Finance Committee on Nov. 1st, 2011

[The Chair, Conservative, James Rajotte]

I call this meeting to order.

I'll just let our friends in the media sort themselves out. For the information of colleagues, there are two cameras here, and they are properly recording the meeting for, I believe, CTV, Global, and CBC. I just want to make everyone aware of that.

Again, it is a pleasure to welcome the Governor of the Bank of Canada, Mark Carney, and the Senior Deputy Governor, Tiff Macklem. It's for the governor's bi-annual report to the finance committee. It's always a pleasure to have the governor and the senior deputy governor here.

You were last with us in August, before going to India. We had a very interesting discussion at that time, and we look forward to your comments today on the Bank of Canada's monetary policy report and on all of the recent goings on in the global economy.

Mr. Carney, I'll let you begin with your opening statement. Welcome to the committee, and thank you for coming.

[Technical difficulty--Editor]

[The Chair, Conservative, James Rajotte]

I call this meeting back to order, the second time lucky, I hope.

Again, it's a real pleasure to welcome the Governor of the Bank of Canada, Mr. Carney, and the Senior Deputy Governor, Tiff Macklem, pursuant to Standing Order 108(2), for our study of the report of the Bank of Canada on monetary policy.

Mr. Carney, and Mr. Macklem, we welcome you here look forward to your statement and responses to our questions as members. Thank you so much for being here with us today.

[Mark Carney, Governor, Bank of Canada]

Thank you very much, Chair, and good morning, members. Tiff and I are very pleased to be with you this morning to discuss our October monetary policy report, which we published last week.

The global economy has slowed markedly, as several downside risks to the projection that we outlined in our July MPR have been realized. Volatility has increased, and there's been a generalized retrenchment from risk taking across financial markets.

The combination of ongoing deleveraging by banks and households, increased fiscal austerity, and declining confidence is expected to restrain growth across the advanced economies. The bank now expects that the euro area, where these dynamics are most acute, will experience a brief recession. The bank's base-case scenario, nonetheless, assumes that the euro area crisis will be contained, although this assumption is clearly subject to downside risk.

We welcome the agreement announced last week by euro area leaders on a comprehensive plan to address the ongoing challenges in Europe. We look forward to additional details on the modalities of the various measures announced, and to their implementation in the coming weeks.

In the United States, real GDP growth is expected be weak through the first half of 2012, reflecting diminished household confidence, tighter financial conditions and increased fiscal drag.

Growth in China and other emerging-market economies is projected to moderate to a more sustainable pace. These developments, combined with recent declines in commodity prices, are expected to dampen global inflationary pressures.

The outlook for the Canadian economy has weakened since July, with the significantly less-favourable external environment affecting Canada through financial, confidence and trade channels.

Although Canadian growth rebounded in the third quarter with the unwinding of temporary factors, underlying economic momentum has slowed and is expected to remain modest through the middle of 2012.

It is projected that household expenditures in Canada will grow relatively modestly, as lower commodity prices and heightened volatility in financial markets weigh on the incomes, wealth, and confidence of Canadian households.

Business fixed investment is still expected to grow solidly in response to very stimulative financial conditions and heightened competitive pressures, although it will be dampened by the weaker and more uncertain global economic environment. Net exports are expected to remain a source of weakness, owing to sluggish foreign demand and the ongoing competitiveness challenges, including the persistent strength of the Canadian dollar. Overall, the bank expects that growth in Canada will be slow through mid-2012 before picking up as the global economic environment improves, uncertainty dissipates, and confidence increases.

The weaker economic outlook implies greater and more persistent economic slack than previously anticipated. The Canadian economy is now expected to return to full capacity by the end of 2013. As a result, core inflation is expected to be slightly softer than previously expected, declining through 2012 before returning to 2% by the end of 2013.

The projection for total CPI inflation has also been revised down, reflecting the recent reversal of earlier sharp increases in world energy prices, as well as modestly weaker core inflation. Total CPI inflation is expected to trough around 1% by the middle of 2012 before rising with core inflation to the 2% target by the end of 2013, as excess supply in the economy is slowly absorbed.

There are several significant risks to the inflation outlook in Canada.

The three main upside risks relate to the possibility of stronger than expected inflationary pressures in the global economy, stronger momentum in Canadian household spending, and the possibility of a faster than expected rebound in business and consumer confidence, due to more decisive policy actions in the major advanced economies.

