Finance Committee on Nov. 15th, 2011

[Dr. James Stanford]

Thank you.

I think monetary policy has absolutely exacerbated the inequality in our society, because it has explicitly targeted inflation control. One effect of that is to enhance the real value of wealth—that's how Chris put it—at the expense of targeting full employment, trying to get to a situation where an average worker even in a Tim Hortons has a shot at getting a higher standard of living. In Fort McMurray, the Tim Hortons worker has a shot at getting a higher standard of living, but the Bank of Canada is there to ensure that situation does not occur outside of a few small isolated areas.

That's why the wage share of national income has declined secularly, not just under inflation targeting but under the whole sort of shift towards inflation control as the top priority. The wage share has declined. The share of income going to those who own wealth has increased, and that is absolutely paralleled in the growing personal disparities of income in society. If we want to address that, yes, fiscal transfers are important, but we also have to give people a fighting chance of getting a job and getting a higher income from that job.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Julian.

I wanted to raise two issues. The first issue was raised by Mr. Alexander with respect to moving away from the inflation targeting and moving to one of the other models. My concern is the impact on the purchasing power of individuals and on their savings and income.

Mr. Alexander, you raised it, but perhaps I'll give Mr. Stanford.... I mean, that's my primary concern in terms of moving away from the model we have now. Obviously people on fixed incomes are of concern as well. Can you just sort of address the concern that I would have in terms of purchasing power of individuals if we move away from the model we currently use?

[Dr. James Stanford]

First of all, there's been a very wide range of risks to the real purchasing power of Canadians' savings, and I would suggest volatility in the inflation rate is near the bottom of the list compared to what's happened in financial markets, the value of assets, and so on.

But my more important response would be: where do Canadians get their savings in the first place? For most of us, you have to have a job that pays you enough to pay the bills, and then sock away a little bit of money. So in that regard, I think more of an emphasis on reducing unemployment—and increasing incomes from employment—would actually benefit Canadians' savings, because they'll have more money going into the bank.

Secondly, the nominal rates of interest are going to increase if the overall level of inflation increases as well, and that can have a benefit.

[The Chair, Conservative, James Rajotte]

Okay.

Mr. Alexander, do you want to briefly address that? Then I want to move on to my second point.

[Craig Alexander]

I guess it comes back to what the impact of even easier monetary policy than what we currently have would be. We already have an extraordinarily stimulative monetary policy. It could help to bolster economic growth to some extent, but I think the down side of it is that we would have much more rapidly rising home prices as well as much more rapidly rising household debt, and we'd have an even greater household debt imbalance that we'd have to address down the road.

One of the things we learned from the U.S. experience is that this wouldn't be a prudent path to follow.

[The Chair, Conservative, James Rajotte]

Okay.

The second point I want to address is with Mr. Sumner in terms of targeting nominal GDP, because you talked as well about the long-term rate of inflation. You indicate that you could actually address both—which I wish would be true, but I have to admit I'm skeptical of targeting nominal GDP and at the same time addressing the long-term rate of inflation.

Can you just explain to me how you could actually accomplish both? It seems to me that if you move the models, then you do move away from inflation targeting. I'm not sure how you could actually do both, if you do the targeting nominal GDP model.

[Scott Sumner]

Of course nominal GDP growth is the sum of inflation and real GDP growth. In most countries, including the U.S. and Canada, real GDP growth has been remarkably stable on average over long periods of time. Of course, it varies over the business cycle.

So if we picked, say, a 5% nominal GDP target, we would have had about 3% real growth and about 2% inflation over a period of many decades—maybe even a century. There are ways of adjusting that for demographics that I won't get into here.

But I would also point to the fact that even if it didn't work perfectly, that flexibility really could help in certain situations. I would point to Australia as a country Canada might look at. By the strict inflation targeting criteria, it hasn't done quite as well as Canada, but that also gave them more flexibility and they didn't fall into the liquidity trap, partly because of slightly higher inflation than nominal GDP growth.

Yet Australia would still be viewed as a country that would have fairly good performance on price stability and was able to almost completely avoid the recession this time around. Now, of course there are differences between the countries, but I think that would point to an example of a country that's somewhat similar to Canada in terms of its industry mix, and also was able to do somewhat better by being a little bit more aggressive on nominal GDP growth during this recession.

But again, long-term real GDP growth is remarkably stable, and if there are demographic shifts, that can be built into the model. If you do that, you're going to have some year-to-year fluctuation in inflation, but you're going to come very close to that average inflation rate you're looking for.

[The Chair, Conservative, James Rajotte]

I have time for one more person to comment. Mr. Ragan or Mr. Alexander, would you want to comment on that?

Mr. Ragan.

[Prof. Christopher Ragan]

On the nominal GDP targeting, I do believe that in Canada—it's less true in the United States—there will be a decline in GDP growth that will be significant over the next 25 years from population aging. I think that is almost inevitable, frankly. Nominal GDP targeting would then have either a steadily increasing inflation rate, which I don't think is a good thing, or it would have steadily adjusted official targets, which I think, from a communications point of view, would be about as close to a nightmare in monetary policy as I can imagine.

