Finance Committee on Oct. 30th, 2012

[The Chair, Conservative, James Rajotte]

I call this meeting to order. I will ask our friends in the media to please step outside. Thank you very much.

This is the 85th meeting of the Standing Committee on Finance. Our orders of the day, pursuant to Standing Order 108(2), are a study on the report of the Bank of Canada on monetary policy.

Colleagues, we're very pleased to have, in our first hour today, the Governor of the Bank of Canada, Mr. Mark Carney. Mr. Carney, welcome back to the finance committee.

We're also joined by the senior deputy governor, Mr. Tiff Macklem, who is also a frequent contributor to this committee as well.

Gentlemen, welcome to you both. Thank you so much for being with us today.

Governor, please start with your opening statement, and then we'll have questions from members.

[Mark Carney, Governor, Bank of Canada]

Thank you very much, Chair. Good afternoon, members.

Tiff and I are very pleased to be with you today to discuss our October monetary policy report, which we published last week.

The global economy has unfolded broadly as the Bank projected in its July MPR. Growth has slowed in ail major regions. The economic expansion in the United States is progressing at a gradual pace. Europe is in recession and recent indicators point to a continued contraction.

In China and other major emerging economies, growth has slowed somewhat more than expected. However, there are signs of stabilization around current growth rates.

Notwithstanding the slowdown in global economic activity, prices for oil and other commodities produced in Canada have, on average, increased in recent months. Global financial conditions have improved, supported by aggressive policy actions of major central banks. Sentiment, though, remains fragile.

In Canada, while global headwinds continue to restrain economic activity, domestic factors are supporting a moderate expansion. Following the recent period of below potential growth, the economy is expected to pick up and return to full capacity by the end of next year.

The bank continues to project that the expansion will be mainly driven by growth in consumption and business investment, reflecting, in part, very stimulative domestic financial conditions. Housing activity is expected to decline from historically high levels. The household debt burden is expected to rise further before stabilizing by the end of the projection horizon.

There are upside and downside risks around the evolution of household imbalances. Residential investment could regain momentum, thereby reinforcing existing imbalances. Conversely, continuing high household debt levels could lead to a sharper than expected deceleration in household spending. In this context, Canadian authorities are cooperating closely to monitor the financial situation of the household sector and are responding appropriately.

Canadian exports are projected to pick up gradually but remain below their pre-recession levels until the first half of 2014, reflecting weak foreign demand and ongoing competitiveness challenges. These challenges include the persistent strength of the Canadian dollar, which has been influenced by safe haven flows and spillovers from global monetary policy.

After taking into account revisions to the national accounts, revisions which had the effect of raising measured growth for this year, the bank now projects that the economy will grow by 2.2% in 2012. Going forward, we expect growth of 2.3% in 2013, and 2.4% in 2014.

With respect to inflation, core inflation has been lower than expected in recent months. This reflects somewhat softer prices across a wide range of goods and services. Core inflation is expected to increase gradually over coming quarters, reaching 2% by the middle of 2013, as the economy gradually absorbs the current small degree of slack, the growth of labour compensation remains moderate, and inflation expectations stay well anchored.

Total CPI inflation has fallen noticeably below the 2% target, as the bank had expected. It is projected to return to target by the end of 2013, somewhat later than previously anticipated, in fact, a quarter later than previously anticipated.

The inflation outlook in Canada is subject to significant risks. The Bank's projection assumes that authorities in Europe are able to contain the ongoing crisis, and that the U.S. fiscal cliff will be avoided.

The three main upside risks relate to the possibility of higher global inflationary pressures, stronger Canadian exports and renewed momentum in Canadian residential investment.

The three main downside risks relate to the European crisis, weaker demand for Canadian exports and the possibility that growth in Canadian household spending could be weaker.

Overall, the bank judges that the risks to Canada's inflation outlook are roughly balanced over the projection period.

Reflecting all of these factors, on October 23 the bank maintained the target for the overnight rate at 1%. Over time, some modest withdrawal of monetary policy stimulus will likely be required, consistent with achieving the 2% inflation target. The timing and degree of any such withdrawal will be weighed carefully against global and domestic developments, including the evolution of the imbalances in the household sector, which I described previously.

With that, Tiff and I would be pleased to take members' questions.

[The Chair, Conservative, James Rajotte]

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

We will start with Ms. Nash, please, for five minutes.

[Peggy Nash, NDP, Parkdale—High Park, ON]

First of all, let me welcome both of you once again to the finance committee. Thank you for being here.

Let me start with your comments on the overall performance of the economy. We've seen some imbalances in the impact of the downturn and the subsequent recoveries, with some provinces hit more than others. The goods-producing sector is obviously still performing far below where it should be. We're seeing persistently high youth unemployment.

The Parliamentary Budget Officer has said that government spending reductions, the cutbacks, will result in an 1% annual decrease in the GDP by 2014. Were these cutbacks and the austerity measures taken by the government the correct fiscal policy? Would you care to comment on that?

