Finance Committee on Feb. 12th, 2013

[The Chair, Conservative, James Rajotte]

I'll ask all of our friends in the media to let us start the meeting, please.

Thank you very much.

Good morning, everyone. This is the 104th meeting of the Standing Committee on Finance. Our orders of the day are, pursuant to Standing Order 108(2), our study at this committee of the report of the Bank of Canada on monetary policy.

We're very pleased to have this morning two witnesses. First we have the Governor of the Bank of Canada, Mr. Mark Carney.

Mr. Carney, welcome back to the finance committee.

We also have the senior deputy governor, Mr. Tiff Macklem.

Mr. Macklem, welcome back to the committee as well.

You have both been here many times before. We look forward to your opening statements, and then we'll have questions from members.

Mr. Carney, I would ask you to begin at this time, please.

[Mark Carney, Governor, Bank of Canada]

Thank you very much, Chair, and thanks to the members of the committee for making the time to discuss our January monetary policy report. It's an important time in our economy.

I'll start by saying that while the global economic outlook is slightly weaker than the bank had projected in our October MPR, importantly, global tail risks have diminished.

The economic expansion in the United States is continuing at a gradual pace, restrained by ongoing public and private deleveraging, global weakness and uncertainty related to fiscal negotiations.

Europe remains in recession, with a somewhat more protracted downturn now expected than in October.

Growth in China is improving, though economic activity has slowed further in some other major emerging economies.

Supported by central bank actions and by positive policy developments in Europe, global financial conditions are more stimulative.

Commodity prices have remained at historically elevated levels, though temporary disruptions and persistent transportation bottlenecks have led to a record discount on Canadian heavy crude.

In Canada the slowdown in the second half of 2012 was more pronounced than the bank had anticipated, owing to weaker business investment and exports. Caution about high debt levels has begun to restrain household spending, but the bank expects economic growth to pick up through this year.

Business investment and exports are projected to rebound as foreign demand strengthens, uncertainty diminishes, and temporary factors that have weighed on resource sector activity are unwound. Nonetheless, exports should remain below their pre-recession peak until the second half of 2014, owing to a lower track for foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar. Consumption is expected to grow moderately and residential investment to decline further from historically high levels. The bank expects trend growth in household credit to moderate further, with the debt-to-income ratio stabilizing near current levels.

Relative to the October MPR, Canadian economic activity is expected to be more restrained. Following an estimated 1.9% growth in 2012, the economy is expected to grow by 2% this year and 2.7% in 2014. The bank now expects the Canadian economy to reach full capacity in the second half of 2014, later than we had anticipated in October.

Core inflation has softened by more than the bank had expected, with more muted price pressures across a wide range of goods and services, consistent with the unexpected increase in excess capacity. Total CPI inflation has also been lower than anticipated, reflecting developments in core inflation and weaker than projected gasoline prices. Total CPI inflation is expected to remain around 1% in the near term. It's expected to rise gradually, along with core inflation, to the 2% target in the second half of 2014, as the economy returns to full capacity and inflation expectations remain well anchored.

Despite the reduction in global tail risks as a result of a series of actions by European and American authorities, the inflation outlook in Canada is still subject to significant risks.

The three main upside risks to inflation in Canada relate to the possibility of stronger than expected growth in the U.S. economy, higher Canadian exports and renewed momentum in Canadian residential investment.

The three main downside risks to inflation in Canada relate to the European crisis, more protracted weakness in business investment and exports in Canada, and the possibility that growth in Canadian household spending could be weaker.

Overall, the bank judges that the risks to the inflation outlook in Canada are roughly balanced over the projection period.

Reflecting all of these factors, the bank maintained the target for the overnight rate at 1%. While some modest withdrawal of monetary policy stimulus will likely be required over time, consistent with achieving the 2% inflation target, the more muted inflation outlook and the beginnings of a more constructive evolution of imbalances in the household sector suggest that the timing of any such withdrawal is less imminent than previously anticipated.

With that, Mr. Chair, Tiff and I would be pleased to take members' questions.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Carney, for your opening statement.

We will begin colleagues' questions with Ms. Nash.

I'll just remind our colleagues and our witnesses that unfortunately, unlike the U.K., we have severe time limits in Canadian parliamentary committees, so I'll ask you to be as brief as possible in your questions and answers.