Plus, I am not convinced that there are the shorter-run benefits over the business cycle, given that you have flexibility in the current inflation targeting system. I think that's an important thing to recognize about the Canadian system—that there is flexibility built in, and in fact it has been on display very well over the past few years.

[Craig Alexander]

I think I would also caution you about using the Australian example, because the fundamental difference is that Canada's major trading partner is the United States, and Australia's major trading partner is Asia and China.

[The Chair, Conservative, James Rajotte]

Okay. I'd like to keep that going, but my time is up.

I'm going to move to Mr. Brison, please.

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

With respect to the question on Australia, Mr. Sumner raised this, and it's an interesting one, given that Australia is facing some of the same opportunities and challenges, I guess you could say, of commodity-based economies, with a lot of disparity between commodity-rich regions and other regions. I would actually want to relate that back specifically to Canada's situation.

Again, it's this whole issue. Given the differences between how well our commodity regions are doing in those sectors--the oil and gas sector in particular--and how badly other value-added and traditional sectors in the Canadian economy are doing, again, does that not strengthen the arguments for the consideration of nominal GDP targeting? Given that high commodity prices push up inflation, in some ways artificially in terms of the impact on the real economy, and that they also crowd out, because of the higher dollar, a lot of traditional manufacturing jobs, does that not augment the arguments for nominal GDP targeting in a balkanized Canadian economy?

Maybe Mr. Sumner could begin.

[Scott Sumner]

Yes, I think it does. I think it better balances the sorts of trade-offs between real growth and inflation and it better trades off the regional disparities.

I certainly agree that Australia was lucky with the Asian export connection, but I think it's also important not to overlook the problem of interest rates falling to zero. I think that's less likely to occur with nominal GDP targeting.

In Canada, if they could have done a little more monetary stimulus--easily by cutting rates--it seems to me it would have been more beneficial, but with the inflation target, that was difficult to do. If you look at the inflation numbers for Canada, you see that they've actually been fairly low for the last three years. So in a sense it may not have been the inflation rate per se that was limiting the adjustment or the response, but the fact that really unconventional monetary policy techniques would have been required, and with nominal GDP targeting it would have been probably easier to do that with interest rates, as Australia did.

But again, I think that although there are differences with Australia, the regional disparities and the manufacturing commodity split and so on have some similarities to Canada. I think it's at least a case worth studying to see if it applies to the Canadian experience. I do think nominal GDP targeting does provide more flexibility to deal with regional or sectoral shocks.

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

Thank you.

Mr. Alexander.

[Craig Alexander]

Very quickly, in terms of the amount of stimulus provided, the overnight rate went down to 0.25%, functionally the floor for nominal interest rates. Then the Bank of Canada could have embarked on quantitative easing to inject more, but quite frankly I think we could have a debate about whether more stimulus would have actually had a materially greater impact on the economy.

I'm not convinced that the inflation target actually did restrict the reaction function of the Bank of Canada. I think they put a lot of emphasis on the flexibility side of the equation. In fact, it goes back to the issue around anchored inflation expectations, because they could afford to provide a lot of stimulus knowing that the market would still expect inflation to get back to 2%.

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

You're kind of saying that because we had inflation targets that had been successful in the past, we could ignore inflation targets in terms of--

[Craig Alexander]

Right, because actually the objective is to get to 2% inflation over the medium term, not a given year, so there was the ability to respond through the flexibility of the system.

Also, I do question this issue around the better ability of the Bank of Canada to respond to the environment by using nominal GDP when we're a commodity-heavy economy. If all else was equal and all that happened was that oil prices went up, nominal GDP would go up and we'd end up with tighter monetary policy. So you'd actually have to work out--

[The Chair, Conservative, James Rajotte]

Okay--

[Craig Alexander]

--some sort of measure of core nominal GDP to eliminate the temporary impact of higher energy prices on nominal GDP targeting. I guess we could come up with something like that, but that's one of the reasons why the Bank of Canada uses the core CPI as the--

[The Chair, Conservative, James Rajotte]

Okay. Thank you.

Thank you, Mr. Brison. We'll have to continue this discussion after the meeting, unfortunately.

One more round, Ms. Glover, please.

[Shelly Glover, Conservative, Saint Boniface, MB]

Thank you, Mr. Chair.

I simply wanted to correct something Mr. Giguère had said. Mr. Giguère actually said that one of the tools the Bank of Canada has is the exchange rate, but that's not possible.

Mr. Seccareccia, can you correct what has been said?

[Prof. Mario Seccareccia]

It is not a question of... It might be a tool; it depends on what we mean by “tool”.

[Shelly Glover, Conservative, Saint Boniface, MB]

The Bank of Canada has no power...

[Prof. Mario Seccareccia]

At the moment, we have a flexible exchange rate, a floating exchange rate. The Bank of Canada does not actually have an exchange rate target. It is not a tool that we use. As I was saying earlier, the so-called reaction function of the Bank of Canada has to do with the inflation rate, period.

But...

[Shelly Glover, Conservative, Saint Boniface, MB]

Thank you. You...