Finance Committee on Oct. 26th, 2010

[The Chair, Conservative, James Rajotte]

Okay—

[Mark Carney]

Please, we've spent a lot of time on this, so I want to continue, if I may, Chair.

We are the ones who give the orders and the objectives to Mr. Hodgson and his team to get the negotiation done, which ultimately has to be closed by Mr. Macklem and me, because it will be decided at the governor level across many jurisdictions and at the CEO level of banks. So this is a complex negotiation and it's why we needed somebody like him.

And finally, to your mutual point, and I respect your question, as to why we didn't have a cooling off period that was very precise ex ante, the likelihood of Mr. Hodgson going back into the derivatives world, or in fact into the derivatives world, is very low, because he doesn't come from the derivatives world. He has a skill set that applies to multiple things that are away from that world.

[The Chair, Conservative, James Rajotte]

Okay, thank you very much.

I know it's a very serious issue, Mr. Carney, and if you want to provide the committee with any further information, we'd certainly appreciate that, I know.

I'm going to take the next government round.

I just want to follow up on the Basel III requirements, which we were going to have Mr. Macklem address. Obviously, two of the reasons that the Canadian financial sector came through the last two years in fairly good shape were our capital ratios and leverage ratios. On the Basel III requirements in terms of the levels of capital required, from what I'm hearing from the financial sector, they can very much live with the levels of capital. There has been some concern expressed by certain institutions with respect to the type of capital required.

I know, Mr. Macklem, you were going to address it generally, but I was wondering if you could address that specific issue in your answer as well.

[Tiff Macklem]

Certainly.

As you indicated, there are a few elements to the new Basel III capital rules. First of all, let me just say that it's a very good agreement, with an appropriately lengthy transition period, reflecting the fact that it is a significant strengthening of the rules.

In terms of some of the specifics, as you mentioned, the levels of capital are higher. There is more emphasis on true capital--that is, capital that can actually truly bear losses, such as tangible common equity. There is a narrower set of deductions, strengthening the definitions, so that we are focusing on true capital.

There are also some other important elements. There's a limit on leverage. As you know, Canada has had a cap on leverage for some time. So we think this is a very positive development. There's also an additional buffer that institutions would build up in periods of excess credit growth that appear related to systemic risk, because of the increased likelihood that ultimately there will be a correction.

So those are some of the core elements.

Canadian banks are certainly well positioned. They came into this crisis with strong capital levels, and were able to raise further capital when needed. But Canadian banks will have to make some adjustments, particularly given the new definitions, and that's certainly something they have indicated they're very confident they can do.

[The Chair, Conservative, James Rajotte]

The second issue I want to raise is with respect to the statement made by Governor Carney that “The strength of net exports will be sensitive to currency movements, the expected recovery in productivity growth, and the prospects for external demand.”

You have some faith in terms of continuing export growth, but you obviously do have these three cautions in here. You've talked about the currency with respect to China, but I'm just wondering if there might be some other countries who choose to devalue their currency to address their own fiscal situation. Are you at all concerned about that and its impact then on our exports?

[Mark Carney]

We are concerned, and elsewhere in our statements and in the discussion today we've highlighted the heightened tensions in global currency markets. To put a slightly finer point on it, there was a period earlier this year when more than 40% of the trade-weighted amount of the U.S. dollar.... If you looked at all of the trading partners of the United States, more than 40% of the currencies, by trade volume, were in some way managed.

Those are the tensions that we need to work collectively to reduce. We had important reaffirmations of the commitments of advanced economies over the course of this weekend, and an extension and important commitment, for the first time, by all countries of the G-20 to refrain from competitive devaluations.

Now, those have to be respected, those have to be implemented. We have to keep focused on this. We have to be relentless on the whole range of issues around global imbalances. But you are right to raise the issue, in that when we look at tensions in foreign exchange markets, we do see the link through to Canada very importantly on the net export side as a risk to the outlook.

[The Chair, Conservative, James Rajotte]

Are you more confident now? Because there was some nervousness leading into the talks in Korea that the consensus that had been formed at Toronto, or at least was being formed there, is actually unravelling. Are there are any concerns, or are you...?

[Mark Carney]

I would say that progress was made in Korea, but the discussions or process is not finished. We need to continue—and the Minister of Finance and the Prime Minister I'm sure will continue—with that in the run-up to Seoul. I'll continue with my colleagues. It will be an important element of the French presidency of the G-20 next year to see this process through.

So yes, there was progress made this past weekend, but no, it's not over; it has to proceed.

[The Chair, Conservative, James Rajotte]

Okay, thank you.

We'll go now to Mr. Brison.

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

Governor, earlier you referred to some macro-prudential measures that are being taken or implemented in other countries, or have been implemented. You spoke of some loan value measures. I think we'd benefit from more information on some of these types of measures. You referred specifically to CMHC reform, but I'd like to learn more about what loan value measures are being taken in other countries, to inform our committee on some of these initiatives.