Ms. Nash, please.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Thank you, Mr. Chair.

Good morning, and welcome again, Governor Carney and Deputy Governor Macklem, to the finance committee.

Governor Carney, I have a question on GDP growth and deficits. Can you tell this committee how much smaller the deficit would have been this year if GDP growth had matched the bank's projections last year?

[Mark Carney]

The short answer is that I can't give you a precise estimate of that. There are two elements of the shortfall that are important.

I can give you a written answer using the back-of-the-envelope calculations that are supplied in the budget forecast. The sensitivities, as you are aware, are supplied in the budget when it's released, to both the level of GDP growth and the level of GDP inflation—although I think that CPI inflation is what is actually used.

What's important, as you're aware, is that the shortfall is twofold through 2012. Growth was less than anticipated; we think it's coming in under 2%. Also, GDP inflation was lower as well, so nominal GDP growth was materially less.

The shortfall on GDP inflation is composed of two elements: one—

[Peggy Nash, NDP, Parkdale—High Park, ON]

Excuse me, Governor Carney. I'm really sorry, but I have such little time. Perhaps I'll ask for a follow-up. Maybe we can get—

[Mark Carney]

All right. I'll give you a very quick written response on this, which will be at a high level.

[Peggy Nash, NDP, Parkdale—High Park, ON]

That would be great. Thank you.

Given the recent move towards a financial transaction tax by 11 euro zone countries, can you comment on its efficiency and revenue-generating capacity?

[Mark Carney]

To be frank, our expectation is that there would be very limited revenue-generating capacity from that tax, unless the tax is truly global, because it's far too easy to move financial transactions to other jurisdictions.

The experience of Sweden is instructive. They tried a similar tax in the nineties, and net revenue actually went down as a result of transactions moving. So that would be our base expectation.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Thank you.

You've spoken out about inequality, and study after study has shown that Canada is becoming a less equal society. Can you comment on some of the negative outcomes that could arise from this situation of growing inequality?

I'm going to ask a second question and we'll see whether there's time for you to answer it. It's about the issue of household debt, which you've also spoken about.

Can you explain what role the introduction of 30-year and 40-year mortgages by this government might have played in exacerbating this debt crisis? And would the levels of household debt exacerbate the harm caused if there were a crash or a serious downturn in housing prices?

[Mark Carney]

I'll make these both quick, and it won't do them justice.

One of the most important elements with respect to inequality is intergenerational inequality—to what extent your economic position is predicated on that of your parents. In this regard, it's a question of equality of opportunity, effectively, of how well the society determines it.

I'll point out that there have been a number of studies. Most recently, the Conference Board did a study in this area that highlighted that at least in this very important respect, Canada fares quite well. A variety of policies that are necessary to reinforce this is essential. I won't go into detail on those, given the time.

With respect to household debt, the view of the bank and the view of the government has been that it was desirable to reduce the access to longer-amortization mortgages—30-year or 40-year mortgages—that had been introduced by CMHC and other mortgage insurers. We welcome the steps the government has taken in recent years to do that. It will contribute to a more prudent evolution.

[The Chair, Conservative, James Rajotte]

You can have a brief question.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Thank you.

Can you elaborate a little bit more? What role could these mortgages, which are still out there, play if there is a serious downturn?

[Mark Carney]

With respect to the mortgages that are still out there, the issue is that with a longer-amortization mortgage there's very little amortization obviously in the early years; effectively, a household is just paying interest. The risk is that five years out or even 10 years out, as interest rates normalize, it is beginning a more conventional mortgage anew. In effect there has been no equity built up in the house, unless overall house prices have risen substantially over that period.

That increases the risk to the individual household, since, as you know, mortgages are repriced every five years in this country, even if you have a fixed-rate mortgage.

It has been one of the concerns that low debt servicing costs today, with longer-amortization mortgages, do not necessarily mean low debt servicing costs tomorrow. In fact, they likely imply higher debt servicing costs tomorrow. This is one of the risks in the structure of household debt; you're right.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Ms. Nash.

We'll go to Ms. McLeod, please.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Thank you, Mr. Chair.

Welcome. It's always a pleasure to have you before the finance committee.

I'd like to start by looking at the forecasting that has been done. If you look at the resolution or quasi-resolution of Europe, the fiscal cliff issue in the U.S., or the items we've known for a long time—the bitumen issues and weakening exports—when I look at your forecasts I have to wonder whether it is normal that you have to downgrade your forecast. What have you done over the last number of years? How accurate have your forecasts been in terms of what ultimately is the reality?

