Finance Committee on April 28th, 2015

[The Chair, Conservative, James Rajotte]

I call this meeting to order.

This is meeting 77 of the Standing Committee on Finance. The orders of the day, pursuant to Standing Order 108(2), are to study the report of the Bank of Canada on monetary policy.

I want to welcome our two witnesses here this morning.

First of all, we have the Governor of the Bank of Canada, Mr. Stephen Poloz. Welcome back to the committee, Governor. I am glad to have you with us.

We have the senior deputy governor, Ms. Carolyn Wilkins, back to the committee as well. Thank you so much for being with us this morning.

We understand you have an opening statement, and then we'll have questions from members. Please begin.

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

Thank you.

Good morning, Mr. Chairman and committee members. Carolyn and I are happy to be here for one of our twice-yearly meetings on the monetary policy report. Today we'll outline for you the bank's latest economic outlook, published in the MPR on April 15.

In this volatile and uncertain environment, it is helpful to maintain a historical perspective. When we appeared before this committee a year ago, the price of Brent crude oil was at $100 per barrel. It had risen steadily for a decade, from $25 in 2002 to a peak of just over $110 in 2012.

By November, when we last met with you, oil prices had fallen to what was then their lowest level in four years. The average price of Brent was $90 per barrel. It was clear to us that while lower oil prices would benefit consumers, the net impact on the economy would be negative. Lower oil prices would reduce Canada's terms of trade and domestic income, and have a material impact on investment, activity in the oil sector and the associated manufacturing supply chain.

All of that happened quite quickly over the next two months. By January, Brent prices had dropped to an average of $60.

Oil prices are an important component of Canada's terms of trade and one of the key drivers of movements in the Canadian dollar. As oil prices rose over the 2002-12 period, so did the value of the dollar, increasing from around 63¢ to above parity. For the convenience of the committee, I've brought my favourite chart. It's a chart of the Canadian dollar with the price of oil—an undeniable relationship in both directions.

Now, the fall in oil prices has set in motion complex dynamics, including sectoral and regional adjustments, which will take time to work their way through the economy. The negative effects of lower oil prices hit some sectors of the economy right away. For example, the impact of lower prices on income and wealth has already led to a fall in household spending. The various positives—more exports because of a stronger U.S. economy and a lower Canadian dollar, and more consumption spending as households spend less on fuel—will arrive only gradually, and they're of uncertain size. Therefore, in January we faced a risk that returning the Canadian economy to full capacity and stable 2% inflation would be delayed significantly. Accordingly, we took out some insurance against that risk, in the form of a 25 basis point reduction in the policy interest rate.

Our interest rate cut occurred in the context of widespread easing in financial conditions around the globe. No fewer than 25 central banks eased their monetary policies in the early months of 2015. All of this monetary policy easing led to lower rates across the entire yield curve.

Now, what was behind this easing? Well, many central banks were adding stimulus in response to persistent economic slack and below-target inflation. This easing, coupled with the positive implications of lower energy prices for world growth, should help the global economy pick up through the year. The bank expects global economic growth to strengthen and to average about 3.5% over the 2015-17 period.

Here in Canada, we saw that some of the effects of lower oil prices, such as the lower household spending I mentioned earlier, were clearly being felt in late 2014 and early 2015. Our updated forecast in the April MPR suggests that the Canadian economy saw no growth in the first quarter. While the impact of the oil price shock is happening faster than initially expected, it does not appear to be larger than we anticipated in January.

Outside the energy sector, other areas of the economy appear to be doing well. The segments of non-energy exports that we expected to lead the recovery are doing so, and we expect this trend to be buttressed by stronger U.S. growth and the lower Canadian dollar.

The results of our Business Outlook Survey suggest that capacity constraints are beginning to emerge for exporters, which is promising for new investment. And, although we still have material slack in our labour market, the market fundamentals have begun to improve. Even so, companies remain cautious about new investment and hiring intentions.

Weighing these various forces acting on the economy, we anticipate a partial rebound in growth in the second quarter and a move to above-trend growth thereafter, for annual growth of about 1.9% this year. This projected growth profile gets us back on track to absorb our excess capacity around the end of 2016, at which time inflation will settle sustainably at 2%. We see the risks around this projection as roughly balanced, but they will be reassessed continuously as new data become available.

The main risk to our outlook is the size and duration of the negative impact of the oil shock, weighed against the positive forces that are building in the non-energy sector. Our outlook is for the positives to begin to reassert themselves during the second quarter, and to do so clearly in the second half of the year. The interest rate cut in January and the lower Canadian dollar are working to speed up this transition.

