Finance Committee on June 6th, 2013

[Stephen S. Poloz]

Thank you. It's a pleasure to be here.

Thanks as well for the opportunity to elaborate. I think this is a very important part of the story.

I referred to it as a post-war reconstruction to capture the notion I have in mind, that the trauma that we've been through was not like a typical cycle in our economics textbooks at all. It was much deeper. It was caused by a financial crisis as opposed to a simple slowdown. It was longer. It therefore interacted with companies' banks. If you have a nine-month recession, of course your bank will let you ride the recession, but if it's a five-year recession, you're going to have to address the debt with the bank and so on. You have a very much more complex kind of story on the way down.

Part of that story was that companies simply exited. So some of the reduction in output and employment that we've seen is in that sense permanent, because the companies aren't there now.

So when we see the recovery process, then, it's not just a matter of expanding your output back to normal. For many companies it is, but for the companies that are no longer there or that have downsized significantly, it's a matter of their re-expanding, which requires a significant new investment, or being created out of thin air, which of course is an even more risky proposition.

It's for that reason that confidence plays a much stronger role in this move back up than it would in a normal cycle. It's also why our models don't really give us the insight we need in order to understand that process.

At the bank, we'll be investing more energy into this, understanding this, as we climb out. In the past, talks have likened it to a post-bubble crater that we are in, which will take a long time to get out of. We in Canada have been lucky, but the world will be in the crater for a longer period.

I trust that gives you more insight into what I'm trying to say there. It's a process that we need to understand. Clearly we need to nurture it, because it will require that gradual buildup in confidence and the actual self-sustaining Schumpeterian process, if I can use that term with the member, of natural growth, of new companies, new products, etc.

Those decisions are hard to make in an uncertain environment. The confidence, therefore, plays a much bigger role than normal.

[Mark Adler, Conservative, York Centre, ON]

Thank you.

Yes, confidence plays an important role, and I see what you're getting at here, but you're now in the monetary policy business. How do you see monetary policy playing a role in this reconstruction effort?

[Stephen S. Poloz]

Well, our monetary policy is designed to give the most predictable and price-stable environment in which to operate, so our key ingredient is to provide that as a playing field in which companies can make these decisions. Secondly, there's the financial stability that goes with that: the strength and resilience of the financial sector, of the financial institutions. We have a role to play as part of a broader team to give that assurance.

The rest is more of a natural healing process that I think we don't understand very well, because we've never been in this sort of setting before. It's one that we need to invest energy in understanding, both as a traditional economist would, which would be studying past episodes and so on for the insights they can deliver, but also by talking to real people about what is going on, about what they see through their lens. It's about asking a company, “What would it take, what would you need to see, before you would be ready to make this expansion?” Would it be this much of a strengthening in exports? This much? Would you need Europe to be settled down? What would be the ingredients?

Then we'd be in a position to watch that unfold and be a little more predictive about when it would come, and that will matter a lot to monetary policy.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you very much, Mr. Adler.

Mr. Rankin, please, for your round.

[Murray Rankin, NDP, Victoria, BC]

Thank you, Chair.

Welcome, Governor. I appreciate your attendance.

I'll take you to some macroeconomic questions that flow out of your written remarks this morning. In your written remarks, you talk about the recession causing “a significant structural change” to our economy in talking about our country's “productive capacity” dropping. As the bank noted, in 2009 that occurred, but then you say, “Standard macroeconomic models don't really capture these dynamics.” You say then that “the financial crisis triggered an atypical recession” with an “unusual” recovery, in your words.

Then you go on to talk about a positive prediction about where our economy will go, with foreign demand recovering, increased capacity, and expanding companies and the like. However, the OECD recently reduced the estimates for Canadian economic growth. In November, it was projecting 1.8% growth for this year. It has now downgraded that to 1.4%. The OECD also reduced their prediction for growth in 2014 from 2.4% to 2.3%.

I guess my question is, given what you call the inability of “standard macroeconomic models” to capture these dynamics, how can we be confident in the predictions that you've just made this morning?

[Stephen S. Poloz]

Thank you for your question.

Well, I think I was careful not to make any predictions, and I think for that very reason. Of course, when we get to July 17, when we issue our monetary policy report, we will put our best numbers forward, as we did in the past MPR, which of course I was not part of.

