Finance Committee on Feb. 10th, 2009

[The Chair, Conservative, James Rajotte]

Be brief, Mr. Carney, in response.

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

Just a few words. You asked us what the cause was of the current situation. One of the causes is the current global trade imbalance between China, for example, and the industrialized nations. In a way, this is a global crisis. The effects on each country are part of the current situation.

[The Chair, Conservative, James Rajotte]

Merci.

We'll go to Mr. Menzies, please.

[Ted Menzies, Conservative, Macleod, AB]

Thank you, Mr. Chair.

Thank you, Mr. Carney and Mr. Jenkins, for joining us once again here this morning.

We seem to be focusing so much on forecasts and not enough on reality. But having said that, I think both this government and you, Mr. Carney, have been criticized regarding forecasts. In fact, my learned colleague Mr. McCallum commented in the first part of January that the government had overstated the risks, suggesting that most experts were predicting a 2.5% growth rate, and then in November he said that we were understating the risks. So I guess I'm confused here. And we had a very interesting comment from the parliamentary budget officer, who suggested that being an economist was a humbling occupation—and I would tend to agree with him.

Not very many people saw this coming, if anyone. Why is that? Do we not understand the situation? Do we not understand what has an impact on the economy as much as we should or could? Or is it all just as you stated in your second paragraph, “the speed and synchronized nature of the recent global downturn”? Did it catch us all off-guard?

[Mark Carney]

I guess there are a couple of things. And I certainly would agree with the characterization of economists.

This time last year, when we cut our interest rate by 50 basis points, which was at the time an unusually large cut, one of the reasons we did so was that we saw a protracted U.S. slowdown. We saw that in part because we felt that the adjustment in the U.S. housing market was going to take a lot longer than others were predicting. We felt, as referenced in my earlier comments, that the issue of rebalancing global demand, once started, was going to take some time and would weigh on global growth. An easy shorthand for the rebalancing of global demand, when talking about the United States, is the need for higher personal savings in the United States; the converse is that there will be lower consumption.

So we had expected things to be slower for longer than others, and that's in part why we started cutting earlier than some other central banks. But did we see the sharp intensification of the crisis in September into October? No, we did not. It's the intensification of the crisis--there'll be history books written, lots of literature, on how it happened, why it happened, and if it could have been prevented--that has called into question certain long-standing practices in the financial system.

There is a huge range of these, but the most relevant here include the ability to finance with collateral in the markets and the degree of leverage that institutions can support in the financial system. There has been a very rapid de-leveraging as a result of both the regulated and unregulated...well, principally the unregulated at this stage, but a need for large de-leveraging in the regulated financial system, and that is intensifying the slowdown. That's a process that needs to be worked through. It's a process that can be managed to some extent, and needs to be managed to some extent, to mitigate the impact on all of our economies.

The last point on this is that there is an element where the public sector can play a role in not just easing the speed of the de-leveraging but moving into selected markets, depending on the structure of their financial system, to ensure that the flow of credit continues.

[Ted Menzies, Conservative, Macleod, AB]

I'll let Mr. Dechert ask a question.

[Bob Dechert, Conservative, Mississauga—Erindale, ON]

Thank you, Mr. Chair.

Mr. Carney, thank you for your very thorough analysis and report today. You've taken us through some of the things that the central bank has been doing over the last year or two to prepare the Canadian economy for the situation that it now is encountering. I wonder if you could tell us about what other tools you have in your tool box, as Governor of the Bank of Canada, to move the economy forward.

Perhaps you could also comment on the effectiveness of monetary policy in the range of interest rates that we currently find ourselves in.

Third, on a bit of a different topic, could you perhaps comment on which industries you would expect to see recover, or which sectors you would expect to see recover first, in the Canadian economy?

[Mark Carney]

In terms of the range of tools that the central bank has, obviously the first and foremost is the overnight interest rate, which, as I mentioned in my comments, we have acted aggressively on. We have dropped it by 350 basis points over the course of just a little over a year. We're at 1%, which is an historically low interest rate, as you know.

In parallel with that, we've been providing exceptional liquidity to the financial sector. The reason we've been doing that is to keep the system functioning as best as possible. We do that in a variety of ways. Effectively, to minimize risk to the taxpayer, we do collateralized lending to institutions. They owe us money, so we have the credit of the institution, but we also have the protection of very high-quality collateral. We've over-collateralized the loan, if you will.

There's a broad range of facilities, and we've been expanding the range of facilities and the degree of interaction. Those facilities peaked in December at $41 billion. If you think about the bank coming into this crisis period, if you will, with a balance sheet of $50 billion or thereabouts, which was all held in government securities, we've shifted that. We've increased to about $75 billion the balance sheet as a whole, of which about $40 billion, at its peak, was outstanding to the financial sector directly to provide liquidity--to grease the wheels, if you will--and keep the system functioning. That has come off by about $5 billion, to about $35 billion right now, but we have made it very clear, and I'll make it clear again today, that we stand ready to provide exceptional liquidity, as long as conditions warrant, to keep the system working, to keep it functioning effectively.

Now, the second question you're asking me--

[The Chair, Conservative, James Rajotte]

I'm sorry, Mr. Carney, we're out of time on this.

[Mark Carney]

I'm sure I'll get back to those.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Dechert.

Monsieur Mulcair.

[Thomas Mulcair, NDP, Outremont, QC]

Thank you, Mr. Chair.

Welcome, Mr. Carney and Mr. Jenkins. Thank you for your presentation.

Mr. Carney, at your first visit before our committee, just before your appointment as governor, you spoke about the need to establish a regulatory system that would include a sense of values. That was in the wake of the commercial paper crisis. That was the start of what turned into a crisis in the summer and fall. We began to sense, particularly in the United States, that a breakdown was starting to occur in a system that, for lack of a better term, had been held together by chicken wire and chewing gum.

