Evidence of meeting #15 for Finance in the 42nd Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was economy.

A video is available from Parliament.

On the agenda

MPs speaking

Also speaking

Stephen S. Poloz  Governor, Bank of Canada
Carolyn Wilkins  Senior Deputy Governor, Bank of Canada
Jean-Denis Fréchette  Parliamentary Budget Officer, Library of Parliament
Mostafa Askari  Assistant Parliamentary Budget Officer, Office of the Parliamentary Budget Officer, Library of Parliament
Chris Matier  Senior Director, Economic and Fiscal Analysis and Forecasting, Office of the Parliamentary Budget Officer, Library of Parliament
Scott Cameron  Economic Advisor, Analyst, Economic and Fiscal Analysis, Office of the Parliamentary Budget Officer, Library of Parliament
Jason Jacques  Director, Economic and Fiscal Analysis, Office of the Parliamentary Budget Officer, Library of Parliament
Helen Lao  Economic Analyst, Economic and Fiscal Analysis, Office of the Parliamentary Budget Officer, Library of Parliament

11 a.m.

Liberal

The Chair Liberal Wayne Easter

Order, please.

Pursuant to Standing Order 108(2) and our study of the report of the Bank of Canada on monetary policy, we're pleased to have as witnesses this morning the Governor of the Bank of Canada, Mr. Poloz, and Senior Deputy Governor Ms. Wilkins.

The floor is yours. Welcome. Thank you for appearing.

11 a.m.

Stephen S. Poloz Governor, Bank of Canada

Good morning, Mr. Chairman, and thank you.

Good morning, committee members. Senior Deputy Governor Wilkins and I are happy to be back to discuss the bank's monetary policy report, which we published last week.

I extend particular greetings to the new members of the committee, which I think is almost everyone. I look forward to being with you twice a year to talk about the Canadian economy and our monetary policy.

Carolyn and I were last in this committee about 12 months ago. It has certainly been a tumultuous year for the Canadian and global economies. Let me start with a quick review.

As you know, the Canadian economy has been dealing with a massive shock to our terms of trade, which was brought about by a sharp drop in the price of oil and other commodities that began in late 2014.

Given that Canada is such an important producer of resources, particularly oil, this shock was a major setback. It set in motion a difficult adjustment process that has been very disruptive for many Canadians. Investment and output in resource industries have fallen precipitously, the decline in national income has curbed household spending, and the resource sector has seen significant job losses. These negatives have clearly outweighed the benefits of lower energy costs for households and businesses.

From a monetary policy perspective, the shock posed a two-sided threat to our economy last year. First, it was a clear downside risk to our ability to reach our inflation target. Second, by cutting into national income, it worsened the vulnerability posed by household imbalances, as seen in our elevated debt-to-income ratio. To address both threats and to help facilitate the necessary economic adjustments, we lowered our policy interest rate twice last year, bringing it to 0.5%.

While we recognized the possibility that this reduction could at the margin exacerbate the vulnerability posed by household imbalances, the more important effect of lowering the policy rate last year was to cushion the drop in income and employment caused by lower resource prices.

Another natural consequence of the shock to our terms of trade has been a decline in the Canadian dollar exchange rate. It's important to note that this is not unique to Canada. Indeed, many resource-reliant countries have seen similar depreciations in their currencies.

Both our policy moves and the lower currency have been helping to facilitate the economic adjustments that have been playing out over two tracks. While weakness has been concentrated in the resource sector, the non-resource economy continues to grow at a moderate place. Within that, non-resource exports are clearly gathering momentum.

By the time we reached the new year, there was a clear sense of anxiety among many financial market participants. The outlook for global growth was being downgraded again, and commodity prices were plumbing new lows. At the bank, we had new intelligence that Canadian energy companies would be cutting investment even more than previously thought. In this context, we said that we entered deliberations for our January interest rate decisions with a bias to easing policy further, but we decided to wait to see details of the government's fiscal plan.

Since January, we've seen a number of negative developments.

First, projected global economic growth has once again been taken down a notch for 2016 and 2017. This includes the U.S. economy, where the new profiles for investment and housing mean a mix of demand that is less favourable for Canadian exports.