Inflation, as measured by total CPI, is running at about 1%, well below our 2% target. This is largely due to the drop in gasoline prices, which is a temporary effect. Total CPI inflation would in fact be quite close to zero were it not for exchange rate effects and some additional one-time factors. Core inflation is a little over 2%, but is also being boosted by the exchange rate effects and other one-time factors. In our projection, total inflation and core inflation converge on 2% as these temporary factors dissipate and the economy reaches full capacity around the end of 2016.

Meanwhile, financial stability risks remain front and centre in our deliberations. These risks are evolving in line with our expectations. The level of indebtedness, as measured by the ratio of debt to disposable income, continues to edge higher. It is likely to rise further as the decline in gross national income caused by the drop in oil prices works its way through the system. On the surface, lower interest rates would be expected to promote more borrowing, which would increase this vulnerability. However, in the near term, lower borrowing rates will actually mitigate this risk by reducing payments for mortgage holders and giving us more economic growth and employment gains. We believe that the best contribution the bank can make to lowering financial stability risks through time is to help the economy return to full capacity and stable inflation sooner rather than later.

With that, Carolyn and I would be happy to take your questions.

[The Chair, Conservative, James Rajotte]

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

Colleagues, we'll do seven-minute rounds. We'll keep to those tight rounds, if we can, and we'll start with Mr. Cullen, please.

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

Thank you very much, Chair.

Thank you, Governor, and thank you, Ms. Wilkins, for being here today.

Let's start with your favourite chart, Governor. You talk about an undeniable relationship between the price of oil and the Canadian dollar. Let's go back 40 or 50 years. Those within the energy sector say about $50 a barrel is the historical average. Is that your understanding from the bank?

[Stephen S. Poloz]

I don't know that number. It sounds like a high number, actually, because—

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

Oh, I see. Yes, some estimate it a little bit lower adjusted for—

[Stephen S. Poloz]

It depends on what period you pick, obviously.

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

Correct.

In terms of this undeniable relationship, typically when oil then fell, and the Canadian dollar—as in your chart—for the last 15 years, but even going back further, also fell, manufacturing would pick back up. One of the things we've heard from some of the Canadian manufacturers is that since having lost 400,000 manufacturing jobs in the Canadian sector, which is acknowledged by StatsCan, the pickup in manufacturing hasn't been realized as it has in previous downgrades in the oil sector.

What's the bank's view on that?

[Stephen S. Poloz]

Our view is that this is in fact connected to the export story that we put a lot of time into both publicly and in this committee last year. Over the course of this prolonged period of low global growth, we had a large number of exits from the export sector, thousands of companies, something like 8,000. It's very difficult to measure, but it was a large number of companies. This of course means that when conditions return to a more normal situation, the U.S. economy strengthens, and they begin to order those exports again, some of the companies are no longer there, and so it's not a case of just re-expanding in order to meet that demand.

What happens, in fact, in these episodes, historically speaking, is that the situation is very fertile for the creation of new companies and the expansion of the ones that remain.

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

But we've seen the Canadian dollar slide. You talked about business still remaining with a certain level of uncertainty. There's a lack of confidence. You said the first quarter had atrocious growth, and, in fact, outside of recessions, we've had the longest and most prolonged period of low, less than 1%, growth in the Canadian economy in four decades. That's worrisome to me considering what Canadians are looking for right now, which is an answer to those fundamental questions. You mentioned very high personal debt rates.

You took action. You talked about stimulus measures that you and 25 other central banks took. Could you name the one or two global risks that you're identifying? You talked about international risks that remain. Could you very quickly give me one or two that come to mind when you mention international risks?

[Stephen S. Poloz]

In fact, we've been living through a period of slow and repeatedly disappointing growth at the global level. That's why the G-20 is so preoccupied with this issue and is taking about a thousand initiatives across the 20 economies to try to boost growth by about two percentage points in GDP over five years.

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

To be clear, do you mean a thousand from central banks or including governments?

[Stephen S. Poloz]

I mean governments. In the G-20 context, the G-20 communiqué is all about coming up with those new policies. They are primarily structural policies such as free trade agreements and those kinds of things that actually improve the growth prospects of an economy.

Of course Canada, being in that sense a small economy relative to all of that, has been heavily influenced by those external events and so our growth has underperformed at the same time. This is primarily because of our major trading partner, the U.S., struggling with the after-effects of the crisis.

