Finance Committee on Oct. 4th, 2010

[The Chair, Conservative, James Rajotte]

Merci.

I will take the committee's direction. We'll start by adding Mr. Wilson, as Mr. Mulcair suggested. D'accord?

On Mr. Menzies' amendment, in terms of his additions, all in favour?

(Amendment agreed to) [See Minutes of Proceedings]

That's unanimous.

And on the motion as amended?

(Motion as amended agreed to)

That's unanimous. Thank you.

I will seek some guidance from members as to when they want to do the timing. As they know, we're in pre-budget hearings and are quite busy with that, but we will obviously have to add some additional meetings this fall to accommodate the motion. Thanks to all of you.

I want to thank our witnesses for their patience this afternoon. I appreciate it very much. We do have a two-hour session here and we wanted to have this session with a number of the chief economists with respect to our pre-budget hearings.

We have with us today, from CIBC World Markets, Mr. Benjamin Tal, deputy chief economist, and from the Conference Board of Canada, senior vice-president and chief economist Mr. Glen Hodgson.

We have Bernard Brun, Director, Government Relations, and François Dupuis, Vice-President, Economic Studies, from the Mouvement des caisses Desjardins. We also have Carlos Leitao, Chief Strategist and Chief Economist from the Laurentian Bank of Canada.

Thanks to all of you for being with us here today.

Each organization will have up to ten minutes for an opening statement. Then we will proceed to questions from members. We'll start with Mr. Tal.

[Benjamin Tal, Deputy Chief Economist, CIBC World Markets]

Thank you very much. I'm going to be relatively brief.

I think the real measure of intelligence is what you do when you don't know what to do. I think Bernanke in the U.S. and Carney here in Canada will tell you that they don't know what to do, because that's the way they discuss the situation. Both of them have told us that the situation now is described as an “unusual uncertainty”, which means that there is significant room for error, one way or another.

If you look at the consensus, the so-called consensus, among economists, you will see that there is a wide range between the optimists and the pessimists. Even the finance minister admitted that there is a significant level of uncertainty as far as the economy is concerned.

The question is what to do when you don't know what to do. The answer is to not overreact, first of all, and to not make mistakes. I think this kind of environment suggests that we should be prudent as far as the budget is concerned.

If you look at the U.S. economy, you see a situation in which the housing market there is really struggling in a very significant way. If you look at the real estate market in Canada, you see that it's slowing down significantly. If you look at China, you see that it's slowing.

You see so many things that are missing at this point. Government money was artificially stimulating the economy in the first half of the year, and now this government money is not available, on both sides of the border. To me this suggests that the economy will slow down much more than was expected six months ago. This means that we will face a shortage of revenues over the next 12 months, with the economy growing by only 1.9% in real GDP and maybe 3.5% in nominal GDP, where you derive the revenues from.

Clearly we are entering a very, very challenging period as far as the economy is concerned. And it's not just Canada; it's the U.S., it's China, and it's definitely Europe. It's a global slowdown that will have significant implications for the Canadian economy and the budget situation. Add to it the provincial shortcomings in terms of budgets and you see why we should be prudent.

What does it mean? It means, first of all, that the Bank of Canada should be extremely careful not to raise interest rates too aggressively. Why? Because our consumers are stretched.

The main reason why the Canadian economy was able to outperform the U.S. was the fact that monetary policy in Canada was extremely effective. You have a situation in which consumer confidence in Canada is only 20% below the rates we saw during the happy days of 2007. In the U.S. it is 60% below. If you live in the U.S. and you're not sure about your job tomorrow, and I can give you a zero-percent mortgage, you will not take it. In Canada you will jump on it. That's why Canada was able to outperform. When the Bank of Canada cut interest rates, we got much more stimulus out of it. That's why in the process we had the situation where we had not only the best financial sector in terms of the ability to provide credit but also the strongest consumer sector in terms of the ability to accept this credit.

So we were shooting from both directions, and in the U.S. they were not shooting at all. That's why we were able to outperform. Monetary policy in Canada was extremely efficient.

The problem is that in this process we have accumulated a significant amount of debt. The debt-to-income ratio in Canada is 146%. This is a major challenge. It means that as a society we have become much more sensitive to any economic shock, including higher interest rates. I estimate that we are 40% more sensitive to higher interest rates than we were ten years ago. That is why the Bank of Canada should be very careful.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Tal, for your presentation.

We'll now hear from Mr. Hodgson, please.

[Glen Hodgson, Senior Vice-President and Chief Economist, Conference Board of Canada]

Thank you very much, Mr. Chairman.

