Finance Committee on Nov. 4th, 2014

[Stephen S. Poloz]

It's an interesting question. I'm going to turn the floor over to Ms. Wilkins, who's an expert on this. Thank you.

[Carolyn Wilkins, Senior Deputy Governor, Bank of Canada]

If I understand your question correctly, it's why we decided now to drop the forward guidance, particularly when at the same time we're saying there's some uncertainty.

We're of the view that the forward guidance we had in there—and that we were neutral with in respect to the future direction and timing of interest rate changes—was implicit in everything else we were saying. If we weren't saying anything new, or that people didn't know, then it really wasn't worthwhile to say it again.

What was underlying that was a view that the most important form of transparency that a central bank could give is about the models we're using, how we're thinking about the data as it evolves, and how we're thinking about the different risks and the quantitative impacts those risks might have. For example, what would happen if oil prices were higher or lower? Those are the kinds of things we've put an emphasis on in the last year and increased in our monetary policy report, including the ranges around the forecast.

From the point of view of helping market participants and people understand where we're coming from, and being transparent in terms of what's underlying our decision, we think we've increased our transparency.

We also said there may be a time when we think uncertainty is particularly high, like it was during the crisis when we did have a forward-looking statement that was fairly precise, or when we're constrained by interest rates that can't go below zero, when we find that useful. We don't think that markets need that kind of guidance today.

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

That is consistent with what you said, Governor, when you mentioned that it should be reserved primarily for use at the zero lower bound. We're not far from that at this point with the uncertainty of the economy. Some countries are still using forward guidance, but they used it at a time when they were not at the zero lower bound. I'm thinking about New Zealand or Sweden, for example.

Have you done an analysis of the way the tool has worked in those countries and in that specific time?

[Stephen S. Poloz]

We have. I've attempted to put my best thoughts forward in the discussion paper we published earlier this month that tries to put all that uncertainty we face into a full context and where forward guidance fits in that menu of possibilities.

What we need to acknowledge is that there are not only benefits to forward guidance, but there are costs. Those costs are associated with markets that function in an asymmetric manner because you've provided specific information on one side of the distribution and not on the other. Forward guidance has its main effect when the market stacks its positions and takes bigger speculative positions on the side of forward guidance. That's why it has an extra effect on interest rates. It means that when you change that forward guidance even a little bit, you can have these massive adjustments in the marketplace that can be very distorting.

In our view, it was time to remove that so the market would no longer be addicted to that statement. Then we can use it with full effect when we believe we need it, and the benefits outweigh the costs.

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

Thank you.

I know that you don't necessarily like to comment on fiscal policy, but I'll keep my question very general. We're at a point right now, and I'll refer to your speech from yesterday when you talked about dead money. It's not really that much of a problem because companies find it very uncertain to assume the risks that are inherent in this economy right now.

If we're talking about fiscal policy and tweaks, such as reduction of corporate income tax rates or even the measure of reducing EI premiums for small businesses, how effective are those types of fiscal policies in an environment where, even when companies have the financial leeway to invest and don't because of the risks, that flow of money won't be invested anyway?

[Stephen S. Poloz]

I'm afraid that's a very complicated question, especially for us since it's not our area. We'll take our fiscal assumptions as they are, as they're given, and we'll embed them in our own forecasting, but we're not in a position to judge the validity of individual tax or other changes.

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

I guess what I meant is the fact that fiscal policy.... How much importance does fiscal policy have in an environment which is still uncertain and in which companies actually have the leeway to invest and don't, not because they don't have the money but because of the risks they are facing?

[Stephen S. Poloz]

I appreciate that. It's as if all the ingredients are present but investment is still lagging. As I said before, the uncertainty is coming from whether the export demand is for real or if it will peter out again and we face another false dawn, of which we've had several. Still in that context, what you really want.... If that's one of the elements of their uncertainty, I'm sure there are 10 others. They'll mention things like frugals, or environmental studies, or other things that add...electricity costs, all kinds of things that enter into that set. If you're able to find others to reduce their uncertainty, I think they'll see it as a welcome development.

That's a very general response to your question; it's not a very specific one.

[The Chair, Conservative, James Rajotte]

Thank you.

Mr. Allen, please.

[Mike Allen, Conservative, Tobique—Mactaquac, NB]

Governor Poloz and Deputy Governor Wilkins, thank you for being here today.

When you talked, Governor, about the change in product categories and the decrease in exports, in other words, capacity in these subsectors has simply disappeared, and if we talk about $30 billion in additional exports if it had stayed in the base case, how does that compare? If you look at analyses in previous decades on this, businesses fail and new businesses come in to replace them, all those types of things. It sounds to me like there might be a couple of factors that are contributing to the fact that these businesses have not been replaced on exports. Is it a factor of a couple of things, such as non-growth in those export economies, or is it that businesses simply haven't been replacing them as they have in the past?