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

Your predecessor and you, somewhat less, have talked about dead money in Canada. We've had the manufacturers and the large corporations in Canada come in and tell us why they are not spending—a very low research and development rate and very low reinvestment rate despite having had many years of relatively large corporate tax cuts.

What is the current status of this productivity conundrum and this conundrum of debt and so-called dead money in the economy? Is the bank at all concerned about the lack of reinvestment in the Canadian economy coming from the private sector?

[Stephen S. Poloz]

The way we would view this is that corporate balance sheets are in good shape and are ready to be deployed as the expansion unfolds, but given what we have been through, and we are now in the seventh year since the financial crisis erupted, any business person is prudent about deploying that money. That's hard-earned money that could be wasted, in effect, if things don't prove out.

But confidence is growing both at the global level and, of course, domestically, and so our belief is that investment is actually under way, particularly in the non-energy export sector where these constraints are beginning to show up.

So we're quite confident in that recovery, and the good news is that the balance sheets are ready for it.

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

I guess that's my question; they have been ready for some time. StatsCan is now reporting that figure at about $674 billion. It's been north of $600 billion for a couple of years. We've heard at this committee from corporate Canada, saying some of the same things you're saying, that, well, there's an uncertain market.

We want to challenge that. There are always uncertainties. Are the uncertainties and the risks so great that we're going to have to downgrade the growth prospects for the Canadian economy, as the bank has had to do several times over the last six months?

[Stephen S. Poloz]

Clearly, the uncertainties are very great. If we look at, say, the U.S. economy, that may be growing at, say, around 2% this year or a little bit more, it's doing so with a zero percent interest rate. We should bear that in mind. That means we're pushing a rock up a hill here.

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

So those risks even south of the border remain.

[Stephen S. Poloz]

Those are what we call headwinds. Those are things that hold the economy back, and it requires a great deal of policy stimulus just to keep them at bay. In that environment, a business decision is real money, and it's real people; it's not a theoretical model. Of course, it performs differently from what our historical model would say. It's precisely because, given our experience, uncertainty is a little higher than it normally is at this stage of the business cycle.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Cullen.

We'll go to Mr. Saxton, please.

[Andrew Saxton, Conservative, North Vancouver, BC]

Thank you, Chair.

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

Governor, in your recent monetary policy report, you noted the importance of Canada's export sector on the economy; however, you also mentioned the issues around competitive challenges that our exporters have. Could you expand on what those competitive challenges are?

[Stephen S. Poloz]

The challenges for the sector are similar to the ones that we've just been talking about. In the past five years or so we have lost a number of exporting companies. Those who are still in the game find themselves running out of spare capacity and are at that trigger point where they need to either invest to expand that capacity and employ more people or ask their customers to wait a little longer for delivery. It's a balance point. Right now we are seeing more of those decisions: that it's now time to invest. It's a process that is gathering momentum. That's a very positive development. It's been long in coming.

Now, the challenges that remain are that none of us are truly certain about the outlook for the world economy, which is your main customer, and in particular the U.S. economy. We're living just after the first quarter where the U.S. economy appears to have wobbled or faltered, and some people think it has slowed down. We think it has got its momentum and has been interrupted by things like bad weather and a port strike.

But as a business person, you're basically waiting for the phone to ring. That sort of trigger takes time and is happening company to company. We're confident that all those fundamentals are very strong, so they will assert themselves.

[Andrew Saxton, Conservative, North Vancouver, BC]

What impact do you expect the lower dollar to have on our export sector?

[Stephen S. Poloz]

That is a side effect of what we've been through. It's true that, on the one hand, we expect the lower dollar to provide a stronger export environment for your average exporter, especially a manufacturer. For example, the average profit margin in the manufacturing sector may be around 6% or 7% in a good year. The Canadian dollar moved five or six percentage points. That is almost like a doubling of profit margins. That gives the exporter the opportunity to compete harder for new contracts and be more competitive, and it's a very positive thing.

But the other side of it is that, if they need to expand and they need to buy a new piece of equipment, and that equipment is bought from another country, it will cost a little more today than it would have back when the dollar was stronger. That's part of the calculus, but in my experience what counts is whether the demand is there for your products. Is it predictable, and something that you can feel confident about? If so, these things will happen.

[Andrew Saxton, Conservative, North Vancouver, BC]

Is the lower dollar a net benefit, then?