[Mark Carney]

Okay, thank you.

One of the more direct measures that has been taken in a range of countries, for example by Israel and Hong Kong on the advanced economies' side, and by China and India and other emerging markets, has been to reduce the amount of a loan that can be set against the value of a property. Those measures are having some impact in terms of asset prices and, more particularly, house price inflation in those economies.

Now, in some of those cases the challenge is as much the stance of monetary policy as the stance of lending policy. In some of those cases monetary policy is loose, which is encouraging house price appreciation because the country's currency is managed, and that creates its own chain of issues. In Canada, obviously, we don't face that issue with the floating currency and our commitment to a floating currency; and we have, in relative terms, a different order of magnitude of activity and asset price behaviour in our housing market.

The CMHC, at the request of the Minister of Finance, took some tightening measures earlier this year and last year to make adjustments to the mortgage insurance that CMHC offers, which is a much more multi-faceted way of addressing the problem than a simple loan-to-value measure.

So I would say this area is something Canada is becoming more familiar with. Measures have been taken. Those are starting to have an impact. We work in close cooperation with the Department of Finance, CMHC, and the Superintendent of Financial Institutions to evaluate situations in the housing market and other markets, and we think about which tools are best suited to adjust. I would say that cooperation is very close, it's very effective, and that we have the appropriate level of vigilance in that regard.

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

On September 16, when you spoke with the Globe and Mail editorial board and discussed the need for the long-form census in order for the Bank of Canada to be able to set monetary policy, you said that you'll take additional measures within the bank to make up for the lack of reliable information from Stats Canada as a result of the decision to cancel the long-form census. What additional initiatives will you be taking within the bank, and how much will they cost?

[Mark Carney]

Well, the principal measure that we're taking at this stage is engaging in much closer collaboration with Statistics Canada, over the coming months and really over the coming year, on the potential--underscore potential--implications of the move to the national household survey. We have a working group that is set up. We're going to work with them. A lot of that work is really going to begin in earnest once the data is collected from the national household survey. It really won't start until the first quarter of next year, and then we'll try to assess the implications, if any, for a variety of relevant surveys and data for the Bank of Canada, such as the labour force survey.

We're engaged. We've got a process in place with Statistics Canada that will unfold over the coming year and we'll assess from there. We're not running off and looking for alternative sources of data at this stage. And there's no cost. At this stage, we're using the people we have who are experts in statistics who are working with StatsCan on this important issue. I would say that we're very pleased with the level of seniority and cooperation we've received from StatsCan on this issue.

[The Chair, Conservative, James Rajotte]

Thank you.

Mrs. Block.

[Kelly Block, Conservative, Saskatoon—Rosetown—Biggar, SK]

Thank you very much, Mr. Chair.

I just have one question, and I would invite any of my colleagues who would like to follow up to do so.

Mr. Carney, you stated earlier, I believe, that there are limits to the role the Bank of Canada's interest rates play in controlling or addressing inflation. Later on it was mentioned that low, stable, and predictable but not zero is what's desirable when it comes to the inflation rate. I want to make sure I understand price-level targeting and how that fits with the two statements. And is this policy of price-level targeting used elsewhere, in any other countries?

[Mark Carney]

Okay. I'm not sure your colleagues will have a chance to follow up, given the range of important questions there.

On the first point, I'll refer to the answer of my colleague on the optimal rate of inflation: the value of that 2%. We have done work on the potential value of lowering that. We have published some of that work, and we'll publish the rest of it in due course, well in advance of the renewal of discussions on the inflation target. I'll leave it there.

To be absolutely clear in terms of the interest rate and the conduct of monetary policy in Canada, we have the tools we need to achieve the 2% inflation target. There are lags with the operation of monetary policy. We can't instantly change monetary policy today and correct an overshoot or an undershoot on inflation tomorrow. It takes time: think in terms of a year to an 18-month type of timeframe.

Sometimes it takes a little longer when there are certain factors that are overlaid. Today, for example, we see inflation fully returning to target. It's very close to target over the forecast horizon, but it will fully return to target about two years from now.

There will be intervening events between now and then that will have an impact. We'll adjust the policy accordingly, if they are viewed to be more permanent than transitory.

We have the tools we need to achieve our objective, and it's our responsibility to achieve that objective.

On price-level targeting, to give a little more colour to what I said earlier, the issue there is a path for the level of prices, as opposed to a rate of change in the level of prices. In that regard, at any given point in time that there is a deviation from the price path.... And let's think of a 2% price path, so if prices today are 100, they'll be 102 a year from now. If inflation were 3% this year, for whatever reason, the commitment under price-level targeting is that we would conduct monetary policy to make up that overshoot in subsequent years so that inflation would go from 102, and ultimately it would end up at 104.--the senior deputy minister can do the math very quickly.

