Finance Committee on Nov. 4th, 2014

[The Chair, Conservative, James Rajotte]

I call to order meeting number 55 of the Standing Committee on Finance, orders of the day, pursuant to Standing Order 108(2), a study on the report of the Bank of Canada on monetary policy.

I want to welcome our witnesses from the Bank of Canada and thank them for rescheduling the meeting which was scheduled to take place on October 22. We want to thank them very much for making themselves further available.

We have with us the Governor of the Bank of Canada, Mr. Stephen Poloz. Welcome back to the committee. We have, in her first appearance before the finance committee, the senior deputy governor, Ms. Carolyn Wilkins. Welcome to the committee as well.

I understand, Governor, you have an opening statement. Then we'll have questions from members. Please begin.

[Stephen S. Poloz, Governor, Bank of Canada]

Thank you, Chair, and good morning to the committee members.

It's my pleasure to introduce you to Carolyn Wilkins, who assumed the post of senior deputy governor of the bank on May 2 of this year. She is like a house on fire.

Before we take your questions, let me give you some of the highlights of the economic outlook. I'll draw mainly on the October monetary policy report, which was published about two weeks ago. I'll also reflect back a little bit further, since it has been some time since we last met.

I'm going to touch on some new advances in our thinking and talk about how the environment that we're living in is affecting that thinking and driving an evolution in the way central bankers conduct monetary policy.

Our outlook for the global economy continues to show stronger momentum in 2015 and 2016, but the forecast profile has been downgraded since July. In the two weeks since we published the MPR, new data on retail sales and monthly GDP have given us a stark reminder that data do not follow a straight line. The good news for Canada is that the U.S. economy is gaining traction, particularly in sectors that are beneficial to Canada's exports.

And our exports do appear to be responding, with some additional help from the lower Canadian dollar. Our conversations with exporters indicate that they are seeing a better export outlook from the ground.

Our exports do appear to be responding with some additional help from a lower Canadian dollar, as we saw in this morning's data report. Our conversations with exporters indicate that they are seeing a better export outlook from the ground, but it is clear that our export sector is less robust than in previous cycles.

Last spring, as you may recall, we identified which non-energy subsectors could be expected to lead the recovery in exports and which would not. We have since investigated in more detail the subsectors that have been underperforming. After sifting through more than 2,000 product categories, we found that the value of exports from about one-quarter of them—some 500 export categories—has fallen by more than 75% since the year 2000. Had the exports of these products risen in line with foreign demand, they would have contributed about $30 billion in additional exports last year.

By correlating these findings with media reports, we could see that many of these were affected by factory closures or other restructurings. In other words, capacity in these subsectors has simply disappeared. This analysis helps us understand a significant portion of the gap in export performance.

Most of the sectors expected to lead the recovery in non-energy exports still have some excess capacity. Our Business Outlook Survey interviews indicate that, while companies plan to invest in new machinery and equipment, few are planning to expand their capacity, at least so far. This helps explain why business investment might be delayed relative to what would be expected in a normal cycle.

This research has important implications for Canada's employment picture. We know that when companies restructure or close their doors, the associated job losses are usually permanent. If companies can meet increased export demand with existing capacity, the associated employment gains can be fairly modest with most of the increase in output coming in the form of higher productivity.

The bigger employment gains will come later when we enter the rebuilding phase of the cycle, when companies are sufficiently confident about future export demand that they begin to invest in new capacity and create new jobs.

These considerations enter into our estimation of the output gap. This is the difference between GDP and potential GDP, and that is the key macro-economic determinant of the outlook for underlying inflation.

When the economy moves into a position of excess supply, inflation declines, and when it moves into a position of excess demand, inflation rises.

There is no single preferred measure of capacity in the economy. Traditionally, we have put the most weight on measures based on output, or GDP. Each October, we do a full analysis of the determinants of potential output, and its future trend. We have done so in this MPR, but in future, we will update this analysis in every MPR. This time, we also offer a special technical box that considers the dynamics of excess capacity in longer business cycles like this one.

The reason this is important is that in longer business cycles like this one, the restructuring or closure of firms reduces potential output while creating permanent job losses. This means that the output gap can appear smaller than the labour market gap, which is our current situation. This is why we pay additional attention to measures of slack in the labour market.