The three major downside risks relate to the sovereign debt and banking concerns in Europe, the increased probability of a recession in the U.S. economy, and the possibility that growth in household spending in Canada could be weaker than expected.

Reflecting all of these factors, last week the bank maintained the target for the overnight rate at 1%. With this target rate near historic lows and our financial system functioning well, there is considerable monetary policy stimulus in Canada. The bank will continue to monitor carefully economic and financial developments in the Canadian and global economies, together with the evolution of risks, and will set monetary policy consistent with achieving the 2% inflation target over the medium term.

Finally, permit me to say a word about an issue this committee recently raised, the renewal of the bank's inflation control agreement with the Government of Canada. This is central to the bank's mission, and we very much appreciate the committee's interest in it.

Since 1991, inflation targeting has proven its worth in both tranquil and turbulent times. Even so, we are always looking for ways to improve the framework. At the time of the last renewal, almost five years ago, the bank committed to continuing its research into potential improvements that might build on the success of the current framework. A concerted and ambitious research agenda focused on evaluating whether two specific changes--first, targeting a lower rate of inflation, or, second, targeting a path for the level of prices--could provide significant net benefits to the Canadian economy and Canadian households. Subsequently, the experience of the global financial and economic crisis prompted the bank to add a third item to its research agenda, asking to what extent monetary policy should take into account financial stability considerations.

Since 2008, we've had three major conferences for our staff and external researchers to present work on inflation targeting and the monetary policy framework and on these questions. The most important of these research papers have been published in three special issues of the Bank of Canada Review. Related studies by bank staff have been published as working papers, and as well, governing council members, including me, have spoken regularly and publicly about these issues.

We've been pleased to answer questions before this committee in the past on the progress to date towards renewing the inflation target, and Tiff and I would be happy to answer further questions on these issues today, as well as, of course, questions regarding the Canadian and global economies.

With that, Mr. Chair, I turn it back to you.

[The Chair, Conservative, James Rajotte]

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

We'll begin members' questions with Mr. Julian for a five-minute round, please.

[Peter Julian, NDP, Burnaby—New Westminster, BC]

Thank you very much, Mr. Chair.

Thank you, Mr. Carney. I'm a new member of the committee, and so I welcome you here. I was looking over the transcript of your August 19 appearance before the committee, where you paid tribute to federal stimulus that “provided important further support to domestic demand, contributing significantly to Canadian economic growth through 2009 and 2010.”

I know that most recently you have projected Canada's growth rate dipping to as low as 0.8% in the last three months of the year. So I'd appreciate any comments you might have about that dilemma or choice between continued fiscal stimulus as opposed to austerity measures, and looking at other tools aside from monetary tools that we as a finance committee might recommend to the government to get through this period of slower growth.

[Mark Carney]

Thank you, and welcome, I guess, to the committee. It's not my place to welcome you, but thank you for having me.

The comments of August 19 relate to, as you know, the important contribution that the stimulus did make to GDP during a very difficult time in the global economy. Up to one-third of the growth in 2009-10 was contributed by direct government spending. Of course, that is from all levels of government—federal, provincial, and municipal—as there were sizeable stimulus programs put in place at all levels of government. They were timely and they had an impact.

Obviously, there are medium- and longer-term requirements for fiscal sustainability. We are seeing that around the world. Those constraints are binding, in many cases, in many advanced economies. In fact, in most advanced economies there are greater constraints on fiscal flexibility than there is actual or de facto flexibility.

I would note that when we look out to the projection, our expectations for the contribution of government are for quite mild fiscal drag. So the actual government spending, the actual program spending, the net spending of government, takes off about 0.1% of GDP growth in 2012. So while there is a drag, it is not the determinative factor in terms of the slowing of the Canadian economy relative to our previous projection. What is determinative is the global situation that is putting additional pressure on exports, which, in our view, is having an impact and will continue to have an impact on the confidence of households and on the margin of confidence of business and, therefore, on household and business expenditures, particularly investment by businesses. So it's within that context that we see the slowing, as opposed to a rapid slowing in direct government expenditure in this country.

[Peter Julian, NDP, Burnaby—New Westminster, BC]

Thank you.

