Evidence of meeting #30 for Finance in the 41st Parliament, 2nd Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was data.

A video is available from Parliament.

On the agenda

MPs speaking

Also speaking

Stephen S. Poloz  Governor, Bank of Canada
Tiff Macklem  Senior Deputy Governor, Bank of Canada
Jean-Denis Fréchette  Parliamentary Budget Officer, Library of Parliament
Mostafa Askari  Assistant Parliamentary Budget Officer, Economic and Fiscal Analysis, Library of Parliament
Scott Cameron  Economic Advisor, Analyst, Economic and Fiscal Analysis, Library of Parliament
Randall Bartlett  Economic Advisor, Analyst, Economic and Fiscal Analysis, Library of Parliament

3:30 p.m.

Conservative

The Chair Conservative James Rajotte

I call this meeting to order. This is meeting 30 of the Standing Committee on Finance.

I want to welcome all of our colleagues back. I want to welcome our two very special guests to the first hour and a half of the session today.

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.

We're very pleased to have with us here this afternoon from the Bank of Canada, the governor, Mr. Stephen Poloz. Welcome back to the committee, Governor. We have the senior deputy governor, Mr. Tiff Macklem. Mr. Macklem, welcome back to the committee as well.

I understand, Governor, you have an opening statement. Then we'll hear questions from all members of the committee. Please begin at any time.

3:30 p.m.

Stephen S. Poloz Governor, Bank of Canada

Thank you very much, Chair. It's a pleasure to be here. I appreciate the opportunity for Tiff and me to be here to share with you some of the highlights from our recent economic outlook.

The bank, of course, aims to communicate openly and effectively so that Canadians know how we are achieving our mandate to promote the economic and financial welfare of the country. One of the best ways that we do this is by appearing before this committee and answering your questions.

I'll briefly discuss the bank's outlook for inflation, and then move on to our outlook for global and Canadian economic growth. I'll touch on some recent bank research and finish with trends that we are observing.

Inflation in Canada remains low. We expect core inflation to stay well below our 2% target this year, returning to target over the next two years. Total CPI inflation, however, will move closer to the target in the next few quarters due to temporary factors. Let me take a moment to explain.

We expect economic slack and heightened retail competition to keep core inflation below target until early 2016. At the same time, higher consumer energy prices and a lower Canadian dollar will contribute to total CPI inflation moving up.

Total CPI inflation will remain fairly close to target throughout our projection period. This is even as upward pressure from energy prices dissipates, because the impact of retail competition will gradually fade and excess capacity will be absorbed. When this happens, core inflation will gradually make its way up to 2% and catch up with total CPI inflation from below.

Let’s now move to our economic outlook.

Global growth should gather steam in the coming three years as the headwinds that have dampened growth dissipate.

Overall, we see global economic growth picking up to 3.3% in 2014, moving to 3.7% in 2015 and 2016. In Canada, real GDP growth is expected to average about 2.5% in 2014 and 2015 before easing to around 2%.

These numbers are essentially in line with the Bank of Canada’s January outlook, but they don't reflect the actual quality of the outlook, which has changed in meaningful ways, especially for emerging-market economies and Europe.

Growth in Europe is modest, but inflation remains too low, and hopeful signs of recovery might be stalled by the Russia-Ukraine situation.

China and other emerging economies are showing solid growth, although there are some growing concerns about financial vulnerabilities—specifically, increased market volatility in response to political uncertainty.

The economic recovery in the United States, however, is proceeding as expected, despite recent softer results largely due to unusual weather. In fact, private demand could turn out to be stronger than we had thought.

The issues Canada's economy faces are not unfamiliar to you. Competitiveness challenges continue to weigh down our export sector's ability to benefit from stronger growth abroad.

Given the importance of the export sector to an open economy such as ours and given the growing wedge between Canada's exports and foreign demand, the bank has deepened its analysis of the export sector, specifically non-energy exports.

By breaking down non-energy exports into a large number of subsectors, interesting facts and new trends emerge. To start, we're discovering that there are some subsectors, such as machinery and equipment, building materials, commercial services, and aircraft and parts, that are in line with their fundamentals, or in some cases doing even better than their respective U.S. benchmarks. This suggests that as the U.S. recovery gathers momentum and becomes more broadly based, many of our exports will benefit. The lower Canadian dollar will also contribute to the recovery of these subsectors.

Other subsectors, including auto and truck makers, food and beverage suppliers, and chemicals, will also be helped by a lower Canadian dollar, but this will be to a lesser extent since they are experiencing greater competitiveness challenges. Their recovery will be slower.

The big picture tells us to expect a gradual convergence between the growth rate of Canada's exports and that of the U.S. economy. This more granular research indicates that the wedge between exports and foreign demand will endure, and make no mistake: this wedge is real and it is large.

