Finance Committee on April 27th, 2010

[Mark Carney]

Yes, absolutely. You've put your finger on exactly the right issue.

Just very briefly, the issue on why the tax, in our view, doesn't get to this externality issue is that by creating this fund...or one of the issues, as there are many.... You're creating a fund, so I, as a lender, a buyer of the bonds of this financial institution that ultimately benefits from the fund...so why is that not a quasi-sovereign obligation, given...? That's what moral hazard means, obviously, and certainly as the counterparties and other people in the transaction.

So what do you do about it? What I would say is that this is the question by which I would encourage members and others to judge financial reforms: by the extent to which, in an efficient way, they address this issue. So are we building a system where large institutions can fail without impacting other institutions and really impacting the real economy? That's the issue.

So what do you do about it? Part of it is that you change market infrastructure so that you have an ability to remove, so if an institution fails, the market continues to function. We're doing that with repo transactions in Canada, along with the industry, through a central counterparty.

There's a major G20 initiative that's relevant to Canada on OTC derivatives and moving standardized derivatives onto central clearing. That's incredibly important for exactly this reason.

The next thing you do is make sure that your supervisors—OSFI and CDIC—have all the appropriate powers to resolve an institution if it gets in trouble. That was one of the failings in the United States. They didn't have effective resolution powers for big proportions of their financial sector, including investment banks and insurance companies—and you can think of who we're talking about.

The other thing we say that you do, just to be clear, is to have contingent capital or contingent capital attributes--we and others, OSFI particularly--and just to be clear on what we mean there, it's not core capital. It's elements of the financing of the institution, subordinated debt and maybe even senior debt, that then converts into core capital if the institution gets in trouble. What it does is that it converts into equity. It dilutes existing equity holders, but it recapitalizes the institution from itself.

There is a variety of ways to do that, but I think it's very promising because it bears the costs within the sector and ensures that somebody who's a going concern, or is about to become a gone concern, if you will, can continue to function because they're recapitalized through their credit stock.

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

Thank you. I agree with everything you said--on that. But I think it's also true that we certainly weren't at that phase when they allowed Lehman Brothers, for example, to fail, and the system practically disintegrated or ran into huge trouble.

So do you think sufficient progress has been made such that if we had another crisis, let's say, five years from now, we would have advanced to the point where such institutions could be allowed to fail without doing huge damage?

[Mark Carney]

Yes, that's the test. If you're asking me right now if sufficient progress has been made, the answer is no. These are issues that are being discussed. We need to come to agreement on them, but we have not yet come to agreement on them.

The key date for this year is the November summit in Korea, and there's the run-up to that. All I can say is that we, the superintendent, and the Department of Finance are working very hard to make progress on these issues.

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

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you.

Mr. Généreux, please.

[Bernard Généreux, Conservative, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Thank you, Mr. Chairman.

Welcome, Mr. Carney.

I would like to come back to the positive effects — according to your statements, contained in your last report — of the measures that were put in place to get us through the latest economic crisis. In what way do you believe these measures were truly beneficial to our economy?

[Mark Carney]

I could probably be more precise with regard to the impact of the easing of the monetary policy. Since the beginning of 2008, the Bank of Canada has quickly reduced its key interest rate. At the end of the month of April 2009, we set it at its floor value and we introduced our conditional commitment. I am convinced that our monetary policy has had and continues to have a major positive impact on our economy.

I could perhaps refer you to the answers I gave to Mr. Wallace's questions with regard to the impact of the federal and provincial fiscal initiatives in Canada.

[Bernard Généreux, Conservative, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

You are presupposing that the recovery will perhaps not be quite as rapid over the next few quarters. Do you believe that the measures taken by the Bank of Canada and the government should potentially be maintained over a longer period if the economy does not rebound as quickly as we would like? That does not necessarily mean that you will be right, because the economy is stronger than you had predicted. We could suppose that it will continue to be stronger despite the statements made in your report, namely that you believe that it will not be as strong as predicted. With regard to the measures that you have put in place and the termination of which you have already announced, would you consider re-establishing them if the recovery of the economy tended once again to slow down?

[Mark Carney]

Firstly, with regard to our Canadian economic predictions, we underscored the fact that there was probably an advancement of household spending, that had a major impact on the final quarter of last year and the first quarter of this year. That was followed by a progressive slowdown of our level of activity in Canada. As for our monetary policy and its orientation, the objective is clear, namely the attainment of our 2% inflation target for the overall CPI. The Bank of Canada will manage its policy in such a way as to reach this target. Lastly, there are serious risks, both upward and downward, that can impact on the level of activity, the growth rate and the inflation rate in Canada. The Bank of Canada will react appropriately to these impacts.