You talked about household debt. I would like to know your thoughts on Canadian household debt levels, which are very high.

In this context, you talked about the fact that spending is likely to increase modestly. How do you see Canadian household debt and its evolution in the coming months?

[Mark Carney]

The Bank of Canada has noted increased Canadian household debt on several occasions. In some cases, it is extremely high.

We expect the growth in household debt to continue to slow down. The growth rate of Canadian debt will slow down during the projection period. The growth of household spending will decline in relation to the rate of wage increases and household income levels towards the end of our projection.

This has to do with the measures taken by the government to bring in tighter mortgage market conditions. Debt levels will also have an impact.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Julian.

Mrs. Glover, you have five minutes.

[Shelly Glover, Conservative, Saint Boniface, MB]

Thank you for being here today, Governor Carney. It is always a pleasure to have you here at our committee.

I'm going to ask you about two things, if I get enough time to do so.

First and foremost, something that we've often heard with regard to trade is the need for Canada to diversify its trading relationships, especially when we're considering the prolonged downturn or slowdown in the economy of our largest trading partner, the United States. You've spoken about the critical importance of this issue before, and especially with regard to the rise of emerging markets. There are still people here who believe, contrary to our belief, that perhaps there is no need to become more globalized in the trading area. And some have even suggested that we actually try to go towards some protectionist measures.

I think you've been pretty clear about that, and in fact I'd like to refer to a speech you made at the Saint John Board of Trade in late September, in which you said:

To put it bluntly, the U.S. economy can be expected to be relatively weak for some time as households repair balance sheets and governments wrestle with deficits. ...Canada will have to look elsewhere to grow our exports. Emerging markets already account for almost one-half of the growth in all imports over the past decade. ...We will need to take advantage of such opportunities.... If we do not develop new markets and if we do not improve productivity, the cumulative loss of income from slower potential growth could be almost $30,000 for every Canadian over the next decade.

Can you share your views on why Canada needs to engage more aggressively in emerging markets? And what would be the implications if Canada actually stopped pursuing trade diversification?

[Mark Carney]

Thank you very much for your question.

Let me say two words on the U.S. first. In the MPR, as I think members know, there is an analysis of this household debt situation that looks specifically at the scale of wealth that U.S. households would need to rebuild. There's a technical box in here, but it gives one a sense of the length of time it's going to take for the households to return to something approaching the levels of wealth they had prior to the crisis—not to the peak prior to the crisis, but something approaching average levels of wealth.

That dynamic, as you suggested with the quote, is going to mean, in our opinion, that the U.S. economy will be more like a 2% growth per year economy than a 3% or 3.5% growth per year economy, the type that Canadian businesses and Canadians have been familiar with virtually all of our working lives. Over time that is a big difference.

To simplify things, we've been making the point that while the U.S. is a large market, it is more of a market-share game to export into the United States. You have to look to grow market share as opposed to participating in the growing pie, if you will. That's possible but that's probably not the best alternative. As you also note, if one looks at the major emerging economies, the growth rate in these economies--in high single digits in real terms, and mid double digits of 13% to 15% in nominal terms--means there is tremendous opportunity. We are under-represented in those markets. They not only account for one-half of the growth in all imports, but emerging markets today also account for one-half of all capital good imports, full stop, to give a sense of the scale of the adjustment there. So there is a big opportunity.

The BRIC countries' share of our overall exports has actually been halved in about the last 10 years.

So when we meet in this backdrop of uncertainty in Europe and the ongoing issues in the United States, we can look at the advantages this economy has and where we are under-represented, which is in major emerging markets, and where the true growth opportunities are going to be for the next five to ten years. And the perspective of the bank--and, of course, we have the luxury of being at a very high level--is that those are the best opportunities, on the whole, for Canadian business.

Now what does that mean? It means that in order to realize them, to the extent to which there can be bilateral, multilateral, or regional trade and technology deals that would open up opportunities for Canadian business, they should be pursued. There are other considerations, but they should be pursued.

There is a need for a degree of reciprocity in this process, which means not just inbound trade liberalization but also foreign investment liberalization, because that goes hand-in-hand.

I'd better stop there, given the time.

[Shelly Glover, Conservative, Saint Boniface, MB]

Am I out of time already?