[Mark Carney]

Thank you for the question.

Absolutely you are correct in the sense that there have been some imbalances or disparities in economic growth. That's frequently the case. In an expansion or in a recession and subsequent recovery, some sectors are affected differentially. Particularly in Canada one of the most important impacts obviously has been the structure of global demand and particularly demand for Canadian exports.

As is referenced in the report, foreign activity, which is an aggregate measure of foreign demand—demand in the United States and across the emerging world, the demand that matters most for Canadian goods—has been particularly weak in the recession period, and its recovery has been relatively weak. I'll give you one example, which is that of the U.S. housing sector. At its peak that sector was producing two million starts a year. It went down to a trough of less than 500,000 new homes per year as recently as a year ago.

Over the projection horizon we see that coming back more rapidly than the actual measured GDP, so there will be some benefit. That will help with disparities.

On your particular question, though, related to government expenditures, I would note that the fiscal expansion in the early days of the recession made an important contribution to GDP and to the recovery. It accounted for up to a third of the growth that came out in 2009-10 on a fully measured basis, a multiplier basis.

The subsequent adjustment and move in the direction of fiscal balance obviously does create some measure of fiscal drag, but as a whole, the direct contribution of government, at least in the bank's projection, the actual government spending—and I refer you to page 27 in the English—in 2013-14 is about 0.3 percentage points of additional growth.

For reference—and I'll hand it back to you—on average historically that contribution would be something like 0.6, but that's the nature of the adjustment. So it's positive, but it's not as much as previously.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Thank you for that.

I'm asking because this was a decision taken at the G-20 summit, to focus on getting to balanced budgets quite quickly. Even the IMF, I think, has underestimated the impact that austerity measures would have around the world.

I want to ask you to expand on comments you made last summer when you talked about inequality. Information released today by Food Banks Canada said they have seen a 31% increase in food bank use since before the recession, with a total of 882,000 Canadians using food banks.

How serious do you think the challenge of inequality is? What kind of a challenge does it pose to the people of Canada and specifically to the Government of Canada?

[The Chair, Conservative, James Rajotte]

You have about 30 seconds left. That's a big question, but can we have a brief response to that?

[Mark Carney]

I would say in general there has been an increase in inequality across the advanced economies over the course of decades, that there is normally and there has been an increase in measured inequality in the recession.

The best contribution of the Bank of Canada to mitigating this is to ensure that inflation is low, stable and predictable, because inflation itself hurts the poor the most, and deflation hurts those Canadians who are indebted the most. Our job is to make sure that inflation, on average, is at that 2% target. We can come back to this if other members wish.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. Nash.

Mrs. McLeod, please.

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

Thank you, Mr. Chair.

It's always a pleasure to have you before the finance committee, Mr. Carney.

I was first elected in 2008, and it seems there has been a number of very significant challenges we've had to face as a government since that time. Certainly, I want to note that in your monetary policy report you underline:In Canada, while global headwinds continue to restrain economic activity, domestic factors are supporting a moderate expansion.

Given that comment, would you conclude that the greatest risks to our economy are really external events outside our control, like the European crisis? Would that be a fair comment?

[Mark Carney]

In our hierarchy of risks, we would say that the greatest risks are external. You referenced the European crisis quite rightly. Our expectation is that that crisis will remain contained. That is different from it being resolved, but it will remain contained.

The next in the near term is the potential resolution, or not, of the so-called fiscal cliff in the United States. This is something that, if not resolved—that's not our expectation, but we're no wiser than anyone else in terms of the eventual resolution of this--if the fiscal cliff were not to be resolved and all of the measures were to come into force that are on the books in the United States, the U.S. would almost certainly be in recession next year with a knock-on effect, obviously, for Canadian exporters, business, investment, etc. We're not predicting that, but it's a possibility.

I would note, as we do note in the report, that we do have a domestic risk that bears attention. That is the level of household indebtedness. This is the risk that we and others have been flagging for some time. It has built over time, since we've both been here in 2008. At present, given measures that have been taken by OSFI, by the government, given as well the stance and the leaning of monetary policy in Canada, there are mixed signals. I say that in a positive sense in that there are some signs that the pace of accumulation of household debt is certainly slowing. The pace is slowing, though it is still accumulating, and some adjustment appears to be under way in the housing market. This requires continued vigilance by all parties, and we certainly intend to play our part in that.

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

To go back to the European crisis because that might potentially have a significant impact, can you talk about the progress that's been made recently? Are we anywhere near a lasting resolution on this issue?

[Mark Carney]

I would not say we are near a lasting resolution on the issue, but that is not to diminish the important progress that has been made over the course of the last year.

Very importantly, the measures taken by the European Central Bank over the summer, the so-called OMT program, the intent of which is to remove so-called convertibility risk from European government borrowing, in other words, removing the risk premium that's paid by those governments for the possibility that the euro would cease to exist in its current form, the ECB has taken that risk off the table, or has made the commitment to take that risk off the table. That is very significant.

