Finance Committee on Oct. 27th, 2009

[Mark Carney]

There are risks on both sides for this recovery, absolutely. Certainly there are significant risks that come from abroad, on both sides, and risks in the United States. So there are upside and downside risks.

What we have said about the labour market, and it's very early days, is that there were some early signs of stabilization in the Canadian labour market. That said, unemployment, as everyone knows, has gone up quite sharply, and hours worked are very low. Average hours worked are very low. I hate to use an economic term, but there's a lot of slack in the labour market at present in Canada. If I may make a general point, that slack and the slack in capacity utilization and business activity means that there is quite a large output gap, which affects the ultimate pressures on inflation. It is part of the reason we have policy where it is, because it's going to take some time to use up that slack.

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

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Pacetti.

Mr. Carney, we'll go back, if we can, to the question posed by Mr. Bernier, please.

Do you want to restate it?

[Mark Carney]

No, that's fine.

Mr. Bernier is right, of course. There are both positive and negative consequences when you have a strong dollar. What matters is how the exchange rate, combined with all the other internal and external factors, impacts overall demand and inflation in Canada. That is what determines the Bank of Canada's monetary policy.

[The Chair, Conservative, James Rajotte]

Merci.

We have about four minutes in this spot.

I just wanted to follow up, Mr. Carney. You talked about the redesign of regulations internationally. In your speech in Montreal, you spoke about the G-20 reform agenda, and in the section “Protecting the Cycle from the Banks” there were three interesting statements.

You talked about “building a system that can withstand the failure of any single financial institution”. Lehman Brothers obviously comes to mind.

You talked about the “conviction among policy-makers that losses endured in future crises must be borne by the institutions themselves”. AIG comes to mind when you state that.

Then you talked about creating “a system in which individual financial institutions are less important and markets more important”. That's quite an interesting statement.

You sort of discuss four measures there. I want you to go into that.

It was obviously a challenge. Lehman Brothers, on September 15 of last year, was the hot spot, the point of the financial crisis. Then there was, I think most would argue, an overreaction with respect to AIG. There was such a fear of any other institution failing that there was an overreaction.

When you talk about creating a system in which individual financial institutions are less important and markets more important, what exactly do you mean, and how would you go about doing that?

[Mark Carney]

Thank you for the question, Chair.

Very briefly, one of the issues in the crisis was that a series of institutions had to be saved. The judgment of the relative authorities was that it had to be saved because their failure would have seized up further broken-down markets and brought down other institutions because they were so interconnected.

Quite frankly, that's an unacceptable situation, that markets are dependent on individual institutions surviving. Certainly what's unacceptable is after that has been revealed, to continue to manage the system in that way, because that changes behaviour if you know that institutions will be “saved” for that reason.

What does one do about it? Our very strong opinion is that one has to change in a variety of jurisdictions, including our own, some of the infrastructure of markets, so that the markets can continue to function if an institution stops working. In other words, we have looked at--and it's detailed in those remarks, as you know--the funding markets in Canada. These would be the repo markets and the interbank markets. We're working with industry players to see whether it makes sense--still to be determined--to move those on to a centrally cleared platform. There's lots of jargon there. The point of that is that transactions go through a clearing house, which is a utility-type structure that is very well capitalized and robust to all states of the world. If one of those institutions that's trading through that clearing house for whatever reason has to fail, the clearing house is protected. It's not lost, and the system as a whole is protected.

If you go back--and I'm sorry to take up so much time on this, but it's important--one of the issues with Bear Stearns was that it was in this very short-term market. It was a key player in the repo market, and the entire market, as judged by the Fed, and I think rightly, would have stopped functioning. That would have seized up the bond market and other markets if Bear Stearns hadn't opened for business the following Monday. That's the type of situation we're trying to get away from. It's going to take some fairly substantial changes to market infrastructure.

[The Chair, Conservative, James Rajotte]

How would that, in a practical way, prevent a future Lehman Brothers failure from occurring?

