Finance Committee on April 23rd, 2018

[Stephen S. Poloz]

That's the one that we have in our forecast. When we go through.... There's a table in the monetary policy report, which I don't have at my fingertips. It's about a 0.2% contribution to GDP as a baseline. This of course is less than we've had in the past because of the moderation we're forecasting in the housing market.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

On the question of mortgage changes, you said “naturally reversed”, and I still don't feel as though I understand what you mean by this. You're taking into account the lower volumes, because people will defer or make different housing decisions on their own, but also, some individuals simply will never be able to qualify again. With this “naturally reversed”, you're just saying that people will make decisions in the first six months, and then by the time we reach the third quarter, which is at about September, we'll see the impacts that the change to B-20 has had, all other things being equal.

[Stephen S. Poloz]

That's essentially it, bearing in mind that our narrative is primarily around the growth of the economy, rather than the levels. In the back of that is a strong sense that the fundamentals of the housing market remain very solid, that demand will remain solid through this, and that higher interest rates and the new B-20 are going to slow that growth rate, although it won't cause a permanent decline in that growth. It's a moderation as we go through, and a smaller contribution to GDP than what we saw during the very low interest rate period.

[The Vice-Chair, Conservative, Pierre Poilievre]

Mr. Julian.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Thank you, Mr. Chair.

Thank you, Governor and Deputy Governor. I appreciate your being here today.

I want to continue the questions around the impacts on housing of a rise in interest rates, particularly variable interest rates, because they're going up. People in some areas of the country.... You mentioned Toronto and the Lower Mainland. I can tell you, as a Lower Mainland B.C. MP, that the housing crisis is profoundly acute and the difficulties people are experiencing are monumental. We have pensioners who have paid into pensions for their entire lives who can no longer afford housing. As the deputy governor mentioned, there are a number of factors, including a problem of supply. We simply haven't been building affordable housing for decades, and with that it has all come to a crisis.

My first question is around the impacts of monetary policy and the rise in interest rates. With your model, do you also look at the number of bankruptcies and foreclosures that come from every quarter-point rise in interest rates? Is that part of the overall model?

[Stephen S. Poloz]

Yes.

We have access to very granular data on household borrowing, on mortgages. We're able to model this quite closely. Where we begin to get more uncertainty in the picture is with how people actually respond. We can do the arithmetic on it, but the economics are more complex, because it concerns behaviour. For instance, as Ms. Wilkins said, we have people deciding to buy a smaller house. It still comes up as a sale, yet they managed to meet the criteria, and there are others who delay, and so on.

It's in the behavioural differences where the more statistical, historical modelling comes into play and where you have a zone of uncertainty around those kinds of predictions. It's why we can't be so definitive about how the thing unfolds. As it unfolds this year, we have three things happening at once. It's going to take more than a few data points to be able to figure out how much is due to the revised B-20 guideline, how much is just due to higher interest rates, and how much is just that pull forward and then the return to quasi-normal.

I accept your point that it is a difficult situation for people. As for the price level of housing, none of these things we've talked about are aimed at somehow controlling the price of housing. They're aimed at improving the sustainability of debt so that our financial system is less at risk. The price of housing is fundamentally driven by demand and supply, and the biggest thing there is that we have strong demand and relatively weak supply.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

I realize it's beyond your purview to comment on the supply of social housing or affordable housing or co-operative housing. That's not your role or your mandate. Obviously, it is one of the factors that the deputy governor just cited in replying to Mr. Fergus's question. It's something that people feel acutely.

When we move to these new rules, there are impacts on people who perhaps have a higher level of income, or at least a higher level of debt, and are able to afford a mortgage. Many of the people who are impacted most profoundly would not be able to afford a mortgage when average prices are over seven figures in most parts of the Lower Mainland for single family homes and, hundreds of thousands of dollars even for condos. It's a real problem.

