Finance Committee on Oct. 31st, 2017

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Thank you, Mr. Chair. I'll try to return some civility to the meeting.

I have a couple of questions. First of all, the October monetary policy report, on page 11, talks about consumption growth and what the Canada child benefit has meant for Canadian families since the report was released, or near the same term. In the fall economic update, we introduced the indexation of the CCB, which will give Canadian families $5.6 billion of extra spending out to 2022-23, and about half a billion dollars a year invested in the working income tax benefit. I think this is wonderful, because it will hopefully draw in people who are not in the labour force to come into the labour force, and provide a cushion to folks whose marginal propensity to consumer-invest is actually pretty high.

I was wondering if you could comment on what it could do to the Canadian economy in terms of firming up consumption going forward.

[Stephen S. Poloz]

Given that the announcement is not part of a formal budget, we have not worked the indexation move or the income tax changes into our forecast for the economy. That would be something we do after a budget actually occurs.

We can talk about what the CCB that was put in place last year has done. We have estimated that it has added approximately 0.5 percentage points on the economic growth over the past year. This is something that raises the level of GDP but does not continue to contribute to growth. We believe that the effect is over. To put the 0.5 percentage points in context, when the economy was at its weakest point and we had excess capacity, it was on the order of two percentage points of GDP. Having that contribution from consumers meant that during the adjustment to the oil price shock, interest rates did not have to go lower, which was a beneficial effect.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Governor, we all know how hard it is to time fiscal policy or monetary policy, and monetary policy tends to operate on more of a lag, but fiscal policy, done right, is right. I think the CCB, from my view, was a timely measure introduced by our government.

I'm going to ask two questions together just so I can have the answers and not run out of time. First off, they say the Lord giveth and the Lord taketh away. There was some monetary policy that was removed through your actions. I'm just curious about the monetary transmission mechanism in terms of the time frame that we're looking at to see how the rate increases are impacting or working on the economy. With that, in your introductory comments, you talked about elasticity. We understand elasticity to a price change in terms of where household debt levels are and how there may have been a structural adjustment in terms of how households respond to changing rates.

I was wondering if you can comment, more on the latter than the former, because that is important. A small change in rates may have a larger impact than in prior years.

As for my second question, you commented about the economy operating at close to capacity, but your preferred measure for the labour market indicator demonstrates some slack. If you can square the “close to capacity”, because I think the Canadian economy has grown in capacity or output potential, and you can comment on that as well.

[Stephen S. Poloz]

Okay, I'll take the second question, and then I'll turn it over to Ms. Wilkins.

When we talk about the output gap or the economy's capacity, one is a broader concept than the other. The output gap refers to output, production, and we believe we are operating more or less at that level at this stage. Economic potential is a broader concept that includes using all of your existing labour supply.

What we see—and our labour market indicator in particular shows—is that it is still a percentage point higher than it was in 2007, whereas the unemployment rate is where it was in 2007. That shows that those secondary measures of capacity and labour market still have slack, and we won't be fully at our capacity until we've re-employed those resources through stronger investment. That's the process I was talking about before.

For a while we'll have a gap between those two measures. It's as simple as that.

On to the interest rate elasticity, I'll ask Madam Wilkins to comment.

[Carolyn A. Wilkins]

We made quite a bit of modelling changes to make sure we could capture the main channels. The intuition behind why interest rates have a stronger impact when we're highly debted is pretty clear. If you have a $500,000 mortgage, 25 basis points is about $60 a month, and that's going to be taken out of the money that you have to spend on other things. All else being equal, consumption is going to go down a bit, or be less strong than it was. If you had $100,000 mortgage, that would be $12. It makes a really big difference.

It may be that it affects people differently over time, depending on whether they have a variable rate mortgage or a fixed rate mortgage, but eventually that transmission gets through the system. In general, it's six to 18 months, a 24-month process, and it flows, not only through consumption but also through the price of houses, because again, if you're spending more of your income on something else, like interest rate payments, maybe you're not as inclined to buy a bigger house than you were. Maybe other people need to wait longer to buy a house, so all these channels come together to mean that, when people are more highly indebted, it's going to have a larger impact.

With our new model, we are more confident than we were in the past that we've been able to capture those effects.

[The Chair, Liberal, Wayne Easter]

Thank you all.