For example, our composite labour market indicator, which we call the LMI, which was first presented in last spring's “Bank of Canada Review” provides a measure of slack based on several underlying labour market data series. The difference between the output gap and the labour market gap persists until after the rebuilding phase of the recovery, which I discussed a moment ago, when the excess capacity measures eventually converge.

Our judgment is that we have considerable excess capacity and that continued monitoring of stimulus is needed to close the gap and bring inflation sustainably to target. However, we take account of our uncertainty around the degree of slack by considering a range of possible slack estimates in our deliberations.

Another important building block of our policy framework is the neutral rate of interest, which is the rate that should emerge once all the dust is settled. Inflation is on target. The economy is operating at full capacity and all the shocks have been worked out.

There is uncertainty about this rate too and we estimate that it now lies between 3% and 4%, which is well below pre-crisis levels, but since the difference between current rates and the neutral rate is our best estimate of monetary stimulus, understanding the risks around this is also very important.

After weighing these considerations, it is our judgment at this time that the risks around achieving our inflation objective over a reasonable timeframe are roughly balanced. Accordingly, we believe the current level of monetary stimulus remains appropriate.

Some of our observers have commented that the considerable monetary stimulus around the world may be sowing the seeds for the next financial crisis. Certainly, financial stability risks, especially those related to household imbalances, remain a concern to us here in Canada, but our economy clearly faces significant headwinds and continued monetary stimulus is needed to offset them in order to achieve our inflation objective.

It is our judgment that our policy of aiming to close the output gap and insuring inflation remains on target will be consistent with an eventual easing of household imbalances.

Just as our analysis of the economic forces has been evolving with events as they transpire, so is the way we conduct monetary policy, adapting in real time to the changing environment. There is now particular emphasis on the incorporation of uncertainty into policy decision-making. We published a discussion paper on the subject earlier this month.

We have begun putting our growth and inflation forecasts in the form of ranges rather than points, and have given even more prominence to uncertainty and risks in the MPR.

We've refined our analysis of financial stability risks and raised the profile of our Financial System Review. And, we've begun to offer a more thorough description of how those risks are entering our policy deliberations, particularly in the opening statement that precedes our press conferences.

These changes have brought more transparency to our decision-making and our policy narrative has shifted from one traditionally seen almost as mechanical engineering to one now characterized as risk management.

One powerful risk management tool that policy-makers have in their tool kit is so-called forward guidance, the ability to provide the market with more certainty about the future path of interest rates.

This effectively takes uncertainty out of the market and places it firmly on the shoulders of the central bank. There are costs as well as benefits to using this tool. We decided that forward guidance will be reserved for times when we believe the benefits to its use are clear: periods of market stress, periods when traditional monetary policy tools are constrained, and so on. Otherwise, we will let markets do their job, which is to deal with the daily flow of new information and grind out new pricing without specific interest rate guidance from the bank, but supported by the increased transparency around our outlook for inflation and the risk that we are managing.

Finally, Mr. Chair, if you'll indulge me for one moment more, the Bank of Canada is as good as it is only because of it's superb staff. We are absolutely delighted with the announcement today that the bank has been named one of Canada's top 100 employers for the fifth year in a row. That's a proud moment for the organization.

With that, Carolyn and I will be very pleased to answer your questions.

[The Chair, Conservative, James Rajotte]

Thank you very much, Governor, for your opening statement.

Congratulations on that accolade once again.

We'll begin members' questions with Mr. Cullen, for a seven-minute round.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Welcome, Ms. Wilkins, to the committee, and thank you, Governor, for your comments.

With regard to a couple of things that you've said recently about the expectations of what recovery now looks like in Canada, and without overgeneralizing, is it fair to say that a low-growth or zero-growth recovery is possible in terms of the job market and new job creation?

[Stephen S. Poloz]

Yes. It's definitely what we're seeing. After a very robust recovery after the recession itself, we've kind of moderated into a more steady and yet slow-growth plateau. Primarily, this is a result of the fact that the global recovery has done the same thing.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

As most Canadians hear the news that a recovery is under way, one would naturally assume that it's associated to new job creation, yet we see that the private sector is not creating those jobs. At the end of the summer, in replying about the job market in the Financial Post, you said:

It’s been pretty weak. It’s been almost all part time so therefore it’s not generating the kind of income you would get from a usual 1 percent employment growth. We know that’s significantly less than we would expect to see in a well-performing economy.

