Finance Committee on April 19th, 2016

[Robert-Falcon Ouellette, Liberal, Winnipeg Centre, MB]

Thank you very much, Governor, for coming here today.

I have two central questions, and I'd like to put them in context a little bit.

As we all know, the Bank of Canada's mandate and that of other central banks is to keep inflation low, and while the bank has been trying to intervene in the Canadian economy and stimulate borrowing and investments with low interest rates, it's also the case that the bank may intervene in the economy when it appears that the economy is too hot; that is, when employment drops to “low the end” or when there's a threat that wages might rise and therefore drive up inflation.

Now, some Canadians might be surprised by this because they generally think that if the Bank of Canada and the government were going to intervene in the market, it would be to create more jobs with better wages, and not deliberately to act to increase unemployment and prevent wage increases.

An economist, Arthur Okun, who was a member of the President's Council of Economic Advisers, wrote in 1976, “The crusade against inflation demands the sacrifice of output and employment.”

Joseph Stiglitz, the Nobel Prize-winning economist, has written:

A focus on inflation puts the bondholders’ interests at center stage. Imagine how different monetary policy might have been if the focus had been on keeping unemployment below 5 percent, rather than on keeping the inflation rate below 2 percent.

Now, the Cambridge economist, Ha-Joon Chang, has written:

Lower inflation may mean that what the workers have already earned is better protected, but the policies that are needed to generate this outcome may reduce what they can earn in the future. Why is this? The tight monetary and fiscal policies that are needed to lower inflation, especially to a very low level, are also likely to reduce the level of economic activity, which, in turn, will lower the demand for labour and thus increase unemployment and reduce wages. So a tough control on inflation is a two-edged sword for workers—it protects their existing incomes better, but it reduces their future incomes. It is only the pensioners and others (including, significantly, the financial industry) whose incomes derive from financial assets with fixed returns for whom lower inflation is a pure blessing. Since they are outside the labour market, tough macroeconomic policies that lower inflation cannot adversely affect their future employment opportunities and wages, while incomes they already have are better protected.

It would appear to me that the Bank of Canada's core mandate since the 1970s has been to put a thumb on the scales in favour of investors, especially established investors, at the expense of everyone in the labour market. The switch to this policy was a turning point in countries like Canada, the U.K., and the U.S., when wages for the most part started to stagnate and the income of CEOs and investors started to increase. It could be argued that this change marked the end of the era of inclusive growth after the end of the Second World War, when as the economy grew it grew for everyone, and the beginning of a new era in which the benefits of economic growth were concentrated in the hands of a few. Inflation has not been a problem in the economy for decades, and in the 1970s it was driven by deliberate manipulation of oil markets by OPEC.

My question is: is it a consequence of the Bank of Canada's anti-inflationary policy and low-inflation target that you will intervene in the economy to sacrifice workers and wages in order to protect investors, as per your mandate?

[The Chair, Liberal, Wayne Easter]

The floor is yours. There's a lot of background there. Go ahead.

[Stephen S. Poloz]

Thank you.

The choice of inflation targets as a regime for monetary policy in Canada is now over 25 years old. It grew out of a horrific experience with high inflation. It is unambiguously accepted in the economic literature that lower inflation over the last 20 years has led to better economic performance for all participants in the economy—all—whether they're working, whether they're retired, whether they hope to retire, everybody. That is unambiguous.

Many of the very fine points that you have made are what I would call disequilibrium points; that is, they are partial equilibrium: it's true that if this happens, then this happens. It must, however, be considered in the context of the entire economy and whether the economy has achieved an equilibrium that will stay.

Our belief, very strongly held, is that the economy does not stop moving until inflation is stable and the rest of the economy has adjusted to that level. That defines what we call the “divine coincidence”, in which we have maximized employment—

[Robert-Falcon Ouellette, Liberal, Winnipeg Centre, MB]

So, Governor, how would your—

[The Chair, Liberal, Wayne Easter]

Robert, we're out of time. You will have the opportunity again.

Mr. Caron, you have three minutes.

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

Let me go back to the impact of deficit spending on infrastructure, and tax cuts that have been announced by this government. You stated there are some times, and this is one, where we have to observe what fiscal policy rather than monetary policy could do. On the other hand, we will need to see the results of what has been announced, especially in terms of where the money will go, how efficient the investments will be.

We know there is some lag, some time between the investments themselves and the benefits or the impact they will have. How long are you going to wait to see what results we get from those decisions, the initial assessment of the success, and how long before you make a definite assessment that it had worked or not worked to the extent that we hoped it would?

[Stephen S. Poloz]

Monetary policy-making is fundamentally data-dependent and by that I mean not the individual bits that we refer to, but the entire economy. Now we know fiscal actions are being taken. Some of them will happen quickly. Some will take longer, but they are happening. For us now, they're just in the mix.