I thought I would do three things today: describe what I think is the context for good fiscal policy and what a good fiscal framework looks like; talk a bit about the economic outlook, which, as I think Benjamin just said, is really fraught with uncertainty right now; and then talk about the future course for fiscal policy.

Very briefly, what is good fiscal policy to the Conference Board of Canada and to me as an economist? It's a policy that really manages fiscal balances over the cycle. In the good times, you run balanced budgets, if not surpluses, and pay down debt. In bad times, you are actually able to step up by virtue of that strong position and provide fiscal stimulus.

I think Canada is really a shining example of good fiscal policy over the last, say, 10 to 15 years. The fact that we paid down debt from 1994-95 until 2008 gave us a lot more latitude than countries around the world to add stimulus without a big burden for our taxpayers on a going-forward basis. In many respects, by being ultra-Keynesians in 2008 and 2009 we did the right thing. We got the balance right between fiscal and monetary policy...and we're through it. We've seen growth recovery in Canada for a year now. We've seen employment return to more or less where we were going into the recession. That's all good news.

Going forward we'll have much more difficult times, but I do think we're now in a period where we have to have a medium-term plan to get back to fiscal balance. I'll come back to that.

Secondly, on the economic outlook, it's a very choppy period. We're entering a period in which there's both structural change going on globally--with the rise of China, India, and Brazil as the new centres of global growth--and all the challenges that still remain in Europe, Japan, and North America. The balance of global growth is really switching now from the industrial countries, where it used to be based, to a world where we're going to rely a lot more upon China, India, Brazil, emerging markets, as sources of growth.

There is still uncertainty in financial markets, in Europe in particular. Japan has the highest debt-to-GDP ratio in the world right now, at about 200%. I see bad things coming down the road in Japan.

Within North America, it's obvious that the United States has gone through a very difficult period. After a financial crisis, it's very hard to see a return to stable, sustainable growth going forward. The lack of consensus in the United States on what is the right policy framework is adding to the uncertainty.

So we're going through a really difficult period as a global economy. We are the shining light, I would argue, amongst industrial countries. Canada is clearly in better shape than almost anybody else in the world. But it's not going to be easy. As a consequence, we are right now in the midst of actually slowing down our forecast for growth in Canada for this year, next year, and going forward. That's going to present a big challenge for budgets. Whoever is in office federally, provincially, and in cities is going to face a challenge, because the strong, sustained growth that we normally have coming out of a recession just won't be there. A growth of 3% will be a good year. More likely growth of 2.25% or 2.5% is the kind of world we're going to live in for the next 18 months.

So what about fiscal policy on a going-forward basis? I strongly believe that in fact fiscal stimulus has done its job now, and we're going to see the stimulus program ramping down. We are seeing slow growth--it's not strong, but it's sustained--from the private sector. I think we've reached the point where we have to withdraw the fiscal stimulus from our system and have a plan to get back to balance over, say, a five-year period.

I also think, though, that we have to build shock absorbers into our fiscal plan. We have to use conservative assumptions when planning, because we're not going to see nominal income growing at 7% or 8% on a going-forward basis.

In terms of the budgeting itself, we had a chance to meet with the minister this morning. One of the comments I made is that we should be rebuilding shock absorbers right into the budget, and go back to a period of having reserves built into the budget, simply because there is so much uncertainty out there and things can move so much in a period of time. I would like to see the federal government with a bit of an absorptive capacity inside to sustain any future shocks to the financial system, to U.S. growth and elsewhere.

So if I pull all of that together, it also means that we're probably going to have to rely more upon monetary policy in the United States and elsewhere in the world than on fiscal policy to deal with any of these shocks as they come along. I'm looking at a three- to five-year plan to get back to balance, relying more upon monetary policy as the means of dealing with shocks to growth, and really planning for balancing the budget by about 2015.

I'll wrap up by saying that I wrote a commentary this summer that seemed to attract a little bit of media attention, talking about the government being slightly ahead of plan when it comes to balancing the budget. We still believe that. I said up to a year; it may be a little less than a year, but I do think the government really should be aiming at getting back to a balanced budget position sometime around 2015.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Hodgson.

Monsieur Dupuis, s'il vous plaît.

[François Dupuis, Vice-President , Economic Studies, Mouvement des caisses Desjardins]

Thank you and good afternoon, everyone.

We have experienced an atypical recession and the recovery has been equally atypical. The financial crisis has greatly affected many countries. After all the public investments made in a number of industrialized countries, we thought there would be a spark last summer and the private sector would take over from the public sector. We finally realized that this was not the case. The economic growth rate is still relatively low by historical standards. I think it is because we are going through a rebalancing phase.