Second, investment intentions in Canada's energy sector have been downgraded even further. True, oil prices have recovered significantly from their extreme lows, but Canadian companies have told us that even if prices remain around current levels, there will be significant further cuts beyond what we foresaw in January. By convention, we incorporate the average oil price from the few weeks before we make our forecast, letting us see through variability in markets. Because of all this, our oil price assumptions are only $2 to $3 per barrel higher today than they were in our January forecast.

Third, the Canadian dollar has also increased from its lows. Our assumption in our current projection is 76¢ U.S., which is 4¢ higher than we assumed in January. While there are many factors at play, including oil prices, most of this increase appears to be due to shifts in expectations about monetary policy in both the U.S. and Canada. The higher assumed level of the dollar in our projection contributes to a lower profile for non-resource exports, as does lower demand from the U.S. and elsewhere.

As the bank's governing council began its deliberations for this month's industry announcement, we saw that these three developments would have meant a lower projected growth profile for the Canadian economy than we had in January. Now, this may sound counterintuitive given the range of monthly economic indicators that started the year strongly; however, some of the strength represents a catch-up after a temporary weakness in some areas during the fourth quarter, and some of it reflects temporary factors that will unwind in the second quarter.

The other new factor we had to take into account was the federal budget. For the purposes of our MPR and interest rate announcement, we took a close look at the finance department's projections of the multiplier effect of the fiscal shock. Our analysis is that the department's projections are reasonable, and that they are within the range of estimates you would find in the economic literature, as well as in our own staff research. There is, of course, greater uncertainty as to how the budget measures will affect growth in the longer term, particularly since they will need to work their way through the household sector. In our report, we outlined the risk that households may be more inclined to save than historical experience would suggest.

Taking all of these changes on board, our projected growth profile is generally higher than it was in January. We are now projecting real GDP growth of 1.7% this year, 2.3% next year, and 2% in 2018.

Our forecast suggests that the economy will likely use up its excess capacity somewhat earlier than we predicted in January, specifically, sometime in the second half of 2017. However, there is more than the usual degree of uncertainty around that timing. It is always tricky to estimate an economy's potential output, and the difficulty is compounded when the economy is going through a major structural adjustment, as Canada is right now. We know that the collapse in investment in the commodity sector will mean a slowdown in the economy's potential growth rate. In the near term, we've lowered our estimate of potential output growth from 1.8% to 1.5%.

In terms of the bank's primary mandate, total CPI inflation is currently below our 2% target. The upward pressure on imported prices coming from the currency depreciation is being more than offset by the impact of lower consumer energy prices and the downward pressure coming from excess capacity in the economy. As these factors diminish, total inflation is projected to converge with core inflation and be sustainably on target sometime in the second half of next year.

To sum up where we are, while recent economic data have been encouraging on balance, they've also been quite variable. The global economy retains the capacity to disappoint further. The complex adjustment to lower terms of trade will restrain Canada's growth over much of our forecast horizon, and households' reactions to the government's fiscal measures will bear close monitoring. We've not yet seen concrete evidence of higher investment and strong firm creation. These are some of the ingredients needed for a return to natural, self-sustaining growth with inflation sustainably on target.

With that, Mr. Chairman, Carolyn and I would be happy to answer your questions.

11:10 a.m.

Liberal

The Chair Liberal Wayne Easter

Thank you very much, Governor, for the fairly in-depth overview.

Starting the first round of questions, we have Mr. Sorbara for seven minutes.

11:10 a.m.

Liberal

Francesco Sorbara Liberal Vaughan—Woodbridge, ON

Good morning, everyone.

Welcome, Governor and Ms. Wilkins.

My first question deals with the efficacy of fiscal stimulus. I won't get onto the topic of fiscal multipliers, Governor, because I believe you've answered a few questions on that and have talked on that in the last few days.

In an environment where we have excess capacity and where interest rates are at the lower bound, can you comment on the efficacy of the government implementing a fiscal stimulus plan?

11:10 a.m.

Governor, Bank of Canada

Stephen S. Poloz

In general terms, we've known since Keynes wrote about the Great Depression in the 1930s that monetary and fiscal policy have their moments when they have their greatest impact. Monetary policy has its least impact as interest rates get close to the lower bound, which is to say people have already borrowed to buy homes or to buy cars, companies have borrowed to do investments, and so on. Lowering interest rates a little further has only a marginal impact on the side.

It is in that context, when we're in that neighbourhood, that fiscal policy has the largest impact of all the possibilities one could contemplate. The reason is simply that when we have models of the economy, and we simulate fiscal policies, normally we start from a position of equilibrium. We are far below Canada's equilibrium at this time. We have plenty of excess capacity.