The government has said that virtually 85% of all jobs created last year were full-time, yet this is noting a report that only a quarter of the jobs that were created were full-time and of lower quality.

I'm seeing two world views collide here, but yet the stats are the stats. The statistics point to something quite damaging, particularly on the manufacturing side.

I know you hesitate toward policy prescription, yet according to the Canadian manufacturers, we've lost 700,000 manufacturing jobs in Canada since 2002, and 400,000 manufacturing jobs since this government took office. They have not been replaced in overall terms.

Is there any particular monetary effort you would see from the government to reverse this worrisome trend, or are these jobs gone and not coming back?

[Stephen S. Poloz]

The context is important to remember. The world economy has lost more than 60 million jobs during this global financial crisis and the subsequent great recession, and then of course the slower recovery than typical. So, over 60 million jobs.... The statistics you quote I'm sure are exactly right. However, in that context Canada has done extremely well as a relative matter. That, I think, stems from having the most robust banking system in the world and having policies put in place at exactly the right time.

It's important to remember that it could have been far worse without this; however, as I said, we did have a strong recovery in jobs as we typically have in the post-recession period. Then what happened is the global recovery sort of stalled. Now we're in a period where that building phase is just starting to catch speed, especially in the United States. It's our outlook that we will continue to benefit from that through a stronger export recovery.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

You've readjusted for 6% lower in terms of trade. We talked earlier and my question was, what price of oil does the bank assume when doing its forecasting? Can you inform the committee what price that is? What assumption is made by the bank in terms of that energy price?

[Stephen S. Poloz]

In the monetary policy report, rather than construct a detailed forecast for the price of oil, what we do is we adopt a convention, which is that it will stay steady at an average price in its recent market observation. The price that we chose for this particular monetary policy report is $85 and we hold that constant for our projection exercise. Similarly, we hold the Canadian dollar constant in our exercise. Then we analyze the risk to the economy of either upside or downside scenarios on the price of oil. There are a number of risks on both sides of that, so it's an important thing to take into account. We have calculated that growth in 2015 will be about a quarter point lower as a result of this decline in the oil price since our last forecast.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

To translate that, what does a quarter point lower mean to the average Canadian? Is that significant? Is it just a margin of error rounding?

[Stephen S. Poloz]

It is within the usual margin of error. When we have a growth rate projected somewhere between 2% and 2.5% for next year, a quarter point is somewhere in there. Of course, it's also in the context where growth is low enough for a quarter point to be meaningful.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

I suppose that's my point. With the 2% to 2.5% prediction for growth in the GDP, saying that the suppressed price of oil right now—excuse me, I loaded the term, a lower price of oil right now—could impact that GDP growth by as much as one-quarter point is significant when we're only talking about a growth rate of 2% to 2.5%, that sum may be as much as....

[Stephen S. Poloz]

To give you some idea of how this would work, given the way exports behaved in the third quarter—and when we did the MPR we had only two months of data—at that point we were in the process of revising up our view for the outlook for GDP because of the stronger starting point, and at the time, the oil price began to decline. Those two effects were roughly offsetting, and for that reason, our outlook was almost the same as what we had in our previous monetary policy report. It gives you some idea of how a couple of months of data on exports can be sufficient to offset the kind of shock that we're discussing. It is within the margin of error and we don't overplay it, but there's no question that for the last few years there has been extra income boosting the Canadian economy throughout the country, because of a higher price of oil.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

I have a last, very brief question.

Consumer household debt is now at record highs. You've raised this alarm before. Is there anything the Government of Canada should be doing to address this and the impact it has on our Canadian economy?

[The Chair, Conservative, James Rajotte]

A very brief response, Governor, please.

[Stephen S. Poloz]

We acknowledge that the risks in household balances are edging slightly higher. They're not declining, as we had hoped; however, we do think with the outlook we have, and we're confident in that, that they will be easing down over the course of that projection.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Cullen.

We'll go to Mr. Saxton, please, for seven minutes.

[Andrew Saxton, Conservative, North Vancouver, BC]

Thanks to Governor Poloz as well as to Mrs. Wilkins for being here today.

Governor, my first question is in regard to the following. First of all, in your opening statement you alluded to the fact that Canada posted a trade surplus in September that was much greater than expected, about $1 billion greater than expected, thanks in part to a bounce back in the auto sector, which helps to underscore the importance of the assistance our government gave to the auto sector during the recent recession.