The economic world has been in a state of euphoria over the last 10 years, perhaps even longer. Many industrialized countries are in the process of rebalancing their public finances. Governments really have spent a lot of money. We are going into a period of rebalancing. The contribution of a number of governments to the economy will become negative. We see that consumers, especially in the United States, are bringing their savings rates up while trying to bring their debt levels down. As to the rate of debt to personal disposable income, we went from 140% to 125%. So there is an improvement.

It is a similar story with the housing market as levels are extremely low. The housing market in the United States will not see increased activity overnight. As a result, the Americans are sort of in limbo and there is very little demand for credit. The SMEs are the main job creators in the United States. But there is no demand for credit right now. Even though American companies are in good financial situation, are flourishing and are making a lot of profit, they seem to be waiting because they realize demand is still very low. So the situation is of major concern for the next few years. That explains to some degree why the economic context will be slightly different over the next few years. That is because a major rebalancing act is in progress in order to ensure healthy long-term economic growth.

This environment is fraught with risks.There is public debt, the housing market could crash, currencies are highly volatile, and so on. So financial markets are very skeptical at the moment towards the global economy and the American economy. As a result, everyone is very cautious and the economic growth rates are lower than usual. They will be slightly lower than the long-term production potential of any major economy would allow for, with inflation that will remain very low for a number of years. So we run the risk of disinflation and even of deflation in some cases. So central banks must be very cautious, ours included. I think it is the end of interest rate increases in Canada. We will soon have an extended break to get an idea of what is going on and how the Canadian economy will react to the American economic downturn.

Canada has a sounder economy except for the exports that have gone down significantly. We saw that our financial system was sounder, household wealth did not decline as much during the crisis and Canadians had less debt than Americans. In short, domestic demand did very well. We have even recovered all the jobs that were lost during the recession. Incomes are fairly good. Our job market is working relatively well and the housing market did not experience a drop in prices during the recession. We have even gone back to some of the prices we had before the recession. So there are less risks but we cannot think of ourselves as a remote island. If the rest of the world or the United States are experiencing difficulties, we will also have problems in the coming quarters. It will be quite a challenge for our economy.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Dupuis.

Finally, we'll hear from Monsieur Leitao.

[Carlos Leitao, Chief Strategist and Chief Economist, Laurentian Bank of Canada]

Thank you very much, Mr. Chair.

Good afternoon, everyone. Thank you for inviting me.

I do not want to repeat my colleagues' remarks, but I would like to reinforce what François has just said. Canada is not an island. What happens elsewhere is very important for Canada. But, in 2009 and in 2010, we still performed very well, better than our neighbours and better than Europe.

We had a very effective monetary policy and good fiscal support. As a result, consumption was really pushed to the maximum. Domestic demand, or consumption, especially in housing, was what really took the sting out of the recession in 2009 and 2010. I think we pushed the area to the maximum. Levels of debt are very high.

As Mr. Carney also mentioned in his speech in Windsor last week, from now on, future growth in consumption expenses in Canada, housing included, should be at more or less the same level as the growth in income. We can therefore no longer continue to sustain a growth in expenses that by far outstrips income growth, or, in other words, an increase in debt. Private debt, household debt, should now stabilize and level off. In the future, consumption will be a much smaller contributor to overall growth.

Exports are therefore becoming an important engine of growth in Canada. Unfortunately, as has already been mentioned here, foreign attitudes in that area, especially in the United States, our biggest trading partner, are none too pleasant, at least in the short term, for 2011 and 2012.

So that is the environment we are in and we have to face up to it. I think that we in Canada are in a period of economic growth between 2% and 2.5% in real terms at most. Inflation is very low, perhaps 1%. So there is a nominal growth in GDP from which come government revenues of 3.5% to 4% at best. When we do our fiscal planning, that is what we have to work with.

That is all for the moment, thank you.

[The Chair, Conservative, James Rajotte]

Merci.

We'll now go to questions from members, with the first round being seven minutes.

We'll start with Mr. Brison, please.

[Scott Brison, Liberal, Kings—Hants, NS]

Thank you, Mr. Chair.

Thank you very much to our witnesses today.

My first question is on the issue of personal debt. One of the areas where we in Canada do not compare favourably internationally is the area of personal debt levels. I believe the average is $42,000 per Canadian in terms of personal debt. That ranks us among the highest in the industrialized world in terms of personal debt.