[The Chair, Conservative, James Rajotte]

You're out of time, unfortunately. Thank you, Ms. Glover.

We'll go to Mr. Goodale, please, for a five-minute round.

[Ralph Goodale, Liberal, Wascana, SK]

Thank you, Mr. Chairman.

Governor, and Mr. Macklem, it's very nice to see you again. You are off very shortly to the G-20 meetings later this week. I'm sure on behalf of all of us, congratulations and good luck. We look forward to seeing you return in a larger capacity after those meetings in Europe.

In your statement today, you talked about the economic troubles in Europe, the anticipation of a brief recession, and some hope coming out of the agreement that was announced a week ago by European-area leaders. But today there is news that Greece is now said to be holding a referendum or plebiscite with respect to how it will react to EU policy. I wonder if you would comment on what that potentially means for this anticipated recession in Europe. Could Greece possibly remain in the EU if it were to vote no to the proposition? And is there any conceivable role that you could anticipate for the Financial Stability Board in trying to facilitate some solution vis-à-vis Greece?

Secondly, I'll ask my other question, and leave it for your response, on issue of the inflation targeting agreement and the possibility of changes that you are researching. When you speak about the necessity or the value of some greater flexibility, going a little bit beyond the careful language in the statement, would that include taking into account, beyond inflation, issues like employment, job creation and job preservation, depending on the economic circumstances affecting the world at any given time, and issues such as the health or not of average disposable household incomes, and the preservation of a healthy, successful middle class in the Canadian economy?

We've all seen the articles about the middle class being under great pressure in current circumstances. That pressure has both economic and democratic consequences, and I'd be interested in your perspective on that.

Thank you.

[The Chair, Conservative, James Rajotte]

If you can do that in two minutes....

[Mark Carney]

Okay, perhaps we'll come back to some of these issues.

First, in terms of the Greek measures, obviously in times of difficult structural adjustment—major fiscal austerity, and the tough decisions that governments, such as the Greek government, are contemplating—it is imperative that there be widespread support, broad democratic support, for those measures, because they will unfold over a period of time. And if it's the judgment of the Greek government that this is the best approach to validate that support, we fully respect that. Obviously, it's Europe's decision about the future there.

Let me say one thing, though, in terms of the role of the FSB or Canada. The European decisions were important decisions. They are higher-level decisions, though, and there still are, as I reference in the statement, more details to come about the modalities of how they're going to be put in place, both in terms of the structure of the EFSF and the mechanisms for raising bank capital, or deleveraging the banking system across Europe. And there are technical aspects to those where the broader experience of some members of the FSB, whether through that mechanism or only bilaterally, could be relevant to help European partners, if they're interested. It's their decisions. Obviously, they are very sophisticated, but we stand ready to help, as appropriate, as they define the details in order to have maximum impact from the decisions.

Quickly on the bigger issue of inflation targeting, our experience has been that targeting 2% inflation is the best contribution that monetary policy can make to low unemployment and to a stable, growing employment market. The experience of pre-inflation and post-inflation targeting, as you're aware, is that of a dramatic fall in unemployment, a reduction in volatility in the economy and of unemployment and inflation.

I'll say one thing about the household debt issue, and then we can come back. When we look at flexible inflation targeting, which is what we've been practising, we have to take into account some of these bigger issues in terms of the time horizon over which we return inflation to that 2% target. And there is some variability in that time horizon, depending on the scale and nature and persistence of various shocks, which could be related to household debt, could be related to Europe, or could be related to the United States, both positively and negatively. And that's part of our core job.

I'll leave it there.

[The Chair, Conservative, James Rajotte]

Thank you. Thank you Mr. Goodale.

We'll go to Ms. McLeod please.

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

Thank you, Chair, and also welcome. It's always a pleasure to have you here. It's always a great session.

I'd really like to focus on the area of business investment. Certainly, that's been critical for our sustained economic recovery, so it was with great interest that I noted in your October monetary policy report business fixed investments continued to recover strongly in the second quarter. That certainly seems like a very good sign. There are links with the trade issue as I look at my riding, where a mill that was shut down then invested $25 million and now has many products going over to China. So there is some good news.