You have worked for Goldman Sachs. That has given you the credibility and experience to manage this crisis, which is now also affecting Canada. You are doing a fine job, and we fully support your efforts. However, you must realize that the credit facilities of some $40 billion that you have just spoken of as well as the other economic levers available to you are not always passed on. Allow me to explain.

On December 9, you reduced the key rate by 75 basis points. Banks systematically held on to exactly 25 basis points. Statistically speaking, that is noteworthy. The probability that each chartered bank retain exactly 25 of those 75 basis points—not 23 for some and 27 for the others, but exactly 25 across the board—is in the range of hundreds of millions to one. It is as if oil companies all decided to set the price of gas at 84.9 cents at 11 o'clock on Thursday morning. An investigation has shown that there was indeed collusion between the oil companies.

Do you not think that that could be a way to influence banks, since your reductions are done in the interest of the public, while banks are keeping part for themselves? Can you not ensure that banks act in the best interest of Canadians?

[Mark Carney]

First of all, as I indicated, we cut our key interest rate by 350 basis points, whereas bank's preferred rates were reduced by 325 basis points. As well, mortgage rates here in Canada are lower than elsewhere. Our variable mortgage rates are unlike those in other major countries.

With regard to the banking situation, first of all, as we have indicated, we are providing an exceptional amount of liquidity. Second, we are trying to influence banks [Editor's Note: Inaudible] rate, as the market has requested.

At present, Canadian banks are well capitalized. This represents costs for them. In our view, it would be timely to reduce that ratio, given the current situation. There are great opportunities for the banks.

We are trying to influence them. Here, in Canada, our monetary policy remains effective. Unfortunately, that is not the case in other major countries.

[Thomas Mulcair, NDP, Outremont, QC]

I would also like to hear you talk about inflationary pressures.

You say that things should be okay in the short to medium term, perhaps with a certain reservation given all the money that is being printed, as during the Creditists' era. I am sure you remember that time. Sooner or later, the money will have to be paid back, and one of the only ways to do so is through inflation, somewhat like we saw in the past.

In the long term, are you concerned about an inflation level similar to the one we had a generation ago, when we had to reimburse money borrowed to wage another war?

[Mark Carney]

Thank you for your question. Our monetary policy objective is to have a low, stable and predictable rate of inflation. We have a symmetrical approach. The inflation rate is currently going down, as you mentioned, and we are working on quietly increasing the inflation rate in Canada to the target 2%. We feel it is a great advantage for Canada to have this target framework system, because we have an absolutely symmetrical approach. And you, the members of this committee, can judge whether or not the Bank of Canada is successful by referring to this target.

[Thomas Mulcair, NDP, Outremont, QC]

You say you are confident you can maintain an inflation rate of 2% in the medium term; are you also confident about the long term?

[Mark Carney]

In the medium term and the long term, absolutely.

[Thomas Mulcair, NDP, Outremont, QC]

All right, and here is my final question. President Sarkozy is leading an all-out attack against the financial sector's approach, in which he is supported by Angela Merkel and by Tony Blair in particular, because this has produced the results that we are now seeing particularly in the United States. This is a system based on bonuses in order to create more and more derivative products, whose sole and unique objective is to create more bonuses and revenues for corporations, such as Goldman Sachs. But there's nothing personal about my comments.

Do you intend to support these kinds of measures in order to bring us back to our senses? Is this not part of what you described as being an objective, that is to have rules that are values-based?

[The Chair, Conservative, James Rajotte]

Just be brief, Mr. Carney.

[Mark Carney]

We absolutely must change the compensation system for large financial corporations. The important thing is to have mid-term compensation with mid-term objectives, and not short-term objectives as is currently the case. That was the case in my former company; that is one of the differences. It is necessary. The issue is the degree of regulation or change in corporations.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Mulcair.

We'll go to Mr. McKay, please.

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

Thank you, Mr. Chair.

Thank you, Mr. Carney, and thank you, Mr. Jenkins.

Last year the difference between the Bank of Canada's prediction for the last quarter of 2008 and the actual outcome was a swing of about 4%. If in fact that kind of analysis is applied to your current predictions, we have a fairly serious issue of really not knowing where the bottom is for our economy. If you look at places like Singapore, they are down 17%; South Korea is down 21%; and Japan is down 10%. All of those economies are highly interdependent with ours.

You put the unpredictability of using all of these models, all 21 models, and then you add to that the fact that during the course of the year you've swung your assets from basically T-bills and government bills to “other” assets—whatever those are—and then you add to that the fact that you've dropped your overnight monetary rate basically down to 1%, with virtually nowhere further left to go, and yet at the same time, you argue that we have all kinds of policy instruments left to intervene.

So my overall question is, Mr. Carney, is the Bank of Canada essentially tapped out at this point?

[Mark Carney]

The short answer is no, absolutely not; we have considerable flexibility. We have flexibility in our overnight rate, and there are other interventions that we could make if it were appropriate to do so, but those other steps would only be taken in the context of our inflation target and in the context of a financial system that, in Canada, has its challenges but is largely functioning, which is unique relative to those in other major economies. So we have to take that in account.

But no, I would not accept your characterization.

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

But if you're down at 1%, there's not much further you can go. So I question how you could argue there is still flexibility and that you still have policy instruments left when your margin is so narrow at this point.

[Mark Carney]

First, we could move further if we saw fit and we've just taken a decision. I'm not going to take another one sitting at the table. But I might ask my colleague Mr. Jenkins to talk about the pass-through of some of these moves we have made, because that is being underestimated because prices are moving.