That, combined with the federal debt and then also provincial debt numbers, creates a more troubling figure. In fact, we're often compared as a country.... Our debt-to-GDP numbers typically only compare our federal debt numbers with those of other countries that are in many cases unitary states, or states wherein other levels of government are not able legislatively to take on the same levels of debt. But if you combine federal debt, provincial debt, and personal debt--i.e., gross debt--within Canada as a percentage of GDP, the Canadian figure is 81.6% of GDP--gross debt as a percentage of GDP. The U.S. is almost at the same level, at 82.3% of GDP.

So those figures are kind of troubling, particularly considering that in terms of gross debt as a percentage of GDP we're worse off than countries like Germany and the U.K. I'd appreciate your thoughts on that, because there's only one taxpayer, even though there may be a number of states that can take on debt, and ultimately we all have to collectively deal with the realities of paying for health care, social investment, and the rest of it. I'd appreciate your thoughts on the risk that this level of indebtedness comparatively represents to Canada.

[Benjamin Tal]

Let me respond to that.

Clearly the debt situation in Canada has deteriorated--I'm talking about personal debt now--over the past two to three years, reflecting the fact that monetary policy was very effective. That's one of the reasons Canada was able to outperform....

However, you can talk about debt and you can talk about the quality of debt; namely, not all debt is created equal. If you look at the U.S., the debt-to-income ratio was more or less the same, but 33% of the mortgage market there was made up of sub-prime mortgages, as opposed to the situation in Canada, where it is less than 5%.

I'll give you another number: only 4.1% of households in Canada have less than 20% equity in their house and a debt-to-service ratio of more than 40%. So there's debt and there's quality of debt.

I will be the first to admit that the debt situation in Canada is unsustainable, and we have to see some de-leveraging happening. We have to see the savings rate rising and we have to see credit going down, and it's starting.

The question is to what extent the government should do something about it. My advice is that at this point it should do nothing, because the economy's already slowing. The market is taking care of itself.

If you look at the housing market in Canada, it is already slowing down. House prices are falling. Mortgage activity is slowing down. Consumer credit is back to the levels we have seen in the recession in terms of a month-over-month rate of growth. So the market is already clearing.

I totally agree that the debt situation is a problem. This is not the time to deal with it. A year or two years from now, if we see a rebound in credit and the housing market starting to rise again, that will be the time to take care of it.

At this point, don't fight the momentum. The momentum is helping us now.

[Glen Hodgson]

Mr. Brison, I guess my reaction is that you just made the case for why the federal government should have a three- to five-year plan to get back to balanced budgets. There is only one taxpayer, and some provinces are in far worse shape than the federal government.

I'm worried about Ontario's structural deficit. For example, my fear is that Ontario's going to get stuck with a structural deficit of at least $10 billion and maybe more. We saw a very tough budget put in place in Quebec this spring because the Quebec government was well aware of the demographics working against it and the fact that it had to get back to a balanced budget by about 2014.

Notwithstanding Mr. Tal's comments, I do think the federal budget did the right thing in terms of the structure--having a five-year plan to get back to balance--because ultimately there is only one taxpayer.

I don't think there's that ongoing need, for example, for federal stimulus in any form. I think we can allow monetary policy to do the job. If there's any slack required on our economy, it can be achieved through monetary policy.

I actually agree with you entirely that we have to be very conscious of the indebtedness--personally, provincially, and federally--and ensure we have a plan to get back to reducing that debt burden over time.

[The Chair, Conservative, James Rajotte]

Monsieur Dupuis wanted to comment.

[François Dupuis]

Yes, I think you are right. In Canada, the level of debt, both public and private, is extremely high. We do not feel quite so bad when we see the situation other countries are in. Ours is a little better. I believe that we must also consider the quality of the assets. In my opinion, Canadian assets are of better quality than assets in other countries. We must also consider the percentage of the public debt which is financed from outside the country. Our risk in that area is perhaps a little lower. However, the constant increase in indebtedness is the result of very low interest rates. If ever rates quickly went up to the levels we saw some years ago, a lot of people would be in trouble, which would cause quite a significant impact on the Canadian economy.

However, I feel that is unlikely that rates will go up very much. We can probably use the opportunity to urge Canadians to reduce their levels of debt as quickly as possible in case rates were to increase. As for the federal and provincial governments, we have seen that a healthy budget situation is the best insurance during a recession or hard times. We saw that in Canada in 2008 and 2009.

[The Chair, Conservative, James Rajotte]

You have 30 seconds.