[Stephen S. Poloz]

That's a very good fundamental point. It's important for me to underscore that when we took those 2,000 export categories, the filter we used was to tell us which ones have had at least a 75% drop in exports since 2000, which is a very long term. If you add in a sunset industry that was going to go out of business for other reasons, we can't blame that on the financial crisis, and so on. That's a very fair point, and we don't make that claim.

In that, what we had though was a long period of dollar appreciation that was associated with the rising terms of trade in Canada, primarily driven by oil prices, but other resource pricing, too. As we've said before, that rise in oil prices in that period, say from $25 or $30 per barrel up to over $100 per barrel, had important income effects for Canada, and it caused underneath that a transformation of the Canadian economy, extra growth in the resource sector, a two-speed economy, lower growth in other parts of the economy. That can be stressful for certain companies, and we see some of the results of that. Then the crisis comes and the downturn, which is icing on the cake. If you're already experiencing problems, that could be the thing that puts you out. The sectors that come to mind are things like large transport trucks, locomotives—you can guess the companies probably—kraft paper, pulp, wood products for houses, wood furniture, knitted fabrics, those kinds of things.

All I'm saying is that we need another period of building to replace that, and as far as we can tell, it may be barely getting started.

[Mike Allen, Conservative, Tobique—Mactaquac, NB]

Thank you.

In your monetary report, the chart on page 17 talks about the slack capacity, and on page 14 you talk about three measures. You have your conventional measure; you have your integrated framework that takes into account the demographics, the macro-economic; then you have your business outlook survey. Are you using all three of those factors more? How has the conventional measure maybe not been so helpful in this lack of capacity, and how are these three measures helping you to kind of bind that a little bit?

[Stephen S. Poloz]

That's a great question and tied to the very nature of the cycle we're in.

I think Ms. Wilkins is best placed to answer it.

[Carolyn Wilkins]

Sure. Thanks.

We've always put a great emphasis on looking at a wide range of indicators when it comes to measuring the amount of slack in the economy. This time we chose to feature some of those a little bit more prominently.

The conventional measure basically looks at the output side and in fact probably misses some of the extra slack that we are seeing in labour markets at this time. This is really just a function of the cycle that we've seen where you do get output that's really hit and you've got a destruction of capacity and people leaving their jobs, either voluntarily or involuntarily, and a spike in unemployment. It takes time through the phases for that labour market slack to be absorbed up.

One really good way to look at this is the chart that shows our labour market indicator, which the governor spoke about. What that does is it looks at a number of other factors aside from the unemployment rate and sees what's the big difference, why the labour market indicator is showing way more slack than the conventional unemployment rate.

There are a couple of things I can point to that give a tangible example of why that is. One is the amount of involuntary part-time employment. It's true that part-time employment has been a major source of employment growth, but not only that, it's that about 28% of it is not voluntary. Another factor is just the average duration of unemployment. We talk about the scarring; whether it's young people or prime age people, the longer they're unemployed, the more likely it is that it will be difficult for them to become re-employed. We see that the duration of unemployment is up to about 22 weeks. You add that with the decline in the participation rate. We calculate that the climb we've seen this year is about twice as much as you would have expected given the demographic change. We know people are retiring, but the prime age people or the young people who are leaving the labour force are probably not retiring.

The good news is it means that there is room in the economy to grow and for the labour market to grow without being inflationary. That's why we have put some emphasis on it now as we're looking towards how much slack is left in the economy and what's the appropriate monetary policy.

[Mike Allen, Conservative, Tobique—Mactaquac, NB]

On the business outlook side of that, when you go to them, when you talk about the trade deals and other things that we've tried to aggressively sign, is that one of the questions that you're asking the businesses in terms of the business outlook survey? How do they see maybe in terms of their businesses how these trade deals may impact them and help them grow in the future?

[Carolyn Wilkins]

We do spend a lot of time with the businesses. In our business outlook survey we ask them some questions with respect to where they see their growth coming from. Certainly we did see some improvement in expected sales in the future. Some of the deals that are there won't come into force within the time period that we're talking about, which is the next couple of years, but certainly we did see some increased optimism, if you want to put it that way, with respect to future sales.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Mr. Rankin for seven minutes.

[Murray Rankin, NDP, Victoria, BC]

Thank you very much to both of you for attending this morning.