We adjust policy in order to achieve that price path over time. So the bygones aren't bygones; we make up the misses.

Why would we possibly do that? What's the advantage of doing that? It's greater certainty on the price level for individuals. So if you're making a long-term contract or you're buying a 10-year bond, the expectation is that the cumulative amount of inflation over the course of that 10-year contract or bond will be more likely to be the level that is consistent with the price path. For that and other reasons, there are potential benefits to price-level targeting.

On your question regarding whether anybody does it, the short answer is that nobody actually price-level-targets today. Sweden did, briefly, in the Great Depression. The United States had a form of it. It wasn't actually run through the Federal Reserve, but it was a commitment by President Roosevelt that he would return to the 1929 price level that was enacted.

It is a powerful mechanism, potentially, to avoid deflation. What one does when one says we are going to return the price level back to that path is to ensure that bygones aren't bygones, that undershoots on inflation will be made up. The consequence of that is real interest rates, which are what really drive decisions ultimately--the difference between the nominal headline rate of inflation and the expected level of inflation, that real number--will be more consistent with the plan of the central bank, and that promotes investment.

I'm giving a short version of it--you may not feel that it is a short version--and we will happily furnish the committee with more, if required.

[The Chair, Conservative, James Rajotte]

Thank you.

Mr. Szabo, please.

[Paul Szabo, Liberal, Mississauga South, ON]

Governor, considering what we have come through with the global financial and economic crisis, has that prompted you to think of any reason there should be consideration to changing the role or mandate of your office?

[Mark Carney]

We have a system that works very well here in Canada. In particular, the focus of the Bank of Canada in monetary policy on price stability is essential, in our opinion, to the well-functioning of the Canadian economy. We have other responsibilities, most notably a shared responsibility with other agencies for the promotion of financial stability. Our principal role in that regard is to analyze risk to the Canadian economy, to financial stability like household debt, like the level of capitalization of banks, like potential financial implications of tensions in currency markets. There are monetary implications of that, but also financial implications. We share that perspective with this committee, with the public. We share it with other agencies, including very importantly the federal Department of Finance in Canada, so that, if appropriate in their judgment, policies they control could be adjusted to lessen the potential impact of those financial vulnerabilities.

This system works well. We have a good level of cooperation. I would say further that what we're all learning from the financial crisis--there are some lessons from the financial crisis, including for Canada, and they relate to the potential use of policy levers that address the health of the financial system as a whole, as opposed to individual institutions. Mr. Brison's questions earlier about loan-to-value ratios and the potential adjustments to elements of mortgage insurance to address vulnerabilities or tensions that build up in the housing market--that's an example; it's something that's been used in Canada.

Mr. Macklem referenced counter-cyclical capital for banks. That's a Canadian innovation at the Basel committee, and that's another example. So there are examples of these system-wide tools. A third example I'd add is margin requirements in the repossession market, which is something we're looking at very closely. There are several examples of the system-wide tools we are working through with our partners in Ottawa and across the country to determine their efficacy and advisability. That's not a change to the mandate of the bank, but I wanted to give you a richer answer to some of the issues we see coming out of the crisis.

[Paul Szabo, Liberal, Mississauga South, ON]

Thank you, I appreciate that. It sounds as if at this time you have the tools to do the job.

[Mark Carney]

Yes.

[Paul Szabo, Liberal, Mississauga South, ON]

The Parliamentary Budget Officer has fascinated me. He's had some interesting projects. He opined on something that.... Let's put it this way: I assume the economic update and all the numbers you've looked at assume there will be a delivery on the full stimulus package that was in the original 2010 budget. The Parliamentary Budget Officer said it's possible that 25% to 50% of the approved projects may not be complete by March 11, which raises the question, and it has been raised in Parliament, about whether the government will abandon those projects or whether it will be a download to other jurisdictions to complete them, etc.

Is the magnitude of the estimates of 25% to 50% of the approved projects of concern to you in terms of their potential impact?

[Mark Carney]

We have not changed our forecast for the sum of federal and provincial government spending between these monetary policy reports. We continue to have the expectation of an important contribution of government through the end of this federal fiscal year, based on current plans that the contribution from the government reduces and there's a slight fiscal drag, a combination of federal and provincial, over the balance of the projection horizon. Part of the dynamic of the projection we have is that we move from a very important fiscal stimulus to relying more on household consumption, investment, and, on the very margin, net exports.

So our expectations are continued contribution from government, consistent with current plans. Obviously we will adjust that projection if we form the view this is unlikely, but we do not have reason to form that view at this point.

[Paul Szabo, Liberal, Mississauga South, ON]

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Szabo.

Mr. Menzies, you have about a two-minute round.