[Scott Brison, Liberal, Kings—Hants, NS]

Okay. With a commodity-led recovery in Canada, if we assume that commodity demand from the emerging countries is going to be quite robust on a secular basis for a long time, what's the risk to Canada from having a very uneven recovery, with upward pressure on our dollar and a continued crowding out of some of our traditional industries in some of our traditional economic heartland areas? I'd appreciate your thoughts on that risk and what that could mean for unemployment.

Thank you.

[The Chair, Conservative, James Rajotte]

Okay. Let's just get one in.

Mr. Leitao?

[Carlos Leitao]

Thank you.

On the commodities side, certainly we still think that the economic prospects in emerging markets, particularly China, India, and Brazil, are much, much stronger than they are in North America or Europe. Therefore, their growth will be higher and demand for raw materials will be higher, so there should be some upward pressure on commodity prices, which will be good for Canada. After all, we do have a large natural resource base. The byproduct of that will probably be a significantly higher or high Canadian dollar--close to parity.

Now, we can open a discussion that we have had for many, many years about the productivity of Canadians, Canadian manufacturers, and a high dollar or low dollar, but I think the economy here now is adjusting to a high currency. We are going to end up with a manufacturing sector down the road that is smaller than what it is now, but more efficient and more productive, or so we hope. That adjustment process is taking place elsewhere in Europe and in the United States.

I think the risk I see for Canada is that we keep on saying, with some reason, that we've escaped the worst of the recession, and we could be a little complacent, as Ben was mentioning earlier this morning. And we shouldn't be, because it's a scary world out there, so we need to be very productive and very efficient with the high dollar.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you very much, Mr. Brison.

Mr. Paillé, the floor is yours.

[Daniel Paillé, Bloc, Hochelaga, QC]

Good afternoon. I agree with the general opinion that the quality of the assets is the key to the interest rate situation. It is all part of risk management. If the debt is partly or mostly domestic, let us not forget that interest income is taxable. That is a good amount of tax revenue.

I am sorry, but I am probably going to direct my questions more or less to the people from the Mouvement des caisses Desjardins, who took the time to write to us.

In your document, you talk about excessive levels of debt, but you also say that we have to achieve a balance in a measured way. I think you mentioned that earlier. Maybe a rate of 80% could be seen as terrible. But when I consider the comparables, I hesitate to use the word “excessive”. It is a significant level of debt, but to call it excessive... Anyway, I do not share the same opinion. In a previous life, I could have discussed this on TVA with Mr. Leitao at any time, but those days are behind me.

In section 2 of your brief, you say that we have to bank on human capital and you mention education. I fully agree with you. We are on the same wavelength there, but I suggest a degree of prudence. I advise you to take areas of competence into consideration. You do it very well. We are here in the federal Parliament. I would like to hear your comments on that.

In section 3 of your brief, you say that Desjardins has a very decentralized system, which gets everyone involved. You seem to be saying that securities trading is working very well in Canada, and you use Desjardins as an example. Your suggestion is: “if it's not broken, don't fix it”. Tell me if I am taking that a little too far, or if you really do think that the Desjardins system is working very well and there is no need to change it.

[Bernard Brun, Director, Government Relations, Mouvement des caisses Desjardins]

We certainly dealt with the question of securities trading in our brief, but in a much more general way. At Desjardins, we put a high premium on cooperation and collaboration between the provinces and the various levels of government. We do not break with those principles, even in securities trading. I think that the passport system, for example, works well. There is work to do, and it continues to be done, but we will make our way to a better outcome by working together.

[Daniel Paillé, Bloc, Hochelaga, QC]

A little further on, in section 5, you say: “The Government of Canada must take rapid steps to position itself, especially with regard to programs like Clean Energy Jobs.” Are you referring to the old incentive program for wind energy from which the federal government has withdrawn? It seems to me that Quebec manufacturers of wind energy systems are going to be setting up shop in the United States, since they cannot operate in Canada. Is that what you were talking about?

[Bernard Brun]

We were not talking about that program specifically, but, yes, we think that we should be aligning ourselves with programs like that. We did not bring our environmental credit expert with us, but we think that our government could be taking concrete action, but that has been slow in coming of late.

[Daniel Paillé, Bloc, Hochelaga, QC]

Along the same lines, in the next paragraph, you talk about greenhouse gases and a regulatory framework. You are probably going to be meeting with the Minister of Finance, if you have not already done so. Can you tell us if Canada is finally going to set rules for carbon gases and whether we are going to get a viable carbon exchange?

[François Dupuis]

We have a meeting scheduled for the next few weeks. We will see if we can bring that issue up.