The good news is that we now know more precisely just where it is, with about half of our non-energy exports. The bad news is that these subsectors are doing worse individually than we thought before. This deeper understanding of our export sector is valuable, but it does not make us any less concerned about the challenges ahead.

Looking forward, we continue to believe that rising global demand for Canadian goods and services, along with the assumed high level of oil prices, will stimulate business investment in Canada and help shift the economy to a more sustainable growth track.

We continue to expect a soft landing for the housing market and Canada's household debt-to-income ratio to stabilize. Nevertheless, the imbalances in the housing sector remain elevated and would pose a significant risk should economic conditions deteriorate.

We are observing, anecdotally at least, an increased awareness of this risk. Consumers are showing responsibility; for example, homebuyers who opt to buy less house than they qualify for so they don't find themselves overextended if interest rates rise.

Banks, as well, are underwriting loans more carefully, ensuring that people can service their debts if rates go up. So, while the risk could be significant, we are comfortable that it is not outsized.

To sum up, the bank continues to see a gradual strengthening in the fundamental drivers of growth and inflation in Canada, but this view depends largely on the projected upturn in exports and investment. There is a growing consensus that when we do get home, interest rates will still be lower than we were accustomed to in the past. This is because of our shifting demographics and further, after such a long period at such unusually low levels, interest rates won't need to move as much to have the same impact on the economy.

With underlying inflation expected to remain below target for some time, the downside risks to inflation are important, as are the risks associated with household imbalances. The bank judges that the balance of these risks remains within the zone for which the current stance of monetary policy is appropriate, and as you know, we decided on April 16 to maintain the target for the overnight rate at 1.0%. The timing and direction of the next change to policy rates will depend on how new information influences this balance of risks.

Just before Tiff and I respond to your questions, I would like to take one more moment to say a few words about the man sitting next to me.

Tiff's contributions at the bank started long ago as a new recruit with a fresh master's degree in hand. I hired him then. His contributions throughout his career have been significant. At the bank, we'll miss him for his intellect and management skills, but we'll also miss a great friend to many, myself included. We can rest assured that Tiff's contributions to the financial welfare of Canada will continue as the dean of the Rotman School of Management, where he will be busy ensuring that the next generation of economists and business leaders are prepared to take Canada into a prosperous future.

Tiff did such a great job as senior deputy governor that to find his replacement we've had to split his position and look for two people to fill his shoes. I'm pleased to report that we will be in safe hands.

I look forward to introducing you to Carolyn Wilkins, our incoming senior deputy governor. Carolyn will oversee the bank's strategic planning and operations and she will share responsibility for the conduct of monetary policy.

I also look forward to working with our new chief operating officer, Filipe Dinis, who will be responsible for managing all of the bank's administrative functions.

With that, Tiff and I are happy to take your questions.

3:40 p.m.

Conservative

The Chair Conservative James Rajotte

Thank you very much, Governor, for your opening statement and your opening remarks. We appreciate that.

Also, on behalf of all the committee members, I want to thank Mr. Macklem for his outstanding public service to this country. We wish him very well. We've always appreciated him very much in committees. We do wish you all the best in your next endeavour, Tiff, and thank you.

3:40 p.m.

Tiff Macklem Senior Deputy Governor, Bank of Canada

Thank you.

3:40 p.m.

Conservative

The Chair Conservative James Rajotte

Members, we'll begin questions with Mr. Cullen, please.

3:40 p.m.

NDP

Nathan Cullen NDP Skeena—Bulkley Valley, BC

Welcome to both. Tiff, I'm new to this committee, but if I had known of this auspicious occasion, a watch from the committee would have been in order, but I see the chairman is far too frugal for such things, so words will suffice for today. Congratulations on your appointment to Rotman.

3:40 p.m.

Senior Deputy Governor, Bank of Canada

Tiff Macklem

Thank you.

3:40 p.m.

NDP

Nathan Cullen NDP Skeena—Bulkley Valley, BC

Thank you, Governor, for your introduction.

I have some initial questions and my colleagues will follow up on them.

I want to pull apart the difficulties you're mentioning in some of our export sectors. You made some distinction in the subsectors, ones that seemed to be responding and certainly connected to any improvement in the U.S., in particular, and others that are not so responsive.

Can you find a pattern in which to guide us in understanding this? Some of those subsectors, intuitively, I would have said benefited both, yet you pulled out auto, food and beverage, and some others that are not. You talked about competitiveness. I wonder if you could be a bit more explicit for us and, as best you can, describe what the risk entails, particularly about those subsectors which you believe will not be benefiting from any recovery south of the border.

3:40 p.m.

Governor, Bank of Canada

Stephen S. Poloz

Yes, of course. I would call the member's attention to a background paper which we published on our website last week. It's a four- or five-page piece which summarizes this, so I'll attempt to bring out the highlights for you now.

