Finance Committee on Nov. 1st, 2011

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

I was asking about excessive debt and the risks those households are exposing themselves to.

[Mark Carney]

The most obvious risk, in the medium term, remains a possible interest rate hike. That is only normal during economic expansion. In this fragile climate, some households will have more difficulty.

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

You also mentioned that the growth of household spending could decline because of certain tools the government has implemented. We know the government is currently privatizing the CMHC, in a certain sense, by opening up the market to competitors offering a broader range of services. Could that not lead to greater household debt or the possibility that families will be forced to default on their payments?

As for the CMHC, its role is opening up somewhat. The market has been opened up to competitors that offer additional services. We have seen this, of course, and that is why the CMHC—

[Mark Carney]

I understand. That is, in fact, one of the advantages of Canada's mortgage insurance system. There are rules, minimum standards for mortgage insurance. And the government has already tightened those rules, even for private mortgage insurance providers.

You raise an important point.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Mai.

We'll go to Mr. Jean.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

Thank you, Mr. Chair.

Thank you for your attendance today and congratulations for your great work on the Canadian economy.

I'm a very old person. I grew up in the sixties, seventies, and eighties in Fort McMurray. I saw what the national energy program did during the eighties, in particular in relation to over-inflation. My questions are in relation to inflationary targeting and the agreement of 1991, and what happens if we do have over-inflation. I remember 22% to 23% interest rates on loans and most companies in Fort McMurray going bankrupt during the late eighties.

Most industrialized countries have some form of inflation targeting agreement, except for the U.S. and Japan. Is that correct?

[Mark Carney]

That is correct, yes.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

The U.S., and Japan in particular, take that into consideration in their fiscal policy.

[Mark Carney]

In the United States, the Federal Reserve has a dual mandate for both inflation and employment. In recent years, the Federal Reserve has interpreted that mandate a little more closely to be an inflation targeting mandate, effectively through the members of the Federal Reserve identifying what their medium-term objective is for inflation.

In Japan, there is a level of inflation at a bit less than 1%, which is the central objective of the members of the board of the Bank of Japan. It's somewhat similar, but it's not as explicit. One of the advantages of an inflation targeting framework is the clarity that it provides. When we come in front of this committee, you know what we're supposed to have done on the monetary side.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

There's also the flexibility of the agreement, as well as the ability to continue with reforms in the financial sector globally. Those things all help us manage our economy. Is that fair to say?

[Mark Carney]

It is fair to say. One of the jobs of the Bank of Canada in managing inflation targeting is to explain where the economy is today, and the nature of the shocks hitting the economy. These can sometimes be positive, sometimes negative. At the moment, they feel a little more negative from outside, but we also get tailwinds from time to time. We need to explain those and give a sense of what the optimal horizon is to return to that 2% inflation target.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

I agree. I liken the managing of the economy to a fire. You put in too much wood, it burns too much, and you get rid of all the wood. You have to manage a camp-fire just as you manage the economy. You put too much in and it over-inflates and nobody has any wood left, which means everybody has spent his money, because they can't afford the interest rates. It burns too rich.

I've often thought of that in regard to infrastructure investments. Sometimes the opposition calls for $20 billion or $30 billion in continual investment in infrastructure. But if we borrow too much money, if we have interest rates that are too high, if we have over-inflation, those things can destroy an economy. Is that fair as well?

[Mark Carney]

Any economy that is running above its potential, whether because of an excess of household expenditures, business investment, government activity, or a combination of all three, will have greater inflationary pressures, which will have the knock-on effect of raising interest rates and also--

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

And borrowing too much money will do the same thing?

[Mark Carney]

It will in extreme cases. There is not a direct link between borrowing and the inflation rate. It's the activity that's brought it about. Ultimately, there is the risk that some of that debt would be monetized by the central bank. But that has never been the case in this country.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

Long term, that would have a disastrous effect if it were done on a continuous and significant basis. Would that be fair to say?

[Mark Carney]

There are many advantages to long-term fiscal sustainability, yes.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

I have a quick question. The C.D. Howe Institute suggested that other factors like financial stability should be taken into consideration when setting interest rate targets. Would that be helpful?

[Mark Carney]

It's an important issue. One of the challenges is that considerations of financial stability tend to have a different time horizon from the reasonable time horizon for inflation targeting. We tend to centre on returning inflation to target within around six to eight quarters, but from time to time we go as long as 10 or 11 quarters and sometimes we go to six, depending on the shocks.

The financial vulnerabilities can build up. Success in fiscal policy, in monetary policy, and in general financial stability policy can actually start to trigger behaviour that builds up a vulnerability. And the question is how you address it.

What we have favoured are good regulations, micro-regulations, starting with the Superintendent of Financial Institutions. In addition, we have favoured selected macro-prudential tools such as the government has used in the mortgage market. Only after those have been used to their maximum impact, and if there's a generalized issue, is there a role for monetary policy to play within a flexible inflation targeting framework. But that has to be clearly explained and it has to be sequenced in the manner I just outlined.

[Brian Jean, Conservative, Fort McMurray—Athabasca, AB]

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Jean.

We'll go to Mr. Marston, please.

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

Well, thanks, Mr. Marston.

[Some hon. members]

Oh, oh!

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

That's how distracted I am today.

[The Chair, Conservative, James Rajotte]

We're almost related.