In this context, there are no other movements anticipated, such as interest rates or exchange rates, that would partially offset a fiscal change. It's in that sense that it has more power for the amount of fiscal action one takes than monetary policy has in this setting.

11:10 a.m.

Liberal

Francesco Sorbara Liberal Vaughan—Woodbridge, ON

I'll move on to my second question and briefly touch on inflation. If I look at the wage pressures faced in Canada, I believe we're running at about a 3% clip. Please correct me if I have that incorrect. That number is a strong number. I know they monitor that data in the United States quite closely. We are having some wage pressures pop up, but in a sense we still have a lot of excess capacity.

My concern is this. Is there a chance—and you've touched on this in your opening remarks—for the core inflation overshooting that 2% earlier than you've projected?

11:15 a.m.

Governor, Bank of Canada

Stephen S. Poloz

At this time we would put a very low risk against that eventuality.

We have a range of estimates for the level of capacity in the economy. We take a mid-range of that range of estimates, but there's considerable uncertainty about how much there is.

The situation is quite in contrast to that of the U.S., which is, I would say, a good year ahead of us in this process of converging. Of course economists watch all of those signals, as you mentioned. As you approach full capacity, you may begin to see wage settlements beginning to pick up. It's one of the early signs that inflation is getting ready to recover. It's at that time the risk management approach to monetary policy sounds that warning and you begin to deal with that.

Bear in mind it's not as exact a science as we tend to convey. We think the level of potential will be growing later this year and next year because of the investment happening in the rest of the economy. That moves that eventual limit on the economy farther out.

11:15 a.m.

Liberal

Francesco Sorbara Liberal Vaughan—Woodbridge, ON

Going back to economic growth, we had a terrific Q1. I think it was a 2.8% growth that was recorded in the Canadian economy. Your forecast, or the bank's forecast, for Q2 is 1% and 2% for the year, and you've noted temporary factors. I think the word was unsustainable.

I'm a little curious in terms of the deceleration, going from Q1 and handing off to Q2. It seems to me that going from 2.8% to 1% is a marked deceleration. I don't know if the word is that the bank is being too bearish. I was wondering if you could comment on that.

I think some of the private forecasts have bumped up the Canadian growth rate for 2016. I'm wondering if, maybe, the recovery in commodity prices, the strength of the hand-off, and the strength to the non-resource sector is stronger than the bank may be estimating. I'd like your comment on that one, as well, please.

11:15 a.m.

Governor, Bank of Canada

Stephen S. Poloz

Even the 2.8% that you mentioned is still a forecast. We have some time to go before we know these things.

Carolyn, perhaps you'd like to walk through some of the details.

11:15 a.m.

Carolyn Wilkins Senior Deputy Governor, Bank of Canada

Clearly always throughout history you see ups and downs in quarterly growth. To do monetary policy well you need to look at the factors that are reflecting underlying momentum, and one of the factors appeared to be contributing to quarter-to-quarter volatility, and that's what you've observed.

Specifically in this instance we see a couple of things. I don't want to go through them all, but there's volatility in the inventories through Q4 and Q1 that will affect that quarterly pattern going into Q2. We've also seen some other factors with respect to autos and auto production that clearly don't look as if they would be sustainable.

I think the third factor is exports. Exports started the year very strongly and if you compare it to what you would expect exports to be, given what we think foreign demand is, and in particular foreign demand from the U.S., it looks as if exports were a little stronger than you would have expected. So we've taken a cautious approach to that outlook and think there will be some give-back in subsequent quarters. Of course that could be overly cautious. We see the volatility in that export data. The last data point we saw wasn't that great, but I think the bottom line is that we try to define the best quarterly pattern, given the underlying factors we're seeing. On the export side we have identified that as a potential upside risk going forward because we've been cautious in our outlook.

11:15 a.m.

Liberal

The Chair Liberal Wayne Easter

Thank you.

Ms. Raitt you have seven minutes.

11:15 a.m.

Conservative

Lisa Raitt Conservative Milton, ON

Thank you very much.

Governor and Senior Deputy Governor, it's very nice to meet you both, and thank you for being here today.