If you look at John Manley with the Canadian Council of Chief Executives, he has said that 50 companies, in responding to a council survey, indicated they “plan[ned] to invest close to $110 billion between now and 2013." To put that in context, that's twice what the federal and provincial government combined spent on stimulus during the recession. So this is important, and this is why our argument is that governments don't need to go out and sprinkle fairy dust all over the country. They should get their fiscal situations in order, as the private sector will take up that slack. That's where we're going to grow out of this.

So I'd like you to speak to what you've seen with regard to business investment in the economy in Canada, and what trends you anticipate going forward. How important is increased private sector business investment for Canada's sustained economic recovery?

[Mark Carney]

Thank you, Ms. McLeod. It's a very important question.

Let me first back up to the experience during the recession, where business fixed investment fell sharply in this country. It fell more sharply than it did in the United States—and particularly, I'm speaking about investment in machinery and equipment. It wasn't entirely clear why that was the case, because the financial system was functioning better here, and the direct impact of the crisis was obviously somewhat derivative. We were affected by a crisis somewhere else, as opposed to being directly in the United States. As you suggest, over just about the past year and a half, business investment has picked up importantly in this country. In fact, the relevant slide is chart 30 in the MPR , which shows how sharp that decline was relative to previous recessions. It is now stronger than it had been in previous recoveries at this point.

We are just at a point where the level of business investment is back to the level it was before the crisis. We've just come back to that point, so this is really the crucial moment or the crucial coming quarters and years for whether we're going to sustain our businesses, as Mr. Manley suggests, who are going to sustain that pick-up in investment and are going to start to build the productivity that we will need in a tougher global environment.

We would say that despite the global uncertainty, all the other conditions are there, as per Ms. Glover's question about emerging markets and those opportunities. Our financial system is functioning very well. This is a fact, not just a slogan. It is true. Our businesses have balance sheets that are in tremendous shape. So there's the ability to invest. We think there's a need to invest, because of the productivity challenge as well as the opportunity in emerging markets. We expect that there will be continued levels of investment, albeit at a slower pace than over the course of the last year. The reason for that is partly because of the global uncertainty that is, on the margin, slowing plans a bit. It's still positive, and it's still central to the forecast, but it is not quite as aggressive at this stage as it was previously. That's one of the reasons why a resolution of the European crisis will ultimately matter for Canada.

[The Chair, Conservative, James Rajotte]

You have 30 seconds for a very quick question.

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

A quick piece that you didn't get to answer in response to Ms. Glover's question is what would happen if we stopped work in the area of those trading relationships. It was part of Ms. Glover's original question.

[Mark Carney]

I would just underscore that continued positive momentum in broadening and deepening our trading relationships, particularly in the faster growing parts of the global economy, such as emerging Asia for example, would appear to be a priority from our perspective—and certainly from the perspective of continued business investment and, ultimately, export-led growth in this economy.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. McLeod.

Monsieur Mai, s'il vous plait.

Mr. Mai, you have the floor.

[Hoang Mai, NDP, Brossard—La Prairie, QC]

Thank you, Mr. Chair.

Governor, I'm sure I can speak on behalf of the whole finance committee in saying that you have our support in becoming the head of the Financial Stability Board.

I have a brief question. During your presentation, you said that household confidence has diminished. You also said that household debt—in other words, debt relative to family income—has increased to 150%.

This is having an impact on people. We see this with the Occupy movements, which you have supported, such as Occupy Montreal and Occupy Canada.

If we also look at the persistence of household borrowing, we see a trend. What risks are Canadian households exposing themselves to, in your opinion? What risks could the Canadian economy face as a result?

[Mark Carney]

Let me begin with the risks for the Canadian economy as a whole. This situation is creating one of the biggest downside risks for the Canadian economy. In the short term, there is still an upside risk, for it is possible that Canadian households will continue to accumulate debt at the same pace.

However, considering the level of Canadian household debt, it is possible that Canadian households would react more strongly to a shock than before, whether it be housing prices, an economic shock, a shock in terms of employment, or any other shock. This could lead to the paradox of thrift. The Bank of Canada is taking that into consideration at this time. In that case, we would have to create a shock within the Canadian economy, but there is none at this time.

We are working very closely with the Office of the Superintendent of Financial Institutions and the Department of Finance to change mortgage insurance rules in Canada. The rate does not necessarily need to be lowered, but at the very least, the household debt levels of the most vulnerable do need to be reduced.

What was the first part of your question?