What I'm trying to get at is whether in the modelling itself you track this. The modelling doesn't necessarily seem to indicate that you do—or you look at the figures afterwards. Do you take into consideration foreclosures and bankruptcies as part of the overall impacts of monetary policy?

[Stephen S. Poloz]

We track those data, as everyone does. In terms of the actual forecast, there is a degree of judgment because B-20 is not the sort of thing that changes often, so it's not as easily modelled, but it's modelled in the way we've described, on a granular level, and then scaled up to make a good estimate. The effective interest rate, however, is more behavioural and more historical, and we think it's enhanced somewhat because of the level of debt.

Would you like to add something?

[Carolyn A. Wilkins]

I think you can be confident that we look at the micro-data, the segregated data, when we try to understand what the interest rate effect is, because the distribution of who is indebted and what kind of assets they have really matters. It matters to the macroeconomic outlook. We've tried to do that in our model changes.

What we also look at in the context of the financial system review are scenarios where it's not just interest rate increases that are happening; it's also perhaps a context in which instead of interest rate increases you end up with a spike in unemployment and things like that. It's there that you see other reactions such as defaults and arrears that would have stronger macroeconomic impacts. According to our modelling, the kinds of interest rate increases we look at in a cycle like this one don't have enough of a reaction in arrears and bankruptcies to create a macroeconomic issue.

That's not to say we don't take it into account, but it's just not big enough. It's really in the tail event, a recessionary situation, or something like that where you would see a remarkable aggregate increase in arrears. That doesn't mean it's not difficult for individuals who are facing that situation. It's just that when you're targeting inflation, it's something that we take into account, but it's not driving the results.

[The Vice-Chair, Conservative, Pierre Poilievre]

Mr. Julian, a quick question.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Do you track, as well, the impacts of measures, for example, that the new B.C. NDP government has taken to counter speculation in the housing market?

[Stephen S. Poloz]

Yes, we track the results of that, and note that it seems to have a temporary effect in B.C. We're still watching the experiment, or the change in Toronto. Also, the experiences in other countries with similar situations is helping us to understand that.

When the laws of demand and supply are operating strongly, then these things don't invalidate them. They can delay them, and if there is a speculative run happening, it can break that psychology, in that it does seem to have some effect on that.

[The Vice-Chair, Conservative, Pierre Poilievre]

Mr. Sorbara.

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

Thank you, Mr. Chair, and welcome, Governor and Senior Deputy Governor.

Obviously, this afternoon our thoughts are with the folks back in Toronto, after the incident that happened earlier today. Our thoughts and prayers are with them, and our thanks go out to our first responders.

Going to the subject at hand, Governor, I thank you for your introductory comments. You commented on the considerable progress the economy has seen over the past two years; the wage growth that's circa around 3%, which is great; and the pace of household growth, which is slowing year-to-year, which is a healthy indicator. I don't think you can binge, if I can use that word, on credit for too long. You need to do that.

There was a correction in the housing market as a result of the corrective measures we have undertaken and OSFI undertook with B-20 and B-21. In the April monetary policy report you increased our potential growth rate in Canada.

As an economist myself, what would cause a central bank to increase a country or nation's potential growth rate?

[Stephen S. Poloz]

We don't do that ourselves, but we are acknowledging that the economy's potential has evolved in a positive way since one year ago. We do a full job on that only once a year, in the springtime, for our April MPR.

What we need to take into account, then, are the latest long-term data from StatsCan, which are published late in the year and give the historical revisions. The last historical revision raised estimates of investment quite a lot back in 2014, 2015, and 2016. That means that Canada has been operating with a higher capital stock than we believed before and, therefore, potential output has been higher. Furthermore, its growth rate is slightly higher. That, of course, is good news.

We speculated the last time we were here that as the economy reaches its level of capacity, investment would begin to pick up more and build more capacity. That is happening too, but, as I indicated, less than we would otherwise expect, because of the uncertainty companies face, particularly around NAFTA.

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

My second question refers to the labour market.

