Finance Committee on April 29th, 2014

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Thank you, Mr. Chair.

Welcome, Governor and Senior Deputy Governor. Mr. Macklem, let me first congratulate you on your appointment. This probably means that we will have an opportunity to see you again in committee from time to time.

My questions will first deal with the issuing of government bonds with a 50-year term. The government was quick to act. In the morning, we heard that the government was considering issuing those bonds and, by late afternoon, we learned that an amount of $1.5 billion had been issued and sold on markets.

We heard the version of the Minister of Finance, but could you tell me what the position of the Bank of Canada is in relation to the issuing of such long-term bonds? We are actually talking about 50 years.

[Stephen S. Poloz]

In this matter, the Bank of Canada acts as an adviser to the government. We manage the government's debt stock. In this situation, investors clearly want to have access to longer terms on the market. At the same time, that can allow the government to minimize the cost of its debt over a long period. In light of these considerations combined, it was suggested to move forward with the issue, which turned out to be very successful yesterday.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I would like to know what that means.

In the spring of 2012, the Auditor General did a study on interest-bearing debt. He looked at the models used by debt managers. Here is what he had to say:

The model's recent results show the advantage of issuing more short- and medium-term bonds rather than issuing long-term bonds. The model shows that such strategies, while improving the debt structure in the long run, would also reduce risks of increased interest charges.

The Auditor General's recommendation also took into account the rollover risk.

I understand that the government wants to provide longer-term funding with relatively lower interest rates. In this instance, should the government aim for a different composition of interest-bearing debt, heading toward long-term debt instead, or should it still be cautious and diversify the debt, as it has done so far?

[Stephen S. Poloz]

That is a very difficult question. The debt stock is high. The government must issue bonds in such a way as to meet demand and maintain cash flow in all areas of the interest rate curve.

Many factors come into play in this recommendation. It is very complex. It is important to consider market conditions and the needs of the government, while bearing in mind the bigger picture of debt stock.

[Tiff Macklem]

I would like to add something to that.

The debt strategy is established by the Department of Finance. As the governor mentioned, we are advisers.

The other factor is that the situation changes. During the crisis, the government launched a big budget stimulus plan, which made the debt go up. Today, the situation is reversed, to the point that we have to examine and adjust the strategy according to the needs.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Does that explain the government's latest decision? According to the Auditor General's report, market participants want the government to increase the number of 30-year bonds, but debt managers have chosen not to go in that direction. In the case of long-term bonds of 30 or 50 years, it is often a question of retirement funds and pension plans.

Is that why debt managers this time actually agreed to it?

[Tiff Macklem]

There needs to be a balance. Pension fund managers or large insurance companies are very fond of long-term bonds because their liabilities are long-term. However, they represent only a segment of the market.

For the government, the curve goes up on average. It costs the government more for long-term loans than for short-term loans. There is indeed a demand for long-term bonds, but the government does not want to issue all its bonds in the long term, because that would cost more. It is a question of balance. It is good for the government that there is a strong demand for bonds, but our advice was to find a balance. So there are a number of objectives.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

So all in all, right now would your recommendation regarding the composition of the debt itself be as between short, medium, and long term, that it should not be changing?

[Tiff Macklem]

What I would say now is, as I mentioned, that the government's requirements are changing, and in combination with new standards for banks, that is affecting the liquidity of global markets to some degree. It's going to be important in the debt strategy to make sure there is enough issuance of the key benchmarks that we can maintain well-functioning liquid markets in Canada and that we have a very well-defined Government of Canada curve, because that is the benchmark on which corporate bond issues are pricing.

That is a new fact. As issuance comes down, it is a new factor that is coming into play and will need to be factored into the debt strategy.

[The Chair, Conservative, James Rajotte]

Do you have another question, Mr. Caron?

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I can try quickly. My question is for Mr. Macklem.

Last time you were at this committee, you stated that the lack of competitiveness for our exports and our production, all in all, that two-thirds of it was due to the Canadian dollar and one-third the lack of productivity growth.

Do you stand by these numbers at this point?

[Tiff Macklem]

Well, the numbers of course always change. Right now since the last appearance, the Canadian dollar has weakened somewhat, so the contribution of the Canadian dollar part would be a little lower than it was last time. But it hasn't changed that much so it wouldn't be that far off.

[The Chair, Conservative, James Rajotte]

Thank you. Merci.

[Tiff Macklem]

Mr. Chair, there's a graph in the monetary policy report that shows that exact calculation and you can see it coming down a bit.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Mr. Adler, please.

[Mark Adler, Conservative, York Centre, ON]

Thank you, Governor, and Senior Deputy Governor.

I want to talk a bit about the international scene. Certainly, the events in Ukraine have upset some economic projects. In terms of the European scene, our recovery is very fragile. The Europeans have been coming out of the depths of their recession. How much of a hindrance is the Ukrainian economic crisis on the European economy? How will that affect our recovery here in North America?

[Stephen S. Poloz]

Well, it's early days for this question. Right now, we treat it as a downside risk, and it enters in the way you described it, which is that the European recovery, such as it is, the output in the European economy is still substantially below where it was before the crisis. Their recovery is very young and fragile.

As we know from our own experience and in the U.S. experience, business uncertainty is one of the variables that has really held things back. It's that lack of confidence that slows things down. Business uncertainty cannot be improved by the situation we're seeing there, so we take it in that way as something we can't really measure yet. Direct linkages are actually fairly small. You could predict linkages through a European banking system perhaps, the sanctions and so on. You may predict implications for certain commodity markets, but it's the indirect effects which are more concerning, I would say. That confidence can get dented at such an early stage in the European recovery, and the European economy is a similar size to the United States, close to 30%, let's say, of the world. That would be the sort of downside risk that we would treat very seriously.