In your speech yesterday you noted that a “sustained expansion in our exports will not only represent new demand, it will ignite the rebuilding phase of our business cycle, which...will create new supply....”

There are many contributing factors that can help spur this economic growth, one of which is a weaker Canadian dollar, and another of which is our government's low-tax plan, which has made Canada one of the top countries in the world to invest in. Another aspect is to open up new markets for Canadian companies.

In your opinion, will Canadian exporters be able to benefit from rising global growth as a result of our government's ambitious free trade plan, which has led to new trade agreements with almost 40 countries, most notably the European Union and South Korea?

[Stephen S. Poloz]

Absolutely.

Over the course of this cycle, with the U.S. economy having taken the brunt of the financial crisis, Canadian exporters have had to invest much more in pursuing new business in new, non-U.S. markets. Those efforts are paying off, and of course will be enhanced greatly by new infrastructure, that is to say, new trade agreements or things that take things out of their way.

If you saw today's data in particular, the surprise, if you will, is where the extra growth was. It's in markets other than the United States, and yes, of course, cars are primarily a U.S. export, but other categories. We can't get carried away with the data this morning; they don't mean a trend, but they are adding to the sense of encouragement that the pieces are coming together.

The point I was trying to make yesterday is that we will require a sustained accumulation of this before the companies in the export sector are convinced that it's for real and will continue sufficiently to use up their excess capacity and begin to invest in new capacity. It's the investment follow-through that will give us the new job growth, which will affect the dynamics we were discussing in the previous question.

That sort of natural sequence is proving to be relatively slow, and I think it's primarily because the global environment remains a highly uncertain place. When you're in business, it's real money and you wait until you're more sure, having lived through these past five years.

[Andrew Saxton, Conservative, North Vancouver, BC]

Thank you.

You alluded to this briefly, but perhaps you could expand on how the increased markets for Canadian exporters will help to increase job creation here in Canada.

[Stephen S. Poloz]

In particular, when a company is trying to build its sales book.... Take a typical company. It might have lost 40% to 50% of its sales book during the great recession, primarily because of the U.S., and it may have downsized or restructured in response. If they're still in existence today, what they're looking for is new ways to grow, and their U.S. customers are starting to phone them again. That combination can be very powerful, but it's something from which we've not yet seen sufficient follow-through.

The important thing is that the higher growth rates to attach your business to are in the emerging markets, so catching just a small piece—one or two customers in a place such as Brazil, China, Indonesia, Vietnam, or some place like those—is going to give a lot more growth to the sales book over time than would getting one more U.S. customer.

That strategy is beginning to pay off. As I said, it will take quite some time for it to add up, considering the $30 billion of lost exports that I talked about before, which is the damage not just from this past recession but from more than 10 years of difficult times for that sector.

[Andrew Saxton, Conservative, North Vancouver, BC]

One of the contributing factors as to whether or not businesses invest in the economy is their level of confidence in the economy. Likewise, one of the strongest signs of a stable and growing economy is a balanced federal budget. Our government made balancing the budget a top priority, and we're on track to balance the budget in 2015. In your opinion, will a balanced federal budget have a positive impact on new business investment decisions by Canadian as well as global companies?

[Stephen S. Poloz]

That's a difficult call to make. Certainly it is a factor in business confidence; I can certainly agree with that. The thing is that throughout this entire stretch, there's been a very coherent plan in place for Canada's fiscal policy. That has been widely acknowledged in financial markets as a positive. Even when there was a deficit, there was a clear plan, a credible plan, for when we would no longer be in deficit. Whether there's another incremental confidence effect of getting there is something we'll have to wait and see about.

[Andrew Saxton, Conservative, North Vancouver, BC]

Would you agree that having a balanced federal budget gives the government the opportunity to continue a low-tax plan and also takes pressure off interest rates because the government is no longer as big a participant in the debt market?

[Stephen S. Poloz]

One of the headwinds we've identified, which is a global headwind, is that almost all governments are looking for ways to move themselves closer to balance, and Canada appears to be ahead of this process. It's one thing that the private sector may be recovering beneath the surface, but in the big numbers you can't quite see it because the government is rebalancing its posture. To the extent that those headwinds are diminishing, that's a positive for private sector growth to emerge more strongly.