But I think the answer to your question is that models don't become useless in this setting. What they become, though, is less useful than they usually are, as if the zone of ignorance or the margin of error is bigger. That requires us to work harder at the judgmental aspects of how we put these numbers together, which I am absolutely certain the OECD would agree with. They have done exactly the same thing.

When you do these things, then, you use the model as a way to ask the right questions, and then you use other evidence or other models to help fill in the shady parts. We already do this at the bank; I've seen enough to know that's true. So it's a robust conversation, and then we'll come in and say that in our best judgment it's this for 2013 and this for 2014.

[Murray Rankin, NDP, Victoria, BC]

All right.

I'd like to ask about two other areas that our committee has been working on. One is tax evasion, and then, if time permits, the other is income inequality.

On the tax evasion front, in 2010 the Bank of Canada published a work that talked about estimating the underground economy. Given that expertise, would Bank of Canada economists be able to estimate the scale of tax evasion and the use of tax havens by Canadians and Canadian corporations? If so, would that be worthwhile?

[Stephen S. Poloz]

Thank you.

This is a question that has always been of interest to economists in general. Of course, from a central bank's point of view almost anything like that is of interest.

However, it's of interest from the point of view of understanding how the economy is behaving better than we would know without understanding that. We'll do research on a wide range of things that appear to be peripheral to the actual decisions we make, which is not unusual, but they help us have a better feeling of confidence around those discussions.

The bank has a crack research team, it's really superb, and this has always has been one of our trademarks, if you like, of excellence in research.

This could be of interest, mainly if it were getting larger or smaller. It has a connection to the currency business, which I talked about in my opening remarks. It helps us understand whether our currency design and our program is in some way making it easier or harder, but that's really the crack in the door, if you like, the angle with which it has a direct link to us.

[The Chair, Conservative, James Rajotte]

You have about 30 seconds.

[Murray Rankin, NDP, Victoria, BC]

Mr. Carney, your predecessor, expressed concern about high rates of inequality in this country becoming an issue. Would you update us on any research that the Bank of Canada may have conducted on inequality?

[The Chair, Conservative, James Rajotte]

Just a brief response. We may have to return to the topic at another time.

[Stephen S. Poloz]

Of course, Mr. Chair.

I'm afraid I don't know what new research has been done on that. I would say that as a central bank we really only have a modest influence on this, which is to lay a good playing field with price stability, which gives us the best chance of having things operate, markets operate, as they should. Otherwise, it's more one of those things that is of interest but not directly applicable to the policy discussion.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Rankin.

Mr. Van Kesteren, please.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

Thank you, Mr. Chair.

I'd like as well to congratulate you, Governor, on your new position.

I want to talk to you about inflation and the difficult job it is to measure inflation. What is your opinion of the method that we use, the consumer price index?

For the benefit of those who may be watching this on television, could you explain how that is measured and what today is included, and what's taken out too. And could you say if that is still the measurement we should be using.

[Stephen S. Poloz]

Thank you. I appreciate that question.

This business of measuring inflation is actually, as you've hinted, much harder than it looks. Probably every one of us has our own personal inflation experience. The reason that's different from person to person is that our spending patterns differ quite a lot by age group or by region, or what have you.

We begin there and ask ourselves what's the simplest and most intuitive way of coming up with something that works pretty well. I think that's a pretty good description of the CPI.

The CPI takes your typical household basket, takes a reference year and says in that year households spent 2% of their money on this, 4% on that, on all these items and so on. Then, of course, it tracks the sale prices of each of those items and then takes a weighted average of all of those things, builds it into an index and asks how much it went up since the last time we looked at ti. That's our measure of inflation.

That's complicated enough, but economists can always complicate something further. There are many other more sophisticated ways of doing this, but the good news for us is that we don't need to go into them because they result in little differences here and there at certain times, but on average they all tell us roughly the same thing. That's what makes the CPI very attractive because regular folks understand what it is. They understand when they're buying the milk that it's going into the CPI and it's recognizable. If we say that's the thing we're going to target, they understand that and it anchors their expectations. That's the combination we're looking for.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

Thank you.

I want to go to something that you remarked about in your opening statement, and that's the near collapse. I think sometimes we forget about this—it has been six years since. I know that our finance minister has on a number of occasions referred to it as our having been on the brink, that not only were we on the brink but the world was on the brink. The fact of the matter is that we are very much dependent on what happens in the world, that happens elsewhere will affect Canada as well.

With that in mind, would you maybe comment on how critical it is, now that we are beginning to move forward and climb out of that situation, to pursue new trade deals and why it's so important to diversify and find new markets?