We will watch the economy and see if the economy measures up to our expectations and as long as it does, then everything's fine, but if there is for some reason a shortfall in growth, that of course will mean that it will postpone our achievement in the inflation target and we will then have to reconsider whether or not monetary policy requires adjusting. If the opposite occurs, such as an upside surprise, which would be very pleasant for a change, then of course we would have the opposite situation.

That is to say the monetary policy is alive throughout that piece, not the precise individual parts, depending on how the data evolve.

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

I understand, but the way I see it is that the bank will take the back seat right now to see how this will work. But at some point you will look at the growth, the impact, the effect it will have, and eventually you will have to make an assessment that it worked or not.

I understand the need to wait for the data, but on the other side, there is an argument to be made that you will have to...even if the data moves in one direction or the other, the temptation will still be there to say let's wait a little more and a little more to see if it will impact.

The lag might be shorter or longer depending on your assessment, so this is why my question of the timing is important. How much time are you going to give those measures before making or considering getting into the play rather than taking the back seat?

[Stephen S. Poloz]

The implication of your question is that monetary policy is conducted very finely, almost as an engineering exercise, and I would resist that interpretation. It's more a question of the risks. So today, we have a forecast that includes the fiscal inputs and if we go six months and we're seeing the economy is behaving less well than we thought, then we would say there's a downside risk there, but don't forget this could happen. Those are just risks.

We have to make our decision every six weeks on the basis of what we have in front of us and our live judgment about how things are unfolding. We're watching a lot of other moving parts other than just government spending. In particular, exports are expected to contribute two-thirds of the growth that we're predicting and so that of course is our big preoccupation. Investment spending by firms will be the second thing as that comes in.

All those things have to be analyzed on a continuous basis and it will be in the aggregate. So there will be fiscal results in that mix. It's very hard to disentangle, if you understand. Thank you.

[The Chair, Liberal, Wayne Easter]

Thank you very much. I do have one question.

You said earlier that part of the economy, the energy economy, is diminishing. You also said, in the Bank of Canada's “Monetary Policy Report” published on April 13, that investment in the energy sector is expected to decline by 60% from 2014 levels. I come out of the commodity industry as a former producer, and we see ups and downs, booms and busts. We see that in the energy sector as well, although there's a lot of global pressure in energy.

I'm just wondering about something. This may be a controversial question, and it may be something that you don't want to, or can't answer.

Have you looked at what the investment situation would be if an Energy east pipeline were in place, or other pipelines? Yes, there would be the investment from putting in place the pipeline itself, but would that have any impact on the oil economy in terms of easier access to market, or in the case of Energy east, putting oil into the refinery in eastern Canada? Can you tell me if you look at those scenarios, or do you know anyone who does?

[Stephen S. Poloz]

Chair, I don't have an answer to that question for you. That's a complicated analysis, better put to people in the industry or associations related thereto. Right now, what we're dealing with is low prices, and I think that's the most important driver here.

Low prices for oil mean that the economy has to re-adapt. The size of the energy economy will be smaller as a share of the total economy, and other parts of the economy will grow faster for a period to fill in that space. That's a process that we expect to take several years to complete.

How a pipeline project may or may not fit into that picture is a very complex analysis that we haven't done.

[The Chair, Liberal, Wayne Easter]

No problem. I just thought I'd ask. If you don't ask, you don't get any answers.

Mr. Champagne, you have five minutes.

[François-Philippe Champagne, Liberal, Saint-Maurice—Champlain, QC]

Thank you, Mr. Chair.

Governor, Ms. Wilkins, thank you for being here with us today.

The media have reported that you said that measures contained in the latest budget will have a noticeable and positive impact on the Canadian economy. Can you elaborate a bit on that for the committee? What measures were you referring to? What measures will have a positive impact on Canada's economy, not only in the short term, but also on our long-term economic growth?

[Stephen S. Poloz]

This is a two-part question.

First of all, in the short term, it will boost the economy.

Second, if this spending represents an investment, for instance in infrastructure or something like that, it could promote a trend in growth. A 0.1% or 0.2% increase over the long term would have a very important cumulative effect. It is hard to estimate, but it's certainly positive if it contributes to growth, as I said earlier.

[François-Philippe Champagne, Liberal, Saint-Maurice—Champlain, QC]

I hear you've just come back from Washington. Is it fair to say that while you were at the G7 or G20 meetings a number of economies were looking at Canada to see what Canada has been proposing in terms of restarting growth?

We know that Madame Lagarde said we're facing mediocre growth. A number of nations are looking at things that could be done in order to grow the economy, not just in the immediate term but in the long term.

What other kinds of measures are people talking about? I know that people have singled out Canada as a poster child. We saw that in the Wall Street Journal and the Financial Times.

Could you elaborate a bit on the feeling of people sitting around the table?