We'll go to Mr. Kelly, and then Mr. Grewal, and we will have time for a couple more, if there are others.

Mr. Kelly.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

Thank you.

I'm going to continue discussing some of the mortgage related parts we've already begun today. When it comes to housing, Canadians don't choose to be heavily in debt from mortgages. They participate in the market they live in, and the price is the price. We know that in many centres the prices are very high, and if a person is going to own their own home they must take on these large debts.

I want to make a comment about a point, Governor, that you spoke about, the trade-off between a consumer choosing to pay the insurance fee for a high-ratio mortgage as opposed to putting the additional money down. I've been a mortgage broker for over 20 years. When a borrower is confronted with the choice between a lower interest rate, paying an insurance fee that's amortized over the life of the mortgage, and the option, then, to put less money down, almost every borrower chooses the lower down payment. That's just a human nature type of decision that most people will make. This business about perverse incentives, I think, maybe ought to be a concern over what behaviours are being encouraged.

[Stephen S. Poloz]

There are more constraints than that on a system. For instance, the insurance market only operates up to $1 million. I know that sounds like a lot for a house, but in certain markets it is not. The other thing is that if we're faced with a choice like that, which way will people go? The data suggests contrary to your presumption, which is that a lot more people were trying to have larger down payments, it has more to do with their ability to qualify for rather expensive houses.

It's very hard to know exactly what's going on, but we have a really big cluster of people at 79% mortgages, so they've just made the 20.5% or the 21% down payment. Some people are highly motivated to do the opposite of what you say, but then of course we have lots of people who are also at the other end. I guess that tells us it's a pretty personal choice.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

I think in terms of the first-time buyer, who typically has to put together everything they can just to make the minimum. If they are told that if they have their 20% or their 21% but they could go with a bit less down and they would get an interest rate that, right now, in some cases is up to 40 basis points better than the conventional rate, they would opt to do so if they had that incentive as well.

Is there any concern about the extent of some of the changes that have taken place, that the competitive pressures will eventually drive borrowers away from lenders who are regulated by OSFI, the federally regulated financial institutions, and into other types of credit, which will be higher interest rate credit, and with all the consequences we've already talked about in the spillover into the rest of the economy?

[Carolyn A. Wilkins]

Having alternatives to the traditional banks for a mortgage allows a market to be served that may not otherwise be served, and maybe at the right price. That market is related to people who don't have a long credit history but over time could get one. I think it's a very important market.

It is true that the more constraints you put on the space regulated by OSFI, there is the possibility that it would spill over to other forms of lenders. I think the question there is whether or not those lenders have as rigorous underwriting processes. That's a question sometimes for provincial regulators that are well-equipped to answer that question, not us, and as well, the institutions themselves.

The fact that the price is higher may reflect the fact that the risk there is also higher. Sometimes we think about, what's the right decision for me as a homebuyer today? What makes sense? What price do I have to pay? Some of these ways of thinking about what you can afford over time take into account situations where things don't happen the way you'd like: interest rates rise or the price of your house falls. I think these longer-term rules can serve to help households over the longer term in having a sustainable level of debt.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

I have a quick question then about regional differences in not only the housing market but in the greater economy. I'm a member from Calgary, where unemployment is still uncomfortably high and many people are very concerned about their jobs.

How do we address the regional differences that exist either within housing or throughout the broader economy?

[Stephen S. Poloz]

The short answer would be not with monetary policy, since we only have one tool and that's the interest rate. It's the same interest rate for everyone. This is almost always the case, in that there are areas or sectors in the Canadian economy that are weak, while others are stronger than normal and there's absolutely nothing we can do except to pay attention to those details, in terms of figuring out how things are evolving at the macro level.

For us, it's one macro economy and that's essentially the way we look at it. Of course, there are other tools in the policy space to try to address developments in individual sectors or individual parts of the economy.

[The Chair, Liberal, Wayne Easter]

Thank you all.

Mr. Grewal is next. Pierre, we'll come back to you for a question as well.

Go ahead, Mr. Grewal.

[Raj Grewal, Liberal, Brampton East, ON]

Thank you, Mr. Chair.

Governor, you're way too young to be a grandfather.

[Stephen S. Poloz]

No, I'm not.