The methodology is not very complex. It's that in our macro models we use to model the entire economy, exports are modelled as a single category or in resources and non-resources. There are still quite a lot of things that are inside the non-resource bucket.

What we've observed over the last 18 months to two years is a growing wedge between the fundamental drivers of our non-resource exports and how many exports were actually selling. Right now, we're at about $35 billion to $40 billion fewer exports than our models would have predicted at this time.

Looking beneath this into the 31 subsectors, we're able to find a number of sectors, approximately half, which in fact have tracked their drivers quite well. That means the error term that we're concerned about is more restrictive to a smaller group, although it is still about half of our exports.

One of the ones you've mentioned is the passenger cars and light trucks. It has in fact matched reasonably well with growth and demand in the United States, not too surprisingly given the integration of the North American auto market. However, it has not historically been sensitive to exchange rate movements and as well, what we know is that the new investments that have gone into that sector in the last two or three years have primarily been outside of Canada. We reach from that the conclusion that although that sector is doing all right at this stage, we are not expecting it to contribute to a major closure of this gap that we've seen emerging.

The sectors that we believe are going to lead the way are mostly tied to U.S. investment activity, which has been relatively quiet given the stage we're at in the cycle. The U.S. recovery has been primarily driven by consumer demand and a rebound in the housing sector. Companies have not really started in full bore to invest in behind that.

We believe, in fact we stated this belief about six months ago, that as the U.S. recovery broadened into the rest of its sectors including investment and government spending—not surprisingly, state and local governments have been very tight budget-wise for some time—those constraints are easing up and so you're getting almost all cylinders beginning to fire. As that happens, we will see a stronger export recovery in Canada for many of the sectors that have lagged.

3:45 p.m.

NDP

Nathan Cullen NDP Skeena—Bulkley Valley, BC

Again, I'm trying to understand. Forgive me, I'm new to this file. A $35 billion to $40 billion gap seems significant in terms of the estimations considering how important those estimations are in determining where your forecast grows.

I'm still struggling to understand why you suspect that these different sectors will make up that shortfall or that gap, the trend line will improve given the two conditions are more of a consumer led rally and some U.S. government easing on austerity.

Am I hearing you correctly?

3:45 p.m.

Governor, Bank of Canada

Stephen S. Poloz

In fact, we don't expect that shortfall to be made up in the near term. Our forecast is based on us having gone down into this deeper level. That wedge will persist, but through time, the growth rate of our exports will converge on the growth rate of the U.S. economy. That will leave this wedge we've discussed in level terms that will persist until such time as the competitiveness challenges in those sectors are gradually overcome or they broaden into other markets. Or, I think the most important part will be that as new companies are created, they are almost certainly going to be exporters, and they will be brand new business for Canada.

3:45 p.m.

NDP

Nathan Cullen NDP Skeena—Bulkley Valley, BC

The bank continues its position on the, to quote your reports, “significant risk” in regard to household debt. I want to move topics for a moment. You say it's “significant risk should economic conditions deteriorate” at all. What specific economic conditions do you find you're most concerned about when considering household debt, which is at a historically high level in Canada?

3:45 p.m.

Governor, Bank of Canada

Stephen S. Poloz

Yes, household debt is at a historically very high level, so we believe that under current conditions and under our forecast it is sustainable and that it will in fact gradually unwind to more sustainable levels as employment growth spreads and the rest of the economy gets firing.

3:45 p.m.

NDP

Nathan Cullen NDP Skeena—Bulkley Valley, BC

I'm sorry, but what is sustainable to household debt rates that we're carrying right now that will gradually ease?

3:45 p.m.

Governor, Bank of Canada

Stephen S. Poloz

The household debt ratio is about 165%. Debt service, of course, is extraordinarily low because interest rates are very low at this point. Our belief is that as the economy continues to close the gap and recover, those ratios will gradually improve because exports will take the lead in economic growth.

However, when we say the risk is that if there's a deterioration in the economic outlook that would be a more fragile situation, what we're referring to is if there were another shock. Let's say the U.S. economy were to falter and slip into recession, or something happened in Europe to cause another global downturn. That would cause unemployment to rise in Canada, and that's when debt service becomes more difficult.

3:45 p.m.

Conservative

The Chair Conservative James Rajotte

Thank you, Mr. Cullen.

We'll go to Mr. Saxton, please.

3:45 p.m.

Conservative

Andrew Saxton Conservative North Vancouver, BC

Thanks to the governor and the senior deputy governor for being here today.

We also would like to thank the senior deputy governor for nearly 30 years of service to Canada and wish him well in his new responsibilities going forward.

Governor, you recently remarked on the bank's monetary policy report, wherein you noted that the performance of Canada's export sector is critical to economic growth, yet competitiveness challenges still exist for Canadian exporters' ability to grow abroad. Can you please expand on what those competitiveness challenges are?