[Stephen S. Poloz]

I won't comment on specifics for other countries, but the general thrust is that there are three fields of policy that should be working together in this situation.

Monetary policy is clearly very stimulative globally, and is close to its maximum ability.

Fiscal policy is less widely engaged, except in certain places that I mentioned before.

The third, and probably most important policy at this stage, is structural change to the economy to overcome the barriers to growth that we talked about earlier. The contention of the IMF, and of those around the table, is that those three can work together.

That is, a structural policy on its own may just have some positive effects long term, and possibly negative effects in the short term. Using fiscal policy with it to cushion the blow and add some extra impetus to the economy helps offset the negative effects while ensuring the long-term effects are good. Monetary policy is there to keep the system well prepared, and to nurture the process.

Using just one of them is not the recipe. The important thing is to have all three operating. That's the nature of our discussions.

[François-Philippe Champagne, Liberal, Saint-Maurice—Champlain, QC]

I think you mentioned three things that I noted in particular. You talked about innovation, productivity, and exports. Can you expand a bit on the impact of investing in fostering innovation and productivity, on measures that are helpful when we look at these three components of our economy? I know the productivity gap in Canada compared with the U.S. What are the possible positive impacts on the economy when you invest in these three things?

You talked about innovation, and you mentioned exports being fundamental to the Canadian economy as well as productivity. Can you expand a bit on that?

[Stephen S. Poloz]

Any investment that makes it easier for firms to grow is going to add to that productivity line, and every little bit counts and adds up. Second, anything you can remove that is an impediment to growth adds to that process.

Finally, I think the most important aspect of all is to nurture the process of creation of new companies because historically it is new companies, young companies that have had the giant leaps in productivity that have made our agri-productivity statistics stronger. That process has been slow since the crisis. In the U.S., it has begun to pick up nicely. In the U.K., it has picked up nicely. We're a bit behind that process. I'm confident it will happen here, too. But the most important phase is where productivity is fostered.

Policies that favour young companies and allow them to grow faster—and there's a wide menu of those—I think, are the main things we should focus on.

[The Chair, Liberal, Wayne Easter]

Thank you.

Ms. Raitt. Five minutes.

[Lisa Raitt, Conservative, Milton, ON]

Governor, the other aspect of your report from April 13 talks about the economy's potential growth rate, and you downgraded it from 1.8% to 1.5%, which I think is a significant number. I'd like you to comment on that.

Secondly, when you say later on in the release that we're going to hit capacity in the second half of 2017, does that mean you think you'll be in a position to increase interest rates when the economy comes to full capacity?

So, the first part is, why the downgrade from 1.8% to 1.5%, which, by the way, is much lower than our historical cruise rate of 2%, to quote Barrie McKenna? And what happens in 2017? Are you looking at returning to your normal 2% inflationary rate?

[Stephen S. Poloz]

I'm going to ask Carolyn to address the revision of potential and what that means.

I would just say, in general terms “potential” is a very uncertain concept, so it's not a brick wall somewhere out there. It can be affected by many things that we've talked about in committee today, a lot of things that can mean more potential as the economy reaches its full stride, and that postpones that point where we're going to run out of extra resources, such as 120,000 youth who have withdrawn from the workforce. That's not early retirement. That's a discouraging effect. Bringing them back in will make all the difference.

Carolyn, why don't you walk through a couple of the numbers?

[Carolyn Wilkins]

On the downgrade in potential and the range for potential, I'd like to emphasize our potential is really reflecting, primarily, the downgrade that we made to business investment, because that business investment that we still have in there represents what we call capital deepening, which means that labour productivity improves.

Now, the downgrade in the investment is primarily in the energy sector, and so it's what I was talking about before, which is we're in this destruction phase, or the phase where the negatives in the energy sector are really outweighing the positives in the other part of the economy. You'll notice that those ranges stay lower for a while but then start to move back up as that transition progresses. You'll see potential output growth, that range, moves up starting in 2018 and going up to 2020, which is the end of our estimate.

I think another factor here is just labour. The more people you have in the labour force, the more you have adding to potential.

What we've seen is a lot of people were discouraged and out of the labour force. Over the last year, we've seen many prime-aged people come back to the labour force. It's possible that even more will come back, particularly younger people who left the labour force after the crisis and over the last couple of years.

[The Chair, Liberal, Wayne Easter]

We'll go to Mr. Aboultaif for the rest of the time.

[Ziad Aboultaif, Conservative, Edmonton Manning, AB]

I do have one short question. It's a very common question. Where will the government be borrowing the money from? Can you brief us on the mechanism behind it?

[Stephen S. Poloz]

Where will the government borrow money from? The government borrows money on the market. Pension plans invest in government bonds, individuals invest in government bonds, foreigners can buy government bonds, so literally everybody. Canada has a very strong credit rating and the appetite for Canadian debt...and a very low level of indebtedness, so it's seen as a very strong credit.