Finance Committee on Oct. 26th, 2010

[The Chair, Conservative, James Rajotte]

I call this meeting to order. This is the 40th meeting of the Standing Committee on Finance in this session.

Colleagues, just before we get to our two witnesses today, I understand that Mr. Pacetti has a motion that I believe all members of the committee have agreed to.

Mr. Pacetti, you have the floor.

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

Thank you, Mr. Chairman.

If you shall seek it, you shall get it. Is that it? You shall reap it?

The motion is that the committee invite Kevin Page, Parliamentary Budget Officer and private sector economist, to appear before the committee on Wednsday, November 3, for two hours to discuss the government's most recent economic update, fiscal projections, and any other item related to the government's fiscal framework or their own revenue and expenditure projections.

[The Chair, Conservative, James Rajotte]

That would be a two-hour meeting on Wednesday, November 3.

(Motion agreed to)

Merci. Thank you very much, Mr. Pacetti. That motion is adopted.

Ladies and gentlemen, on behalf of the committee I want to welcome back to the finance committee the Governor of the Bank of Canada, Mr. Mark Carney. We're also delighted to have for the first time.... We've had Paul Jenkins here before. We're delighted to have Mr. Tiff Macklem, in his new or fairly recent role as senior deputy governor of the Bank of Canada. They are here to discuss the report of the Bank of Canada on monetary policy.

Thank you for being with us here today, gentlemen.

Mr. Carney, you have up to ten minutes for an opening statement, and then we'll get into a discussion with members.

[Mark Carney, Governor of the Bank of Canada]

Thank you very much, Chair.

Good afternoon, members. It's my pleasure to be here and to formally introduce Tiff Macklem as senior deputy governor of the Bank of Canada. Tiff assumed his post, appropriately, on Canada Day this past year.

We're very pleased to be here to discuss the bank's views on the economy and our monetary policy stance. l would like to give you some brief highlights from our latest monetary policy report, which was released last week.

The global economic recovery is entering a new phase. In advanced economies, temporary factors supporting growth in 2010, such as the inventory cycle and pent-up demand, have largely run their course and fiscal stimulus will shift to fiscal consolidation over the projection horizon.

The bank expects that private demand in advanced economies will become sufficiently entrenched to sustain the recovery. However, the combination of difficult labour market dynamics and on-going deleveraging in many advanced economies is expected to moderate the pace of growth, relative to prior expectations. These factors will contribute to a weaker than projected recovery in the United States in particular.

Growth in emerging economies is expected to ease to a more sustainable pace as fiscal and monetary policies are tightened. Heightened tensions in currency markets and related risks associated with global imbalances could result in a more protracted and difficult global recovery.

The economic outlook for Canada has changed. The bank expects the economic recovery to be more gradual than it had projected in July, with growth of 3% in 2010, 2.3% in 2011, and 2.6% in 2012. This more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending.

Overall, the composition of demand in Canada is expected to shift away from government and household expenditures towards business investment and net exports. The strength of net exports will be sensitive to currency movements, the expected recovery in productivity growth, and the prospects for external demand.

Inflation in Canada has been slightly below the bank's July projection. The recent moderation in core inflation is consistent with the persistence of significant excess supply and a deceleration in the growth of unit labour costs.

The bank judges that the output gap is slightly larger and that the economy will return to full capacity by the end of 2012, rather than the beginning of that year, as had been anticipated in July.

The inflation outlook has been revised down and both total CPI and core inflation are now expected to converge to 2% by the end of 2012, as excess supply in the economy is gradually absorbed and inflation expectations remain well anchored.

Important risks remain around this outlook. Three main upside risks to the inflation outlook are higher commodity prices, a stronger than anticipated recovery in the U.S. economy, and the possibility of greater than projected momentum in the Canadian household sector.

These upside risks are balanced by three downside risks relating to Canada's international competitiveness, global growth prospects, and the possibility of a more pronounced correction in the Canadian housing market.