I'm going to focus on one aspect of your analysis, and it has to do with determining whether or not the measures the government has introduced in the budget are going to add to growth in the country. In your report you indicate correctly that it's about $11 billion in infrastructure investments, and about $12 billion in households, and you think that the effects will be felt in 2016. That forms a basis for your analysis that in a sense it's going to help and overwhelm the negative factors we're seeing in the economy, but you also have two really important caveats in there, and one has to do with households and whether or not they're going to be spending.

You also point out in the very next section that household debt has gone up in this country because more mortgages are being taken on in Ontario and B.C. Of course we're seeing the negative effect on housing markets in the oil-producing provinces. With all of those taken into consideration I want you to expand a little on your comfort level saying that putting money into the hands of families in this country is necessarily going to be spent in the economy and moved along when we're looking at such high levels of debt. There's a propensity for people to save or pay down that debt because they are concerned about whether jobs are being created. I would overlay that with one anecdote. It's very difficult to see cousins and brothers and sisters and friends across the country losing their job and seeing a lot of discussion about the oil sector. You refer to it as a structured change in our economy. They're seeing that and they're very concerned about what that means to them.

So tell me a little about how the council ended up deciding that people will spend this money instead of saving it. I would say one last thing; the tax cut we have before us that the government has introduced amounts to 90¢ a day for an individual, and I fail to see how that's going to spur great economic growth that's going to counter what we're seeing in terms of the losses in our country.

With that I'll turn it over to you.

11:20 a.m.

Governor, Bank of Canada

Stephen S. Poloz

Many of the things you mention are important factors in this analysis. I think we've been very clear that this analysis has a certain amount of uncertainty associated with it. As you mentioned, that is why we chose to highlight one of the risks, which is that people may save more than the average through history.

We saw an experiment that was similar to that a year ago. When the UCCB changes went into place we began with an assumption, which is really what it is, that perhaps around half of that money would end up being spent and the other half might be saved, in the context we found ourselves. That turned out to be not too far off the mark, so when we put this in we don't assume everyone spends all of the money. This is a multiplier that is less than one, which is, some of the money is inevitably saved, and it would depend on house to house, and as we say, it would depend through time. It is not just right away. In the beginning, people may be more cautious than they are longer term.

Therefore, yes, there is uncertainty there, but our monetary policy doesn't require that we have our forecast exact. It is about what the boundaries are and what the risks are around our forecast so that our monetary policy is appropriate for a range of possible outcomes.

11:20 a.m.

Conservative

Lisa Raitt Conservative Milton, ON

Last year, when you appeared before our committee, Governor, you talked about the housing market and you had an interesting statistic with respect to concerns in the housing market. You said in your report that the markets were overpriced by about 10% to 30%.

I know my former colleague, James Rajotte, and you had a discussion about that at committee. I'm wondering if you think we have a housing bubble in Canada at the moment, because things certainly have deteriorated in the economy since then. We are seeing severe situations in the Prairies and Alberta, for example, where my colleague Ron is from. I'd just like to get a sense from you where the housing market is a year on from when you appeared before this committee last.

11:20 a.m.

Governor, Bank of Canada

Stephen S. Poloz

Let me just clear up something on the facts, then I'll turn it over to Carolyn.

A year ago, we were reporting a new piece of research that we had published that made an attempt to analyze housing markets globally, not just Canada's, but global housing markets, in cases where there had been periods of overvaluation and then adjustments. It's an attempt to understand the fundamentals.

That came in the context of a number of other studies that others reported where there was a wide range of estimates as to whether the Canadian market was overvalued and whether you could even say something like that about the Canadian market since it varies so much from region to region.

Our conclusion was that those kinds of figures are very risky to appeal to, given the variety of experiences we have across the country, and that there are a number of significant differences from market to market that aren't actually incorporated in models like that.

With all of that as background, perhaps I'll turn it over to Carolyn for an update on how the housing market has evolved and what our current standing is on it.

11:25 a.m.

Senior Deputy Governor, Bank of Canada

Carolyn Wilkins

We continue to look at the housing market very closely because of the potential financial stability implications. What we've seen over the last year is what you would expect, given the transformation of the economy going from more energy based to non-commodity based. You noted, quite rightly, that in places that are dependent more on energy, not only Alberta but other provinces, you see their housing market conditions slowing quite considerably. It's what you would expect as people become unemployed, perhaps move to other provinces to find new employment, or just go home to where they originally worked before they moved to Alberta. There is a lot of that going on and you see the slowing there.

