Finance Committee on Nov. 1st, 2011

[Wayne Marston, NDP, Hamilton East—Stoney Creek, ON]

Almost.

Good morning, sir, and welcome.

In your presentation, you spoke about the diminished capacity of households, and I would suggest that the high level of household debt has to be concerning to all of us. But the external pressures we're seeing now because of the euro crisis certainly have to be very, very concerning as well, especially if they continue.

Should these roll out further, what do you see as the consequences for the Canadian economy?

[Mark Carney]

Well, let me say two things. First, embedded in our projection is that we do expect a recession in Europe. We have highlighted that. The issues—both the scale of the fiscal adjustments that many countries are having to make in Europe and a process of de-leveraging of the banking system that is picking up in that economy—in our view, are going to lead to a brief recession in Europe. That's the first thing.

Second, our expectation for the measures that are being taken by European authorities is that they will contain the crisis, but that's different from resolving the issue. Resolving the issue is going to take years, and there may need to be additional steps even in the near term in order to ensure containment. But containment gets to the issue, in terms of the effect on Canada. Our trading relationship, our direct link with Europe, is relatively modest and so the principal channels to the Canadian economy are two.

First are financial conditions as a whole. Now, again, our banking system does not have a lot of exposure to the European financial system as a whole, so when we talk about financial contagion, we're talking about a generalized reduction in the price of risky assets, such as we're seeing today in financial markets, which of course tightens overall financial conditions, makes it more expensive for Canadian businesses and households.

Then second are confidence impacts, because of the knock-on effect of what's happening in Europe on other economies and through to Canadian business and Canadian households. That's why one of our upside risks is actually that there be more decisive policy actions taken in advanced economies. We think it's fair to say that the overall level of confidence in the ability and willingness of policy-makers in the major economies to take the necessary steps in a timely manner to right their economies and help the global economies has been somewhat diminished by events over the course of the last year.

[Wayne Marston, NDP, Hamilton East—Stoney Creek, ON]

Well, it's been so prolonged; I think that's one of the reasons for it.

The other question I have is this. What do you feel is the level of risk to Canada's banks and our economy, because we're tied so closely to the U.S. and because of the exposure of U.S. banks to what's happening in Greece, in particular, and the impact that could have on them?

[Mark Carney]

Well, part of what we look at when we look at Canadian bank exposure is not just at the direct link to the European system but, as you suggest, the second-order effects. In other words, what is the impact on the U.S. and therefore what is the impact back into Canada?

There is not a significant exposure of the U.S. system to Greece per se. I think we all need to remember that Greece is very important for the Greek people, but it is 1.5% of the European economy. So the scale of the issue in Greece, from a global perspective, is quite modest. More important, from a global perspective—and it's more important for some institutions than others—is that it's an important indicator of how well the overall process is being managed to solve a range of issues within Europe. We would suggest that.

In terms of the health of the Canadian banking system as a whole, I think we're all aware of the experience in 2008-09 and how well our system performed. Since those years, the liquidity position of Canadian financial institutions has dramatically improved; in other words, they're much more liquid than they were then, at a time of a liquidity crisis. So they're in even better shape now, and this has more than doubled, in terms of the overall liquidity position. The capital position of the Canadian banks has further improved and, in addition, their risk management—which was strong in our opinion and, I believe, in the opinion of the superintendent—has further improved, because we've been going through stress tests and other analysis of these exact types of situations.

We can never be complacent about these issues, and we will stand ready to do what's necessary to keep the system functioning. The system has strengthened at a time when maybe some of that strength might be called upon because of global events.

[The Chair, Conservative, James Rajotte]

Thank you, and thank you, Mr. Marston.

We'll go to Mr. Hoback, please.

[Randy Hoback, Conservative, Prince Albert, SK]

Thank you, Chair, and again, welcome to the committee.

It's always great to hear you talk, Mark. It's really interesting for me, coming from Saskatchewan. We're still having trouble finding electricians and plumbers and in locating people. To think there's possibly going to be an impact in Saskatchewan from something going on in Europe or in Greece has a lot of people in my constituency wondering just how that will be the case. Why would it ever impact us? Of course you explained the global economy and how important trade is, and that end of it.

Concerning some of the comments you made about deleveraging in the U.S. and how that's going to have an impact on our economy here in Canada, the joint select committee on deficit reduction in Congress is going to have a report in about a month, talking about trillions in government spending cuts. How will that impact us? Will it impact us? Again, is this the cod liver oil that we have to take right now to be healthy as we move forward? Are we moving through the economic crisis in different stages? Are we at another stage that we're going to progress through until we finally see the light at the end of the tunnel? Where are we on that stage, the period of time in which this drag will affect GDP?

I'll stop there and give you time to answer.