3:45 p.m.

Governor, Bank of Canada

Stephen S. Poloz

Yes. The competitiveness equation is something from a company perspective that includes a large number of things, but the economists usually narrow it down to the relative costs of production, and what goes into that mix is any movement in the exchange rate. That would determine the price that you're able to sell, let's say, to an American buyer.

The bigger picture of this story, as we discussed in a speech last week, is that the rise in Canada's terms of trade that has happened in the last five to six years has in fact been an important gift to Canada. It's primarily resource prices that are high, oil in particular. When foreigners are spending more money on the things we're exporting, that's just more money that gets spent in Canada.

One of the consequences of this is that it tends to carry with it a higher currency. I liken that to walking your dog on one of those stretchy leashes. The terms of trade are the owner, and the dog is the exchange rate, and it zigzags around it, but they eventually leave the park together. The footprints look like an economist's chart, which means.... So you get the idea. They tend to be related over the long term.

The fact that our terms of trade today are about 25% higher than they were on average in the 1990s is a very significant development. It means approximately 7% more income in aggregate for Canada as a whole. This is pretty significant. One of the consequences of that, and one of the ways that gets spread around, is that the Canadian dollar goes up with it.

If you're a manufacturer in that mix, you have two things happening. The U.S. had this massive downturn, so you lost perhaps 40% or 50% of your export orders, on top of which the Canadian dollar drifted up over the course of that recession, because the price of oil was still rising. Those two things made it very challenging for that sector. As the U.S. cycle comes back, that's half the problem. The other half remains for our companies that over a long term have not been able to overcome those conditions with stronger productivity growth or other cost-saving measures.

That's why we say that about half of our export sector is labouring under that deterioration in competitiveness, and it for sure will take longer for them to gradually rebuild that, possibly through finding new customers in other growing markets, in Asia and so on.

3:50 p.m.

Conservative

Andrew Saxton Conservative North Vancouver, BC

Would you also say that a lower tax burden on Canadian businesses, in particular Canadian exporters, also helps to make Canadian exporters more competitive internationally?

3:50 p.m.

Governor, Bank of Canada

Stephen S. Poloz

Yes. As I said in my introduction, the competitiveness equation includes a lot of elements. Anything that costs a company money, whether it's a form of taxation or red tape or logistical connections, all of those things, if they're made better, then of course contribute to the overall competitiveness of the sector. But no single thing could be pointed to as the most important, except perhaps the relative productivity growth rates between ourselves and our competitors, and Canada has historically been lagging in that respect.

3:50 p.m.

Conservative

Andrew Saxton Conservative North Vancouver, BC

Okay, thank you.

The G-20 recently met in Sydney and they pledged to raise the global GDP rate to 2% through their removal of impediments to growth. These measures include the removal of trade barriers and the expansion of free trade agreements such as our government's recent agreement with the European Union and also with South Korea, as well as the potential with the Trans-Pacific Partnership. In fact, it's also important to note that since coming to government in 2006, we've signed free trade agreements involving over 40 countries.

To what extent will expanding Canada's international trade have on contributing to economic growth and job creation here in Canada?

3:50 p.m.

Governor, Bank of Canada

Stephen S. Poloz

Well, I believe that's a very fundamental contributor to that set of opportunities for companies. The Sydney declaration is intended to be aspirational. The fact is that in most countries, fiscal policy has done what it can, monetary policy has done what it can, and growth across the world remains, to some degree, disappointing relative to where we think it could be. So, as a group, the G-20 declared that they would bring other measures which are, if you like, removing impediments to growth, such as adding a free trade agreement removes tariffs, removes impediments to growth, to raise the potential for the world by about 2% in level terms over this five-year period, so, say, roughly, .04% per year.

I think that's a reasonable aspiration. It's been demonstrated through simulations with very complex models at both the IMF and the OECD, and Canada certainly has an opportunity to participate in that.

3:55 p.m.

Conservative

The Chair Conservative James Rajotte

You have one minute.

3:55 p.m.

Conservative

Andrew Saxton Conservative North Vancouver, BC

Thank you, Chair.

In a recent speech, you noted that Canadian households across all age groups were getting wealthier despite the financial crisis and the great recession. Could you please expand on these findings for the committee?

3:55 p.m.

Governor, Bank of Canada

Stephen S. Poloz

Yes, in fact Canadians have managed to continue to build their balance sheets through this. We know, just as a casual observer, that Canada managed the crisis better than most countries, although, of course, we had a down cycle, but it was not as big as other countries’.

As well, as many households own a home, we know the average price of homes has gone up and so there's been a wealth effect from this. Stock markets are strong. All those things go together to build up the wealth balance sheet for Canada's consumers.

I mentioned before about the terms of trade and it's a 7% increase every year in income for the country, which is very significant, and of course, it hinges on the maintenance of those high energy prices.