[The Chair, Conservative, James Rajotte]

Merci.

We'll now go to Mr. Pacetti, please.

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

Thank you, Mr. Chairman.

In your opening remarks, on a few occasions I think you mentioned the words “monetary stimulus”. On your second-to-last point, you say that we should “lessen the degree of monetary stimulus”. What would be the definition or an example of monetary stimulus for the Bank of Canada?

[Mark Carney]

Thank you for the question. This is a very important point.

If you'll permit me, sir, to go back to this time last year, when we reached the zero lower bound or the effective zero lower bound--25 basis points--for technical reasons we couldn't see the interest rate going any lower than that. We felt that given the level of activity abroad and in Canada, and the perspectives for inflation, in order to achieve our inflation target, we needed more monetary stimulus.

At that point, we were faced with a choice. Other central banks have been faced with this choice. The first step they took was to “quantitative ease”—to print money, colloquially speaking—or to “credit ease”, which was to purchase securities.

We provided a policy. First off, we wanted to have a policy that was rooted in principles and that was transparent. We were fortunate that we were able to put that out and come to this committee immediately afterward and explain ourselves. And we saw a third option. We had those two options, and we continue to have those two options if needed, but the third option was to provide extraordinary guidance on the path of interest rates. That's why we gave the conditional commitment.

So to your point about what we got as monetary stimulus out of that, what we got was a movement in the short end of the yield curve from the overnight rate out to the end of June, 2010, a movement down. Over the course of the year, as we've reiterated that commitment, that bit of the yield curve has been anchored. Those are important yields for a variety of prices, which have eased financial conditions in Canada, including for prime rate borrowing, as discussed earlier.

So by removing that commitment, even though the amount of time left in that commitment was relatively short, it gave a corresponding adjustment to those expectations, which removed some of the monetary stimulus that was there. That was an unconventional policy. It was done for extraordinary times. Our message is that those extraordinary times—not difficult times, but extraordinary times—have passed or are passing, so it was appropriate to remove that, and that was the monetary stimulus that we have taken out.

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

But what if we use the example of quantitative easing? I remember when you brought that up; that's what I thought you were referring to in your monetary stimulus, but my understanding is that you never used quantitative easing.

[Mark Carney]

Yes.

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

What was the second one? Credit...?

[Mark Carney]

It was credit easing. For example, the Federal Reserve, but also the Bank of England, would directly purchase bonds/credit securities in markets that were particularly distressed in an effort to get those markets restarted. The most dramatic example, if you will, or the largest example of that, is the Fed's purchase of a very large number of mortgage-backed securities in the United States.

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

So the fact that you never actually used them is still considered to be lessening the degree of monetary stimulus--

[Mark Carney]

No. What I meant in my remarks at the start, to be absolutely clear, was that what we have done to lessen the monetary stimulus is that the decision taken last Tuesday to remove the conditional commitment was lessening monetary stimulus in Canada.

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

Okay.

I have a quick question on something entirely different. We talk about growth. With the growth numbers being over 3%—3.7%, I think it is—doesn't growth at that high a rate just automatically give you inflation?

[Mark Carney]

No. It's a function of the rate of growth, the capacity of the economy, where we are relative to the potential of the economy. It's a function of other factors as well: the exchange rate pass-through and other things such as that.

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

But when it happens in such a short timeframe--

[Mark Carney]

But we have, in a summary measure or on a summary basis, an output gap that is still 2%—even after that surge in growth in the fourth quarter of last year and first quarter of this year. So we still have a fair degree of slack in the economy. These are not precise measures, but we've been pretty conservative in our estimate of that.

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

The reason I'm asking is that if the growth is so quick and it's such a short timeframe, wouldn't it be just for specific items, products, and sectors that are already equipped, which then just shoot up, and that's what would cause inflation? But you're saying it's an overall...?

[Mark Carney]

There's a lot of slack in the economy. Some of that slack is starting to be taken up. In fact, this is typical growth, in many respects, for a recovery. On the pace of the recovery as a whole, though, given the severity of the recession, which was short but sharp, it's is not back at historic averages. Our forecast is not back at historic averages. There's a variety of reasons for that.

As a general factor, early in recoveries, because of lags in labour markets and a lot other factors, there tends to be a slower recovery in the pace of inflation, and.... Well, we can talk about the specifics of the forecast if we have time.

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

Thank you.