[Mark Carney]

It would--

[The Chair, Conservative, James Rajotte]

It's not the failure but the effects to the entire system of the failure.

[Mark Carney]

One of the issues with Lehman Brothers, Bear Stearns, and other major institutions when they fail was that institutions didn't know which other institutions that were trading with Lehman Brothers had just lost a lot of money because Lehman failed. That made everybody suspect and that made everybody pull back.

The point would be that if the trading in a given market is done through a central counterparty, the only thing that matters is whether that central counterparty fails. The institution can fail, and that's bad news for them, but in terms of the repo market, which is my example, because the central counterparty is still there nobody has lost any money, including the central counterparty, because it's on a collateralized basis. Now, somebody has to oversee the counterparty and make sure that this is robust. But it is doable. It's done in other markets and it should be applied.

The big question mark, which is the subject of active discussion--more relevant outside of Canada than in Canada--is what happens in the credit derivative market, which by some estimates is tens of trillions of dollars in size and is entirely dependent on bilateral relationships.

[The Chair, Conservative, James Rajotte]

I would like to continue that, but I am out of time. Perhaps we'll come back to it later.

We'll go to Mr. McCallum again, please.

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

Thank you.

I'd assume you'd agree, because it is a fact, that Germany, France, and Japan experienced positive GDP growth in the second quarter of this year.

[Mark Carney]

We agree with that, in fact. Yes, they did.

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

I assume you would agree, since it is also a fact, that therefore by definition those three countries emerged from recession in the second quarter of this year.

[Mark Carney]

I would hedge my answer on that. As you well know, definitions of recession and recovery based simply on GDP are a little unrepresentative. There are broader factors, like industrial production, unemployment, etc.

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

Okay. But at least if one takes the simple definition of recession, if we have consecutive quarters of negative growth and then positive growth, by that simple measure are you out of recession?

[Mark Carney]

For the purposes of this exercise I will agree with that.

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

You may figure out where I'm going. There is this myth propagated by the government that Canada is leading the G-7 out of recession. Now the governor has just agreed that three of the G-7 countries, in the second quarter of this year, actually experienced positive growth and by one measure were out of recession, whereas Canada experienced not only negative growth but the most negative growth of all the remaining four G-7 countries.

Maybe this is a little political—

[Voices]

Oh, oh!

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

—but how can one say that Canada is leading the way out of recession among G-7 countries when three of the four had emerged by Q2 and Canada had not?

[Mark Carney]

Could we get a ruling on that?

I think in the fullness of this experience of the recession and the recoveries, and the amount of time it takes for economies to return to their previous path of potential growth, it is likely that Canada will return to its path of potential more quickly than the other crisis-affected economies, including the two European countries you mentioned. But that's something one sees over the fullness of time, and that's what ultimately will matter.

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

Thank you.

If I may turn to a less political question, I'm sure you won't want to tell us how high the dollar has to go before you're worried, but let me ask you two questions related to that.

I would assume that if the dollar appreciates because of higher oil or commodity prices, you would be less concerned than if the dollar appreciated because of...speculation, shall we call it? And second, I would assume that you're concerned partly about the level but also about the speed. Are those two assumptions I'm making true, that you're less concerned if the dollar appreciates because of commodity prices, and you're particularly concerned if the appreciation is very rapid?

[Mark Carney]

I would say simply that what matters for the bank is where the currency is and where all other domestic and external factors are and the totality of their impact on aggregate demand and therefore inflation in Canada. And obviously our terms of trade, prices of commodities, are one of the external factors that matter. But just to take the exchange rate and just to take the terms of trade, and to ignore everything else—U.S. activity, domestic activity, housing market, etc.—would be a partial analysis and would be inconsistent with our mandate to meet our inflation target.

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

What about the issue of speed?

[Mark Carney]

Again, partially there is a question of speed and impact through confidence, as a channel, but that needs to be brought into the broader analysis.