As I often go around the riding that I'm blessed to represent, a number of employers have remarked on labour vacancies and the difficulty of finding labour. On page 13 of the April monetary policy report, it says that job vacancies have risen by nearly 25% in the past year, with 470,000 job vacancies from coast to coast to coast. There's a little catch-22 there, in the sense that the Bank of Canada has identified that we still have a long-term unemployment rate issue.

I want to make this plug. One of the measures we brought in the budget was the Canada workers benefit, which hopefully will pull more folks into the labour force.

With the idea of wage growth following-in, could you talk about how we can continue to attempt to attract people to enter the labour force, whether they are retired or have taken themselves out, and how important that is to increasing our potential output even more?

[Stephen S. Poloz]

It's true that one can't really build too much more potential output without the people. That process I described of higher investment usually means an expansion in a company, and therefore also more jobs.

It's true that the statistics on vacancies—and 470,000 is a lot of vacancies—are up a lot over the past year. That is, of course, a symptom of a very strong job market, but it's also a symptom of.... When I talk to companies, they tell me they're having trouble finding people with the skill set they're looking for. It can be a geographic mismatch, or it can be just an absolute shortage mismatch.

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

Do I have a couple of minutes left, Chair?

[The Vice-Chair, Conservative, Pierre Poilievre]

You do.

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

Thank you.

One question I had is on the business loan survey that came out, I think, last week. The “Business Outlook Survey”, I think it's called, is an indicator I looked at. It seemed pretty robust. The overnight rate is at 1¼% versus where it was even in 2010 at above 4%. When inflation came in at 2.3%, you identified some transitory factors in play. It was the highest rate in four years, I believe, on a year-over-year measurement.

Should we be worried about inflation, especially on the wage side, but also on the cost side at all? Rates have been low for a very long time, since the financial crisis in 2008. We see U.S. yields now backing up to around 3%.

Should we be concerned, Governor and Senior Deputy Governor?

[Stephen S. Poloz]

No. Our forecast is for inflation to be 2% in the window that we have some influence over, which is 18 months to two years from now. Over this year, it will be above 2% because of the short-term factors that we've identified, primarily energy costs. Those things will come out in a year-over-year basis by the end of next year.

As it connects to your previous question, what we're really watching is the pickup in wages as those job vacancies continue to grow. As wages pick up, this will encourage more people to re-enter the workforce.

We are just now, in the last six months, reaching wage movements that are positive in real terms—above 2%. That's an important bridge to cross. As we said, when we get up into the 2.5% to 3% zone, then we have more scope for getting faster reintegration of people back into the workforce.

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

I have a very quick one on trade, because trade is obviously very important for a small open economy such as Canada, with the ongoing NAFTA negotiations.

There have been some green shoots on trade. In the last couple of days, Mexico has signed a trade investment accord with the European Union. We've joined CPTPP. We've concluded our CETA agreement. The European Union has also made the same agreement with Japan. There is some protectionist hubris at the top. We've also entered into negotiations with Mercosur. I think that's important for Canada and further trade liberalization for the global economy.

I know in the MPR that you comment on measures in the States. You comment on global trade patterns and identify them as a risk for the Canadian economy, which I understand. However, suffice to say, there are some policies being put in place by governments around the world for trade liberalization.

[Stephen S. Poloz]

That's correct. There are, and Canada is taking advantage. I'm quite certain that our export growth is higher today than it would be without those extra opportunities. However, it's still a little on the lacklustre side because of our uncertainty around our principal trade partner. These are as you call them, “green shoots”. These are promising changes.

In some sectors, we're doing quite well, especially in IT services, transportation services, and tourism, which are the fastest-growing areas of our economy, and goods sectors, things like aerospace, heavy trucks, machinery and equipment. So we have encouraging effects. I'm hopeful that when we get past the bottlenecks we saw during the wintertime, we will get some clearing of inventory out. Exports will rebound, and we will feel more comfortable of our baseline.

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

Thank you.

[The Vice-Chair, Conservative, Pierre Poilievre]

Mr. Albas.