[Mark Adler, Conservative, York Centre, ON]

I will shift around the globe a bit.

New Zealand has raised interest rates, the first economy to do so in a couple of years.

We've seen the U.S. rates being zero. First the FOMC, Federal Open Market Committee, was saying that they're not going to be increasing rates until inflation goes above 2.5% or unemployment goes below 6.5%. We have now seen inflation around that figure. We've seen unemployment at 6.7% in the United States, and now they're looking at other economic indicators in whether they are going to be increasing interest rates.

There has been talk now of these series of dots that appear on a chart; you've read all about that. How much of a problem is that for these projections, with the Fed going to be shortly stopping buying bonds, and how much of an effect is that going to have on our situation here in Canada? How much pressure is that going to put on you to increase rates here in Canada, if at all?

[Stephen S. Poloz]

Well, we begin the analysis with, we believe that the U.S. economy is gathering momentum and so it's entirely appropriate that there'll be, in prospect, some adjustment to monetary policy. The tapering, which last year caused what they called a tapering tantrum in financial markets, is now much better understood. I think markets are clearly distinguishing between gradually reducing the rate of purchases of debt by the Fed, and eventually a change to monetary conditions, and not necessarily hinging it on a particular variable, such as an unemployment rate or anything like that. It will be about general economic conditions and their inflation objective.

In our case, our monetary policy will be developed in a completely independent manner from that, based on where our economy is relative to its potential and, therefore, the implications for our inflation target.

Just as you can see New Zealand raising interest rates quite independently, you could see the Bank of Canada either adjusting interest rates or not adjusting interest rates, regardless of what the Fed may be doing. That of course may have some implications for our bond markets and so on, but it's the sort of thing that, if carefully explained, markets will understand. I think our interest rates aren't the same as U.S. interest rates now. Ours are 1%, not zero.

[Mark Adler, Conservative, York Centre, ON]

Given that it is 1%, you said earlier that fiscal and monetary policy have done everything they can possibly do up to this point. You said a few weeks ago, on April 16, at a press conference, that you wouldn't rule out an interest rate cut to stimulate the economy. What would precipitate you to do that?

[Stephen S. Poloz]

Yes, I did say that, and the question remains relevant. What we have done is, in the zone of uncertainty that we've sketched out, we've tried to balance the risks that inflation may prove to be too low, against the risk that in acting to reduce that risk, we would worsen household imbalances, which are elevated and at a state where we don't wish to worsen them. We decided that we're about right in balancing those risks.

What would change that would be, for example, if the export recovery that we talked about earlier did not turn out as we expected. Say, the U.S. economy doesn't quite get up as much speed as we think and our exports don't pick up, then we'd be looking at a longer period during which the economy would be below potential, and at a much higher probability that inflation would fall significantly below target for a long time.

Then we would need to re-evaluate that balance of risks with that new information. That's why I said at the time that if something like that transpired, then I can't be taking rate cuts off the table because I can't forecast everything.

If the reverse were true, then the reverse would be the reverse. You would have a different story altogether.

That balance of risk is not some knifepoint or razor's edge, but rather a zone in which we try to manage the risk that we're facing, including forecast risks.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Adler.

We'll go to Mr. Rankin, please.

[Murray Rankin, NDP, Victoria, BC]

I want to welcome both the governor and the senior deputy governor to the committee. I want to say in particular, as a proud University of Toronto alumnus, Rotman School is really glad to have you, sir. Thanks a lot.

I'm advised that the bank regularly has been overestimating export and investment performance in the past. If that's so, why has that been, and why was export performance finally downgraded?

[Stephen S. Poloz]

It's not just the bank that has been mis-forecasting these things. The economy has underperformed in these two respects in every economic model that I know of. When we ask ourselves why that is happening, it is of course our biggest research question. We look into things such as we discussed before, the animal spirits phenomenon, which is how much uncertainty needs to go away before a company will make its investment.

Given what we've been through over these past five years.... Many companies have disappeared; some 9,000 manufacturing firms have disappeared. The ones that survived may have downsized through the course of that period. We're asking when a company like that will be ready to re-expand to meet the new demands coming, let's say, from the United States or some foreign market.

The answer is they need to be more sure today, having been through all of that, than they needed to be five or ten years ago in a similar situation. This is that confidence thing, which is very hard to put your finger on, yet you know intuitively that it's true. You can talk to real people, and they'll tell you that it's true.

Our models don't capture things like that; it's as simple as that. On the export side, there are things now that, as I said, we are able to look at more deeply. We understand which sectors—we understand that they've had long-term problems maintaining their competitiveness—have lost market share in the U.S.

We can point to those and say that now we understand where it is, do we really understand what it is that is going to turn it around? That is what our model suggests will happen, but in the real world, it's real people making real decisions, so historical behaviour has not been a great guide to what we're seeing. And that is an excuse for how models work.

[Murray Rankin, NDP, Victoria, BC]

That's fair enough. Thank you.

I want to know whether you would agree in general terms with the Parliamentary Budget Officer's assessment that as a consequence of the last three Conservative government budgets, 46,000 fewer jobs were created and the GDP has been half a per cent lower than it would have otherwise been as a consequence of those austerity budgets.

Would you agree with that assessment of the PBO?