[Raj Grewal, Liberal, Brampton East, ON]

I know. Having the governor as a friend is never a bad idea.

Governor, you mentioned that your number one tool in terms of monetary policy is the interest rate. Even if they don't have a finance degree, a lot of Canadians recognize that when the Bank of Canada reduces the interest rate, it's generally to help stimulate the economy. Why would the Bank of Canada increase the interest rate?

[Stephen S. Poloz]

I think it's better to start the story with why we reduced interest rates in 2015. We did so because the economy was hit by a very significant negative shock, which was the fall in oil prices. As I mentioned earlier, it had the effect of taking $60 billion a year of income out of our economy. It was a very significant shock, so the adjustments to that would mean cutting back on investment and cutting back on consumption spending in the affected areas in particular. By cutting interest rates, we were able to smooth out that process. It didn't make it that much easier for folks in Newfoundland and Labrador or Saskatchewan or Alberta, but it did make the rest of the economy adjust more quickly. The exchange rate fell more than otherwise would have been the case, and speeded up export growth in other sectors, and so on. That's the full story.

The next question is, why would you raise interest rates? We raise interest rates because the adjustment that was going on in the macro space is complete, not in every region but macro. We did that because we would have undershot our inflation target significantly had we not reacted. By cutting rates, we were able to project that inflation would be back to our target, by some time in 2018. If we did not move interest rates back to a more normal level, then we'd be at higher risk of exceeding our target.

[Raj Grewal, Liberal, Brampton East, ON]

Thank you, Governor. You said in your testimony today that growth in housing is projected to slow further, in part because of the measures introduced by the Ontario government. We also have the new mortgage rules coming through from OSFI, which a lot of my colleagues on the committee addressed. The anticipation in the market is that this is going to further slow down housing.

How will that impact growth in the Canadian economy on a macro level?

[Stephen S. Poloz]

The changes to OSFI's rules and other changes are not the normal things that are in macroeconomic models, whereas interest rates are obviously in our models. It requires a little extra and more innovative analysis. We have microdata, which was alluded to earlier.

We know, for example, how many people who qualified for mortgages in 2016 will not qualify for them under the new rules and how much less they can borrow. We were able to do almost a simulation, as if we had put the rules in place earlier. We can do that and we can then translate it into an approximate effect on the economy, on the order of 0.2 or 0.3 percentage points in the subsequent year or two of GDP. If it's growth, then it might be half that over two years, or if it's faster it will be all in one year.

Importantly, the way one reacts is an individual decision. Here are the new rules; what do you do? This is the house you wanted to buy, and now you don't qualify. Is your reaction to postpone for a year? Possibly. Is your reaction instead to say, “I think the house next door, which is a little smaller, suits my needs as well, so I'll buy that one instead”, in which case you still go ahead with the transaction.

It's very hard to know how it actually translates into GDP impacts. This is exactly why we say, with the new level of interest rates today compared with those of six months ago, that we need to monitor very carefully how people are actually behaving in real time. We can't just rely exclusively on our models to do that.

[Raj Grewal, Liberal, Brampton East, ON]

I agree with you, Governor, that it very much could be reactionary. It could be positive in certain markets. It could be negligible in certain markets, as most assumptions are. There are assumptions that in Vancouver and in Toronto the changes won't have too great an impact because demand in housing will keep pushing it along.

Because Canada's economy is very much regionally based, however, it will differ. It will have disproportionately negative impacts upon the east coast provinces and some of the prairie provinces because of housing. People won't qualify for mortgages anymore. I think this is something that only time will tell as the policy is rolled out.

Deputy Governor, my colleague asked a question on data concerning fixed-rate mortgages. I'm assuming you also track the default rates on mortgages across the country.

[Carolyn A. Wilkins]

Yes.

[Raj Grewal, Liberal, Brampton East, ON]

Has there been significant movement in the last 12 months, after the measures by the provincial governments in Ontario and B.C. and the federal measures were announced?

[Carolyn A. Wilkins]

They're very low.

[Raj Grewal, Liberal, Brampton East, ON]

They're minimal. Has Alberta recovered? There was a spike in defaults after energy prices fell in the province of Alberta—

[Carolyn A. Wilkins]

Actually, they edged up a bit to—

I'm sorry. I interrupted you.