In addition, there has been progress, not completion but progress, on issues such as banking union and progress on some other broader fiscal arrangements that are there, but as we've underscored on a number of occasions, there is an ongoing need to deepen the economic union, to relaunch the financial union within Europe. Ultimately, there may need to be constitutional changes in Europe. There is a host of fiscal and structural reforms in each of the member states that are necessary for a lasting resolution of this situation, so it will take years.

[The Chair, Conservative, James Rajotte]

Thank you.

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

I was hoping to talk about the speech you gave at the Spruce Meadows round table, if you could give a quick summary within 15 seconds, but perhaps one of my colleagues will pick that up later.

[Mark Carney]

The quick summary is that Canada has been blessed with immense commodity resources. We should develop them sustainably and intelligently and to the benefit of all of Canada. That is entirely within the realm of possibility. All other things being equal, if commodity prices are going to be higher than historic averages, which they have been and we expect that to continue, it's better to have commodities than not.

[The Chair, Conservative, James Rajotte]

Thank you, Mrs. McLeod.

Mr. Brison, please.

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

Thank you, Mr. Macklem and Governor Carney, for joining us today.

Governor Carney, yesterday the Minister of Finance lowered projections for government bond and T-bill rates until 2016. We have the Parliamentary Budget Officer's report which expects interest rates, Bank of Canada rates, to stay where they are until about 2015.

Are you concerned about what seems to be an emergence of a consensus that Bank of Canada rates are going to remain just about where they are for the foreseeable future, given your warnings to Parliament and to Canadians about rising personal debt levels?

[Mark Carney]

The Bank of Canada sets monetary policy consistent with our inflation target and consistent under flexible inflation targeting, we're supporting other objectives such as financial stability in Canada, and we will take whatever actions are necessary.

Obviously in a view that we have in this projection, which includes some modest withdrawal of monetary policy stimulus over the course of the projection, a projection which runs until the end of 2014, in other words in advance of the 2015 date you just quoted, that would not necessarily be consistent with the projection, but I would reiterate that any adjustment to monetary policy would take into account the evolution of domestic and global factors, including the imbalances in the household sector.

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

In the area of shadow banking, you've been active as chair of the FSB in calling for more oversight. In your speech at the CAW, you talked about Canada's auto leasing market, and what happened in 2007, and the effect in terms of the asset-backed commercial paper issue. Could you provide some current examples of shadow banking activities in Canada that would provide concern? What are the public policy measures we ought to be taking as parliamentarians?

[Mark Carney]

Jointly with other authorities, both federal and provincial, we have been conducting a monitoring exercise of the level of activity in the shadow banking sector. I would say that—I'm not going to be Pollyannaish about it—but there are not identifiable pockets that have the same level of risk and vulnerability that existed in the asset-backed commercial paper market in 2007-08. That's the first point. This is an area which requires consistent vigilance.

The second point is that the response to potential risks—and it's not just about risks that exist now; it's to ensure that vulnerabilities don't develop—should be proportionate and should be timely. With respect to policy, I will defer. The FSB is proposing to the G-20 this weekend and on Monday in Mexico City, a series of potential reforms which, subsequent to the presumed endorsement by the G-20, would go out for broader consultation next week. It should be considered here in Canada by parliamentarians.

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

We all know how vulnerable we are to events and decisions made in the U.S. I'd appreciate your insight very briefly on three such events and decisions: QE3, some of the recent strengthening numbers in the U.S. housing market, and given that Bloomberg is reporting that hurricane Sandy will cause up to $20 billion in damages, what will be the impact of that? I know they are three distinct events and/or decisions, but I'd appreciate your thinking.

[The Chair, Conservative, James Rajotte]

You have about a minute left to respond.

[Mark Carney]

I have one minute? Okay.

Let me start from the bottom, which is first to acknowledge our sympathies for the families in the U.S. and in Canada who have been affected, and tragically so, by this storm, which as you know is ongoing.

Obviously it's very early days and the damage, unfortunately, is not yet complete. The estimates in the order of $20 billion are very early stage. What I would say in general is that with these types of disasters, there obviously is an impact on growth and activity. Initially there are activities that can never be redone: a visit to a restaurant or a movie or something similar that didn't happen over the course of the last few days represents lost GDP. There's obviously destruction, which isn't actually measured, but then there's the rebuilding, which is measured, and the extra activity and the shifting in time of activity.

I'm not trying to belittle the hardship that is being felt and continues to be felt, but in general it tends to be a relatively negligible impact over time. There will be noise in the data. There will be some stronger data and lesser data.

Those other two questions are very important, and hopefully, we'll come back to them.

[The Chair, Conservative, James Rajotte]

We'll come back to them, Governor. Thank you very much.

We'll go to Mr. Van Kesteren, please.