[Mark Carney]

In terms of the overall deleveraging process in the United States, it will be centred first and foremost on the household sector, as we've indicated. There has been a double-digit percentage reduction in the level of household debt in the United States. Unfortunately, it's been done the old-fashioned way; by and large, they defaulted on the debt. It's been more that than the actual build-up of financial assets. That asset build is starting.

In terms of our expectations for the U.S. economy, we expect U.S. household savings rates to be in the neighbourhood of around 5%. You'll see that we believe the U.S. household savings rate was lower than that in the most recent quarter, and that's one of the reasons we see a little less momentum in the U.S. into 2012, as household savings go back to working through deleveraging. Without question, though, what the federal government in the United States does will have a material impact on the economic outlook.

To explain the way our projection is working this time, we are not including any of the provisions of the American Jobs Act in the forecast for the U.S. economy. So there's a little more than 1.2 to 1.3 percentage points of potential growth next year in the U.S., if all aspects of the American Jobs Act were to be passed by Congress. We're including none of that. So one of the things to watch in terms of where the U.S. goes next year is what, if anything, gets passed through that process.

Further on the spending side, as I think you're aware, the spending cuts that are part of the budget deal, including the 50% on the military, we're including because they have been passed. That's legislation until it changes, so we're not trying to read the tea leaves of Congress and adjust accordingly. We will adjust the forecast if there are changes to the spending reductions, and there could be changes that would be net economically positive, less draconian spending reductions—not in the amount, but in the composition of how it's reduced. So we, with others, wait and see.

There is some upside on the fiscal side in the short term for the U.S., depending on how these discussions go in Congress, but we are not counting on them. So for the people of Saskatchewan, if we see budget deals coming out of the U.S., there may be a little more growth that comes from that—but still in the context of overall deleveraging, particularly on the household side.

Let me say one other thing, which goes back to the deleveraging point. One of the issues that can have the biggest impact on the deleveraging side is anything that further facilitates the adjustment to mortgages, the level of--and here I don't want to say the foreclosure process necessarily, but--reworking of the mortgage burden of American households, around a third of whom have negative equity in their homes. This is one of the aspects of that deleveraging that would speed things up and get the U.S. back on its feet sooner. We don't anticipate major moves there, but if we did see something, then it would be material across the country, including Saskatchewan.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Hoback.

We'll go to Monsieur Giguère, s'il vous plaît.

[Alain Giguère, NDP, Marc-Aurèle-Fortin, QC]

Thank you for coming today, Mr. Carney.

At present, the main goal of your institution is still controlling inflation. However, the current climate of economic stagnation in Canada suggests a few problems, specifically, a major deficit in the balance of payments, low productivity, a lack of investment, higher unemployment, marked by a drop in the participation rate of the population. Finally, debt levels are so high that they limit the possibility of consumer growth. All of this information indicates that we must continue to support and even stimulate the Canadian economy.

Paradoxically, other central banks have introduced additional policy measures to provide monetary easing and promote economic growth. In this regard, I would like to know your thoughts on such interventions to promote economic growth. Could you give us any advice regarding fiscal policies to promote investment? This is a really important factor in addressing many of the problems facing the Canadian economy.

[Mark Carney]

I am going to ask Mr. Macklem to answer your question.

[Tiff Macklem, Senior Deputy Governor, Bank of Canada]

With regard to other countries, it is important to note that one of the major advantages of a flexible exchange rate is that we can have a monetary policy that is right for our country. As we have already mentioned, when the global recession hit, Canada fared much better than anywhere else. Nevertheless, it was a major recession. Our monetary policy consisted of lowering the key interest rate as much as possible. The government also provided significant fiscal stimulus.

As we stated in our monetary policy review, when we look at the current situation, there is still considerable monetary policy stimulus in Canada. We expect this to allow us to achieve the 2% inflation target. In other words, we think we are on the right track.

Furthermore, it is important to note that keeping our inflation target at a low, predictable and stable rate is the best thing our monetary policy can do right now. History has taught us that when we try to target things directly, such as the unemployment rate, in the end, we wind up with a higher unemployment rate and higher inflation. That is what happened in the 1970s.

It is also important to note that our inflation target is flexible. We take factors like debt levels and the unemployment rate into account when adjusting our inflation target.

For instance, let's look at a few simple figures. The unemployment rate has gone down since we last targeted inflation. It is more stable. If we look at other indicators, such as the labour market, we see that many of them have improved considerably.

Thank you.

[Alain Giguère, NDP, Marc-Aurèle-Fortin, QC]

Do I have another minute?

[The Chair, Conservative, James Rajotte]

You have 30 seconds.

[Alain Giguère, NDP, Marc-Aurèle-Fortin, QC]

Oh, dear. This will be brief.