[Stephen S. Poloz]

Thank you.

That is a great point. The preamble is exactly right. The world economy and the financial system were clearly on the brink and we're very fortunate that there was a such a well-coordinated—dare I say orchestrated—response that everyone participated in, because the downside could have been much bigger.

In any case, we continue to heal from that process, and in some cases the adjustments that are necessary were put off, so it's being stretched out. But I've often said that if you had six or seven years to build up that bubble—like, say, from about 2001 to 2007—the crater is going to be of a similar magnitude. So we have some time still to go, especially since we're stretching out some of the adjustments.

In that context, the world has not sat still. What has happened is that emerging markets or developing markets have actually fared quite well and they continue to grow.

I would ask you to think about how the world would look if there were people living on every planet in the solar system. Where would all the trade be happening? I'll give you the answer. The big trade flows would be between Jupiter and Saturn, the two really big places that are close to each other and would be trading with each other. We, on earth, would be sitting here wondering why we couldn't get more of that. That's the kind of world that will emerge over the next five years. We call that south-south trade.

The only way for Canada to be able to grow with the world, as a small open economy, will be to increase its reach to those markets. We see it in EDC's data that companies are doing so. Trade deals are a fantastic way to pave that road.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Van Kesteren.

Mr. Côté has the floor.

[Raymond Côté, NDP, Beauport—Limoilou, QC]

Thank you very much, Mr. Chair.

Thank you for your presentation, Governor Poloz.

I have to admit that some parts of your opening statement impressed me deeply. I want to talk about one of them, the Canadian context. You said: “In short, we need to see the reconstruction of Canada's economic potential, and a return to self-sustaining, self-generating growth”.

In a previous meeting, I had a discussion with your predecessor. At that time, I talked about the work that we should be doing on ourselves and I talked about my own problem with pride, the pride in not wanting to depend totally on growth in other countries or in being at the mercy of a return to global growth.

Governor, how can the Bank of Canada help us to start moving in that direction?

[Stephen S. Poloz]

Thank you for the question.

I ask myself the same question. Basically, I do not really know if we have to nurture the process or simply be patient. I do not know. As I mentioned, there is one major variable. That is the matter of confidence, and it cannot be measured. You can try, but you will not get a reliable answer. So we have to wait, but we can also conduct research in order to better understand the issues.

If I may say so, it is a process of trial and error, because it is something completely new, something quite unique. Models guide us to a certain extent, but we are going to have to wait and understand problems bit by bit. I do not have the answer today, but I can assure you that it is a fundamental area of research, even of my own personal research. We have to talk to companies directly to help us understand the mechanisms we must choose in order to boost confidence and to make quicker investment decisions. We are asking ourselves the same question.

[Raymond Côté, NDP, Beauport—Limoilou, QC]

Given that the crisis has been going on for several years, people's patience, meaning entrepreneurs, workers or families, is wearing thin.

I must congratulate my colleague, Mr. Adler, for not having asked you questions about your political past. But he put his finger on something that impressed me a lot. You mentioned that the global economy is still in recovery. You also said that it was somewhat like the post-war reconstruction period.

That is a very powerful image. The historian in me wants to draw parallels, even though I know it is not fair to make comparisons, and that it is not possible to do so completely. Does it mean that we have to go further with our monetary measures? In the global context, do we have to embark firmly on a more interventionist path? Of course, the United States are in a completely different position than they were right after the war.

[Stephen S. Poloz]

Perhaps it is a powerful image. For me it is a way of explaining the difference between our current situation and a previous cycle such as the one we find in the textbooks. It is very different. As economists, we use our textbook models every day. I would say that this is a kind of post-war reconstruction. We have to wait for new developments and for our potential to be rebuilt. At some points in the cycle, that will increase quicker than usual. At least, I hope that will be the case.

Specifically, we need demand from outside. That will be followed by confidence and by investment. Capacity will increase. I mentioned—

[The Chair, Conservative, James Rajotte]

Mr. Poloz, can I ask you to wrap up quickly?

[Stephen S. Poloz]

I mentioned in my remarks that, in 2009, the Bank of Canada indicated that there was a drop in production, in potential. We saw that with companies in the automobile and forestry sectors. There was about a 50% drop in capacity in forestry. If we get demand because of construction starts in the United States, we will see it open up.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Poloz. Thank you, Mr. Côté.

Ms. Glover, please, for your round.