In response to the sharp synchronous global recession, the bank lowered the target rate rapidly over the course of 2008 and early 2009 to its lowest possible level. We almost doubled our balance sheet to provide the financial sector with exceptional liquidity. With our conditional commitment, the bank provided exceptional guidance on the likely path of our target rate. These policies provided considerable additional stimulus during a period of very weak economic conditions and major downside risk to the Canadian economy.

With the initial rapid narrowing of the output gap, the return of employment to its pre-crisis peak, the highly effective transmission of monetary policy in Canada, and the sustained momentum in household borrowing, the need for such emergency policies has passed.

Since the spring, the bank has unwound the last of our exceptional liquidity measures, removed the conditional commitment, and raised the overnight rate to 1%. Last week, on October 19, the bank maintained the target for the overnight rate at 1%. This leaves considerable monetary stimulus in place, consistent with achieving the 2% inflation target in an environment of significant excess supply in Canada.

At this time of transition in the global recovery, with a weaker U.S. outlook, constraints beginning to moderate growth in emerging market economies, and domestic considerations that are expected to slow consumption and housing activity in Canada, any further reduction in monetary policy stimulus would need to be carefully considered.

With that, Mr. Chair, Tiff and I would be very pleased to take questions. Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll begin members' questions with Mr. Brison, for seven minutes.

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

Thank you very much, Mr. Carney and Mr. Macklem, for appearing before us today.

I want to raise first the issue of housing prices. The October 23 edition of The Economist magazine has cited Canada as having a housing bubble. In fact comparatively, The Economist believes that the Canadian housing market is overvalued compared with those of countries such as China and the U.S. How concerned should Canadians be about this risk, and what does this housing bubble mean to Canadian families?

[Mark Carney]

Thank you for the question, Mr. Brison.

I'd make two distinctions. First, the bank's expectation with respect to economic growth has been that activity in the broad housing sector, meaning housing starts, renovations, and housing sales and the commissions that come from those, would decline markedly starting in the second quarter of this year and continuing over the course of this year. That is what we've seen: the level of activity that we've seen in the housing market has been consistent with our expectations. This has been a function of basically a concentration of housing activity through last year and the start of this year, because of pulled-forward demand because of the HST coming into place, pent-up demand because of the recession, obviously, and also the positive impact of the home renovation tax credit. So there's been that concentration. Now we see there's a decline markedly.

On the separate issue of the levels of valuations of housing, I would say that our expectation is that housing price appreciation and the net worth accumulation associated with the house price appreciation over much of this past decade has provided stimulus to consumption, and we do not expect that such stimulus will be there over our projection horizon.

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

Do you believe that there could be a correction, in fact, in the housing prices in Canada?

[Mark Carney]

We believe that one of the important downside risks to our projection is the possibility of a more abrupt correction in the housing market than we're anticipating. We're not forecasting an abrupt correction, but it is a possibility, given two factors: first, the speed with which house prices rose; and secondly, the absolute weight of debt in the economy that is tied to housing.

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

You raised recently the issue of household debt in Canada, and the TD Economics report further validated that risk. I'd appreciate some of your insight as to what government policy levers we should be looking at in order to reduce the risk of excessive household debt and what kind of regulatory reform we can be looking at. And in terms of macro-prudential measures, what are some other countries doing that we ought to be doing in Canada?

[Mark Carney]

Let me begin by making absolutely clear that there are limits to the role of interest rates in addressing this issue, or more specifically, the role of the Bank of Canada's interest rate. We conduct monetary policy with the sole objective of achieving our inflation target and that's the agreement with the Government of Canada. And as you know, it's a 2% inflation target.

So issues around financial stability and potentially issues around potential emerging vulnerabilities in the household sector are best addressed by other tools. And sometimes those tools are termed, as you just did, macro-prudential tools.

The options include changing elements of the terms of mortgage insurance—

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

CMHC.