[Mark Carney]

The quality of forecasting is something we look at. If we look at forecasting relative to consensus and relative to other external observers, such as the IMF, which publishes a forecast for Canada, on average we are slightly better than that consensus since the recession crisis and the recovery. There has been a pretty wide range, though—standard deviation, if you will—around those forecast outcomes.

Let me make a point, though, about the forecast going forward, which is that we have marked down the outlook for the United States and correspondingly the outlook for Canada—there are other reasons for Canada. But importantly, and you touched on some global issues, there have been some very large so-called tail risks in the global economy: the risks around the euro, the risks around the fiscal cliff, which you mentioned. There has been substantial progress in reducing those tail risks.

So even though we now expect the European recession to last longer, Europe is in a better place today than it was in October. Even though U.S. growth has been marked down—and it may actually be lower than we expect, depending on the outcome of the current debt ceiling negotiations in the U.S.—the quality of U.S. growth is better, because what's supporting U.S. growth right now is better-quality activity in the household sector, in the housing market, and the start on corporate investment. So the sustainability of the position is better, and over the medium term this augurs well for Canada.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Is the shift from 2.2% to 1.9% a significant shift for the Bank of Canada, compared with other years?

[Mark Carney]

Speaking to Ms. Nash's question, it's significant from a fiscal perspective, when coupled with lower GDP inflation. But in terms of the dynamics of Canadian growth, what's important, if one wants to look at the positives—and we should look at the positives sometimes as well as the negatives—is, as I said, that the quality of U.S. growth has picked up. That is important. We haven't fully filtered that in or fully taken it into account in our export forecast for Canada. We have negative judgment, so to speak, in our exports forecast for Canada.

The second thing is that we are starting a rotation of demand that we have expected for some time in Canada. Housing is less important; consumption debt—finance consumption—is less important; and investment and exports ultimately are going to be more important.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

To follow up in terms of the U.S., they contracted in the fourth quarter of 2012. This was the first contraction seen in the U.S. You talked about the U.S. growing, but how does that align with the contraction?

And of course they're obviously an important trading partner. Are you concerned that the recent GDP contraction in the U.S. is an indication that they're heading for a double-dip recession?

On the other hand, of course, if the U.S. recovery picks up pace, what will that do to the projections? I guess I'm trying to align your comments about the stronger U.S. data with the fact that they actually had a contraction.

[Mark Carney]

Yes. Well, there were a few factors that weighed on growth in the U.S. in the fourth quarter, including hurricanes and other one-off factors. Importantly, though, at that time we did expect, and we have seen, the effects of the uncertainty around U.S. fiscal policy weighing on particularly business investment.

We expect to see a pickup in U.S. growth over the course of 2013. The biggest risk, though, given where we are here today, on the fiscal side, is the possibility that sequestration is left untouched in the U.S., which would take about another 0.4 or 0.5 percentage points off U.S. growth this year. That's a fully multiplied number, if you will, from our estimation, and that would be straight off the top of U.S. growth.

That said, we do see a very constructive evolution in the U.S. housing market, in consumer balance sheets and corporate balance sheets, and we see underlying activity in the U.S. picking up over the course of this year. That's our expectation.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. McLeod.

We'll go to Mr. Brison, please.

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

Thank you, Chair.

Welcome, Governor, and welcome to the Deputy Governor.

You said just a few minutes ago that you supported or welcomed the tightening of mortgage rules in Canada. Would you agree that loose mortgage rules in the U.S. helped create the housing and personal debt bubble?

[Mark Carney]

Without question, the decline in underwriting standards in the U.S., in a variety of forms, contributed to that rise in the housing bubble. I mean, the Americans got to a position on the eve of the crisis where about 15% of mortgages were subprime.

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

Thank you.

It's notable—I'm looking at page 21 of your report—that growth and household debt peaked in 2008. In the first half of 2008, 50% of new mortgages were 40-year mortgages.

You said earlier that you welcomed the steps to tighten the rules. What's your view on the decision to loosen them from 25 to 40 years? You supported the decision to tighten them from 40 years to 25 years. You must have an opinion on the decision to move them from 25 to 40 years back in around 2006.