I would like to talk about the exchange rate for the Canadian dollar against the U.S. dollar. Many manufacturers have told us that it is a major problem. Some are saying it was the determining factor in the loss of 300,000 jobs in the manufacturing sector, jobs that we cannot get back at this time.

Could you suggest any possible intervention strategies for bringing the exchange rate back to a more reasonable level?

[The Chair, Conservative, James Rajotte]

Please answer very briefly.

[Mark Carney]

Clearly, the persistent strength of the Canadian dollar is a serious challenge for the Canadian economy. As we said in our report, it poses a risk for the Canadian economy.

The Bank of Canada and the Canadian government have an intervention policy on foreign exchange. This policy is very clear and applies to extreme situations. It is up to the Governor of the Bank of Canada and the Minister of Finance to determine whether a situation requires intervention.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Giguère.

We'll go to Mr. Van Kesteren please.

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

Thank you, Mr. Chair, and thank you, Mr. Carney and Mr.Macklem, for appearing again before the finance committee.

I want to talk about two things. I'll get my questions out of the way and I'll let you answer them.

First of all, there has been a clamouring again for a new financial transaction tax. We hear it pretty loudly in Europe. As a matter of fact, I think when I served in industry there were some parties that were advocating for it in Canada as well. I want to know, Mr. Carney, what your thoughts are about that and whether that tax would be able to do the things its advocates claim it would do.

The second thing that concerns me is something that we've touched on briefly with a number of questions, and that is the danger of ongoing deficits. The previous questioner asked about stimulus spending and whether we should be spending more money. What would be the consequences in this country if we engaged in a policy of ongoing deficits? We've targeted 2015 as the time we would wrestle that to the ground. We are now looking 2014. What would be the consequences if we had a policy that allowed for continued deficits?

Those are the two questions, you could say.

[Mark Carney]

In terms of the financial transaction tax, I think it's always a little difficult answering that question, for two reasons. First, the prospect of a global financial transaction tax is extremely low. In fact, I would say that it's null, so we're into the realm of the hypothetical. The second reason it's difficult is that the proponents' reasons for a financial transaction tax are varied. Sometimes it's a revenue exercise for a very worthy objective, but it's a revenue exercise. Sometimes it's to stop certain types of bad behaviour or perceived bad behaviour.

Let me try to address the second one. What are some of the reasons you would have with a financial transaction tax? What are you trying to get at? The first is to raise additional revenue, obviously, from the financial sector, feeling that the financial sector as a whole doesn't pay sufficient sums. That's a political decision. Different countries will come to different views.

There are better ways to tax banks. Taxing the profits of banks is the most effective way to do it. It causes the fewest distortions. It will raise the most money.

We had a long experience in this country of taxing the capital of banks, which was a terrible idea, because it, of course, discouraged them from having adequate capital, which we've learned from the last crisis was not a good idea. That was phased out over the course of the last decade, and I commend various governments for having done that.

If it's to raise money from the sector, we would advocate taxing the profits, as is done. The banks, as Mr. Goodale and others know, are large payers into the federal fisc.

The second reason one might have a financial transaction tax is to reduce so-called wholesale funding of banks. In other words, it is not the retail deposits that everyone around this table and your constituents put into banks; it is borrowing in the markets. That type of borrowing, particularly if it's short term, is riskier than retail deposits. It can move quickly away from an institution that's perceived to be in trouble, and those perceptions can become reality. So sometimes there is a desire to use a tax to reduce that type of behaviour.

Again, there's a better way to do it, but it doesn't raise revenue. It's through various liquidity standards that actually encourage institutions to have longer-term borrowing rather than short-term borrowing, and borrowing that more closely matches their assets. It is part of the Basel reforms, the so-called Basel III reforms, that are being put in place now through to the end of this decade. They are actually being implemented. There are liquidity standards, both short- and long-term liquidity standards, and they will dramatically change the incentive of financial institutions to borrow too much in the short term.

The third reason you might have a financial transaction tax, from a policy perspective, is to reduce “speculation” and churning in the markets, or actual market behaviour. The strategy there is to adjust the capital requirement for the trading books of banks. As part, again, of the Basel III reforms, the capital requirement for the trading book of a financial institution--the capital you put against all those people who are sitting in those dealing rooms and what they are doing--has tripled. That is being put in place from the end of this year. And that will significantly increase that requirement, which is going to, on the margin, reduce this type of activity.

The last point, just to go back to where I started, is that the reason it is not going to come into place, in our view, is that there is significant opposition to it, because it is the second, third, or fourth best way of addressing various issues. Unless everybody does it, activity is going to flow to those jurisdictions where they don't do it. The experience of Sweden and others, who had variants of this tax in the eighties and nineties, has been that they lose money in net terms, because the level of activity that goes abroad is so significant that it overcomes any [Inaudible--Editor].