[Mark Carney]

—CMHC mortgage insurance, as the government did earlier this year, when it introduced some restrictions on the use of high-loan-to-value mortgages for investment properties, it changed the qualifying interest rate, and it made some other adjustments. We are starting to see the effects of those adjustments on cooling activity in the housing market. So that's one type of tool.

I will say that changes of this type—everybody has a different housing system around the world—including direct regulation on loan-to-value ratios for mortgages are an instrument that has been used in a variety of other locales. And I would further point out that the issues we are facing, in a period of low interest rates and relatively stable prices with accumulation of debt and some asset price pressures, are common to other economies around the world today that did not have the financial crisis. We felt the effects of the financial crisis, but we continue to have financial systems that work and policies relatively low.

So the options in Canada include those types of measures.

The other option, which is not something that has been done, nor are we in an immediate position to do, would be adjustments to the level of capital through the cycle that banks carry against certain types of lending, including to housing.

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

Thank you.

Between 2006 and 2009, in the three years leading up to the economic downturn, government program spending in Canada increased by 18%, just the program spending component. As we enter a period of halting recovery, is that kind of program spending increase—18% over three years, three times the rate of inflation—economically sustainable?

[Mark Carney]

Well, while we don't give precise projections for the growth of nominal GDP—and certainly this committee would understand the revenue side of government finances, whether they're federal or provincial or closely tied to the growth of nominal GDP—it would be inconsistent to sustain that level of spending increase and be consistent with a gradual reduction in the level of deficits as have been planned on both the federal and provincial sides.

That's not going as far as your point on economic sustainability but in terms of consistency.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Brison.

Mr. Paillé, you have seven minutes.

[Daniel Paillé, Bloc, Hochelaga, QC]

Welcome. Welcome back, as I told the Minister of Finance earlier on. I would also like to welcome Mr. Macklem.

You stated very diplomatically in an aside to your brief that the easy part is behind us now. Some people might argue that the hardest part is yet to come.

I would like to begin by asking a question about currency. We are not engaged in a currency war, but there might be some elements to this on a global scale. You point out that many countries or central banks have huge U.S. dollar cash reserves. I would like to know whether this is a tool the bank uses, and what our variation in our U.S. dollar reserves is.

Regarding actions which might attack the Canadian dollar, do you think there is a danger this might happen and that the bank could lose any flexibility it has? I know that we do not officially control the value of our currency and that it is very flexible, but at a certain point, there might be movement in the value of our dollar.

Do you have, or could you have, internal tools which would enable you to play the currency, or, as some people might say, to at least play the market? These internal tools might be those of the bank, or they might come from the pension fund sector, or even from major capital reserves; they could even come from the Caisse de dépôt et de placement du Québec. Certainly, when you have a floating currency, the currency rates vary.

These are the questions I have with regard to the Canadian dollar.

[Mark Carney]

Thank you for your question.

First, the bank has observed that there is presently heightened tension in the currency markets, that is clear. The global economy is in a difficult process, which is that economic activity and economic demand are being transferred from advanced countries to emerging countries.

There was another part to my sentence in which I said that the easy part is over, and that is that the economic drivers are being transferred. The government is not the driver anymore. Nor is it the easy activity generated by Canadian households, for instance, but rather investment and net exports. You are right, the situation is more difficult now.

As a result, there is heightened tension in the currency markets. The Bank of Canada and the Government of Canada are both keeping their options wide open so they can, if need be, manage the situation. What is important is that the Canadian dollar remain strong, because a strong dollar might have a considerable impact on economic growth in Canada.

[Daniel Paillé, Bloc, Hochelaga, QC]

Yes.

[Mark Carney]

The dollar must remain high and have a strong effect on the growth rate in the economy. In those circumstances, we have options.

[Daniel Paillé, Bloc, Hochelaga, QC]

Let's just say that the bank has an interesting toolkit.

As you mentioned, the 2% rate of inflation seems fairly stable. In that case, we can be more flexible regarding everything else.