I found the analysis that you did and discussed today about the 2,000 product categories and the 75% fall-off and so on to be very sobering. The excess capacity that you described coupled with what has been termed dead money in other contexts.... You mentioned that companies have been restructuring, closing their doors and that the “bigger employment gains will come when we enter the rebuilding phase of the cycle—when companies are sufficiently confident”.

With all of the money that's around, is the failure to enter that rebuilding phase merely a function of lack of confidence in the economy? What can explain that remarkable statistic that you've provided?

[Stephen S. Poloz]

I think lack of confidence is a good summary given what we've been through and the fact that several times now we've had a false dawn in the global economy, including the U.S. economy, where we think the recovery is real and then it backtracks on us. It has made companies understandably cautious about putting their hard-earned money on the line into new investments. The good news is that their balance sheets are strong. They are ready to grow their business but they need the demand side to be there. We're seeing the first ingredients of that showing up in our trade data. That adds up to a lot of positives. I don't think of it at all as dead money but as ready money.

The basic analysis is that in our textbooks we talk about how a lower rate of interest will cause more investment. That, of course, assumes everything is equal, but of course in the world nothing is equal. If you ask what the expected rate of return on a dollar of new investment is today, well, it has risk associated with it. That risk is fed by things like the Ukraine-Russia crisis, the Middle East, the price of oil, the price of other commodities, and the movement in the exchange rate. All kinds of things go into that. And of course, there is just what you live through.

If you go to your board of directors today and say, “I'm ready to make this investment; I'm the CEO”, they'll say, “Wait just a minute. Let's be a little more sure before we make that commitment.”

That's the environment we're in and so the risk-adjusted rate of return is lower than it seems to us because risks are high. If risks go down, confidence will rise. As that happens, then of course we get more work from that part of our demand side.

[Murray Rankin, NDP, Victoria, BC]

This is a question about the discouraged workers.

You elaborated just a moment ago, Senior Deputy Governor Wilkins, on some of what I wanted to talk about. You talked about the increasing duration of unemployment, the declines that are twice as much as expected that could be explained by demographic issues, and what you termed involuntary part-time employment. You talked about scarring, youth unemployment, and youth underemployment. We have, in short, a problem, I think you've identified, of discouraged workers in Canada, large numbers of them.

I wonder if you could expand a little bit more on your analysis of discouraged workers. I think you used that expression in an earlier speech.

[Stephen S. Poloz]

Discouraged workers is a specific category in StatsCan's survey. When they phone you up, you can classify yourself as willing to be employed but unable to and discouraged. We take a somewhat broader view of this. When we see, for example, 200,000 or so youths not in the workforce who normally would be, they aren't classified officially as discouraged workers because they haven't gotten their first job yet. They're kind of discouraged young people. We just assume that it's very unlikely that they are taking early retirement. I think that's a fair assumption. They are particularly vulnerable to this scarring effect that we discussed earlier.

All that is lacking, I think, is that underlying movement in the global economy, particularly the U.S. We do see the signs there so we have a fair degree of confidence around that, that over the next two years it's going to make a big difference to the way it seems to those folks.

[Murray Rankin, NDP, Victoria, BC]

I'm sure you're aware of the problem Canada is facing with respect to an aging workforce, and you alluded to that just now as well.

This may be outside the purview of monetary policy, but I'm going to ask anyway. Do you agree that a child care policy that meaningfully boosts labour force participation can help cope with the problem of a declining workforce due to demographic factors?

[Stephen S. Poloz]

As an economist, I think if we look at all things being equal, increased participation in the workforce is a positive.

We see in Japan, for example, a long-term issue in terms of labour force participation. It's an open question about whether it makes a meaningful difference when it changes, as again we can see Japan as a case study because you can't make necessarily supply changes and expect them to be magic without the demand side pulling people into the workforce. What we think is most important is that we make sure that the demand side is percolating nicely.

You do have a point that our estimates of the trend participation in the labour force are beginning to decline because we're all aging. That's a natural demographic force, of course, and there's very little we can do about that, so across the world we'll have to get used to a lower trend growth rate. Can we make a little difference around the edges? Potentially, but it's pretty hard for me to put any measures against that.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Rankin.

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

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

Thank you, Governor and Deputy Governor for being here. It's been a great discussion.

Governor, I wonder if you would indulge me.

You correctly stated that nothing is equal in life. There's always a yin and a yang. As a businessman I'm very happy to see low interest rates, but there is a downside, of course.

Mr. Brison talked about pensions being invested in infrastructure long term, but the reality is we're talking about very low returns. We need higher returns.

At what stage do we hit a tipping point? Do you see a return to more traditional interest rates at some point? What stage do you feel that it's critical that we get there?