I missed the second bit.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Van Kesteren.

We'll go to Mr. Adler, please.

[Mark Adler, Conservative, York Centre, ON]

Thank you, Chair.

I'd like to also welcome the Governor and the Deputy Governor to the finance committee.

I want to begin by saying that you and the finance minister have for a while now been talking about the dangers of high consumer debt, especially with regard to the housing market. On my way back to Ottawa last night, after taking my kids out trick or treating, I read with great interest the NDP platform from the last election. In one provision, they were calling for consumer credit card interest rates to be capped at prime plus 5%, which I think, had that been implemented, would have exacerbated the consumer debt crisis. You also note in the October monetary policy report that there's been somewhat positive information emerging in terms of household credit and the debt rate slowing down a bit.

As you know, the government has taken numerous steps to help Canadians enter the housing market, and also to strengthen Canada's housing market by reducing maximum mortgages to 30-year amortization and significantly reducing the interest payments Canadians have to make on the interest on their mortgages. But the government has also done a lot to encourage broader improvements in financial literacy—and this is where I'm going on this—including a task force on financial literacy headed up by Don Stewart of Sun Life. Now the government is working to implement its recommendations. In fact, even our esteemed chair of the finance committee has put forward a motion in the House on financial literacy.

I want to ask you: can you speak to why improving financial literacy, particularly among our youth, is an important goal?

[Mark Carney]

We certainly welcome broader efforts to improve financial literacy. We play a modest role in that, or we try to play a role in that, through our outreach efforts, through our website, and through our museum. We're going to continue to enhance our explanations of how the economy works, how money works, and elements that I think would be consistent and broadly supportive of this effort.

When explaining these things to youth or any age group of Canadians, part of the issue is that sometimes we all take the recent past as indicative of the future. As you know, past performance is no guarantee of future performance, which is why we focus so much on the economy and achieving our inflation target, and we keep working at that. We don't take it for granted.

In terms of this issue and the household debt issue, one of the great risks in the current environment is that Canadians take low interest rates—very low, extremely low, historically low interest rates—for granted. They construct their financial affairs with very long-term liability, such as a mortgage, on the expectation that interest rates will basically stay at these levels over the life of that mortgage. What we have tried to counsel is the very basic point that, in taking on a longer-term debt, people should look at their ability to service it at a more normal rate of interest. We supply on our website all the rates of interest going back through the last decade, the nineties, the eighties, and back to Confederation, so the Canadians can make their own judgments about what normal is—but it's considerably higher than where rates are today.

That's a very basic important fact. The other basic fact for younger Canadians is the benefit of compounding, even at low rates of interest, and the value of starting some element of savings early on, particularly in a society where the vast majority of Canadians are saving for their own retirement. If you start early and build over time, even in periods like the present when there is extreme volatility in markets, the value of compounding will overcome that volatility over the lifetime of your building up a nest egg for a home, for retirement, or for your children's education.

If I may, Mr. Chair, I would say the final thing is that there are a variety of programs and tax advantage programs to enhance savings for Canadians. Just being aware of those programs and using them is incredibly important.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Adler.

Colleagues, we have time for one more round of four colleagues, so we're going to ask you to be very brief.

We'll start with Mr. Julian, please.

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

Thank you, Mr. Chair.

I'm a little surprised that Mr. Adler was reading the NDP platform last night, given that it was Halloween. It would have been more appropriate to read the Conservative platform, because that's scary.

Mr. Carney, since this is our last round I have a number of questions for you.

Mr. Jean put a question to you about our overall level of financial sustainability, which I think you answered very effectively. We in the NDP believe fully in financial sustainability, of course. For the last 20 years the ministry of finance has said that NDP governments were the most fiscally and financially sustainable of all party governments.

I think you were making the point that in the current context there is some room for fiscal stimulus within a sustainable framework. That's what I understood, so perhaps you could come back to that point.

Second, on page 12 of your report, you mention the impact of fiscal austerity measures in Europe as one of four factors contributing to a mild recession in the euro area. Perhaps you can speak to that.

Third, in your third technical box, you speak of the relationship between crude oil and gasoline prices. We know the impact of energy prices on the average family budget as well as on inflation. There has been increasing concern about speculation in the energy industry. Are you concerned about the volatility of gas prices and how that could contribute to inflation? Do you favour measures that might rein in that speculation?

Fourth, Canada's balance of payments deficit in terms of the current account is estimated by the IMF to be among the worst of industrialized countries for next year, at -3.8%. That's worse than Spain, Italy, and France. Are you concerned about that, and do you see that as perhaps a byproduct of what many on this side feel is a failed export strategy by the government?

[The Chair, Conservative, James Rajotte]

Governor Carney, you have three minutes to answer, but if you want to follow up with the committee you can do that as well.