Concerning risks, you identified three upside risks and three downside risks. Let's go over these risks and assess the likelihood that they will happen.

Let's first look at the upside risks. It is possible that the price of commodities will go up. The risk that the U.S. economy will recover faster than expected is low. As for spending going up in the Canadian household sector, we can only hope this will happen, despite the household debt load. I can only conclude that the upswing risks are not very likely to happen.

As for the downswing risks, you talk about global growth prospects and the possibility of a more pronounced correction in the Canadian housing market.

Am I mistaken, or am I still too pessimistic when I say that the likelihood of the downside risks happening are higher than the likelihood of the upswing risks?

[Mark Carney]

Thank you for your question.

In fact, according to the bank, the risks are balanced. What we did with this projection is that we reduced our forecasts for the Canadian economy, and we reduced them significantly for the American economy. There has been a significant reduction in our growth projections in the interest of balancing the risks underlying this forecast.

As for risks relating to emerging countries, there is a real likelihood for the upswing risks to happen, because as it now stands, in several emerging markets, the monetary policy is too accommodating. This is explained by a situation that has been caused by an imbalance in world markets and in the currencies of emerging countries. That is one example.

As for the upswing risks for the United States, we have reduced our forecast by 0.6% for next year, for example. That is a significant reduction. There are reasons to believe that the American economy will perform better than that.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Paillé.

Mr. Menzies, please.

[Ted Menzies, Conservative, Macleod, AB]

Thank you, Mr. Chair.

Thank you, Mr. Carney and Mr. Macklem. Welcome to both of you.

Welcome to your new role, Mr. Macklem. We worked a lot together at finance. I still miss you there, but we think you found a good home where you are.

If I may, I would like to follow up, Mr. Carney, your lightning quick trip to Korea--no pun intended, I guess, from your flight--to reflect on the coordinated effort. I realize we have a long way to go, but I think we need to remember that this is a coordinated effort. That's why the minister, you, and many others have put so much effort into making sure we work with our international partners.

The comment coming out of there, the statement that we would move to more market-determined exchange rates, I view as a positive step. There was some concern going into these meetings in Korea that we would even come out with that strong a statement. Is that positive, or are they only wiggle words?

[Mark Carney]

Thanks for highlighting that. You are very well informed. There was a little more lightning in my trip than I would have wished.

Yes, this is a positive statement. Let me say a couple of things, if I may, and ask my colleague to expand.

This is a process. This process of rebalancing the global economy, having cooperative solutions to do so in a way that's going to sustain global growth and ultimately enhance global growth in a sustainable manner, is something that is going to unfold over the course of years, as opposed to one meeting with a magic solution.

Importantly, first with Pittsburgh and then fleshed out more in the Toronto summit, the four aspects of policy that have to change have been identified, and meat has been put on those bones. It's fiscal--the Toronto summit, a very important path for fiscal policy. It is structural, but we still have a lot more to do on the structural side. That will be part of the work going up to Seoul, but it will extend beyond. It's financial sector policy. Mr. Macklem, both in his previous job and in his current one, has been working hard on developing that. Hopefully, we'll have a chance to talk about that a bit today. Then also, it's exchange rate flexibility.

So your question, what's relevant here on exchange rate flexibility, it is for the first time a commitment in a G-20 communiqué to move towards more market-determined exchange rates. It is for the first time an explicit commitment to refrain from competitive devaluation of currencies. There is also a commitment to look at indicators of sustainable external balance--think current accounts--in conjunction with the IMF, and then to centre policies around that.

That last bit is part of this consistent approach, this cooperative approach that is getting more and more structured, more and more nuanced, more and more concrete. So I would say that yes, it was worth it to be in Korea, and progress has been made. But as the Minister of Finance has indicated and we've indicated, we all need to remain very focused on this issue, at subsequent meetings over the course of this year and well into next year, to ultimately regulate the situation or to address the situation.