you end up having a situation where management is spending a disproportionate amount of its time on the work-out of these assets, as opposed to running the institution on a go-forward basis, thinking about new loans and new activities they could do.

That's why in general in banking crises—and there have been a hundred-odd banking crises over the course of the last 30 years, unfortunately, around the world—the preferred strategy ultimately becomes to separate those assets from those institutions that are going to move on, going forward, because you really do need to have banks that are thinking about the extension of credit on a go-forward basis, as opposed to spending the vast majority of their time working out distressed credits.

So where will they go? There are a variety of strategies. Different countries will take different strategies, and there is the option of either purchasing them or transferring them to a vehicle so that the upside and the downside from those assets accrues to the taxpayer. In some countries that is what will be done and is being done. That can be done through nationalization and separation. It can be done through the sale of assets or the appropriation of those assets in exchange for new capital. It can be done through an insurance scheme. It can be done in a variety of ways, and different countries will do different things.

The United States' plan is that institutions would be able to sell those assets to market participants, who themselves have received financing from the public authorities in the United States in a way to jump-start the asset sale process, both for securities, toxic assets, and for impaired loans under a couple of extremely important programs. That's an element of this stabilization we will watch quite closely.

[Ted Menzies, Conservative, Macleod, AB]

Thank you.

Mr. Wallace, I believe, has—

[The Chair, Conservative, James Rajotte]

There's another round, if we want.

Thank you, Mr. Menzies.

We'll go to Mr. Pacetti.

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

Thank you, Mr. Chair.

Just quickly from where I left off last time, from what I understand, part of the quantitative easing part is the printing of money. What happens when we start printing money? Does it really matter what we purchase with that money we print, or is it just going to cause inflation? I don't want to cause panic. I'm just wondering what happens with the next tool you have at your availability.

[Mark Carney]

It's an extremely important question.

The first point is to re-emphasize that we'll only use it if we have to use it.

The second point is that the important step is the purchase of the assets and the implications of those purchases on overall financial conditions, whether it's government bonds or some other securities, to improve, ultimately, the cost of credit and the availability of credit to businesses and households in the country.

Now, at the same time...I'm getting to your point.