If you look at elsewhere in the country, there are two other things going on. You have major cities like Vancouver and the greater Toronto area, where the markets are actually going very strongly, and we're watching that closely. The context there is that how strong that is is just a function of the supply and demand dynamics that have been going on for years. Adding to that is the interprovincial migration of people and the fact that their employment is up and their economies are doing relatively better than the energy-dependent places.

When you look at that and try to make an assessment of the market you really need to take into account those supply and demand dynamics. The supply constraints are well known in Vancouver and Toronto. It is because of geography, because of the permits, and because of the interest people have in working and living there.

Clearly, from a monetary policy point of view it is something we look at and we take into account. At the same time, given the localized nature of the things that we're really focusing on right now, monetary policy as a tool really is just too blunt for that. Maybe there are other tools.

As you know well, the government has taken some actions recently that just came into force, so we'll be watching it closely.

11:25 a.m.

Liberal

The Chair Liberal Wayne Easter

Thank you.

Mr. Caron.

April 19th, 2016 / 11:25 a.m.

NDP

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

Welcome Governor and Ms. Wilkins.

In the previous Parliament we had lots of interesting exchanges on the need to include or not to include certain tools in the bank's tool box. At one point we were talking about quantitative easing.

Last year you commented on the possibility of, or your openness to, considering negative interest rates. Some countries are currently experimenting with this, including Sweden, Japan, and Denmark, as well as the eurozone. There seems to be a growing consensus. I would ask you to comment on your evaluation of the experiments so far.

The consensus I'm seeing is that, in the short term, it might actually provide the help that's needed and is sought, but mid-term, we're losing that efficiency. There is an adaptation to that reality that actually brings about a loss of efficiency in stimulating the economies and interest rate, while trying to get the investments needed.

Could you comment on what you're seeing so far?

11:25 a.m.

Governor, Bank of Canada

Stephen S. Poloz

Certainly.

In terms of the tool box that you referred to, our tool box was laid out back in the midst of the crisis in 2008. Last fall we undertook a project to update it in light of experience since that time. Most of the experience that we referred to, happily, was not in Canada, but was in other countries where the problems have been more serious.

In the institutional context we have, we now believe that our markets would continue to function more or less normally at interest rates as low as -0.5%, whereas we used to think of 0%—or 0.25%, actually, to be specific—as the actual physical lower bound. That means we have on the order of 75 basis points more room to manoeuvre, as you suggest, for relatively short-term issues. It's true that the distortions that may emerge grow with the length of time that is there, and possibly the effectiveness of this policy would diminish for a longer time period.

It's in that context that we think of quantitative easing. We've had some very interesting uses of quantitative easing that have had a significant impact on performance in various economies.

We don't say concretely which of those tools we would appeal to if the situation arose. We just start with saying that fortunately our outlook is that none of that is necessary. Our outlook is quite a positive one. But if there were a significant negative shock to the economy, we know we have a tool kit available to help buffer the effects of those things, and what order we might use those things in, or in which combination would depend on the circumstances and what seemed best at the time.

11:25 a.m.

NDP

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

Speaking still about that tool box, I remember comments that you made once again in the last Parliament about the fact that we are in a new normal right now with lower economic growth. You're currently negotiating with the Department of Finance for a renewal of the inflation target which comes to an end by the end of November. That inflation target has always been at 2%, plus or minus 1%, of course, but that was set back in the 1990s. At the time, I would submit it was a different normal than what we're experiencing.

Is there an evaluation being made on the possibility of actually giving the bank more flexibility by adjusting the target at least for the next five years, maybe to a higher level so that you would actually have more flexibility in the establishment of the nominal interest rate and more influence in terms of the real interest rate? I've seen the documents that the bank has released but it was a while ago.

11:25 a.m.

Governor, Bank of Canada

Stephen S. Poloz

That's a live issue for us at this time. I won't go into the conclusions of that work, but some of the working papers have already been published.

There are three issues that we've set out that need to be addressed this time before we renew that agreement.

First, what's the right measure for inflation? Should we change from the CPI that we've used traditionally?

Second, what is the level, which is the question you've just raised; 2%, or some other number?

Third, how do we integrate financial stability issues into that policy framework?

The one about the level is perhaps the most prominent issue, and it's because of the experience of the last few years when central banks, including ourselves, got to the lower bound. If interest rates had been one percentage point higher when it all started, you would have more room to manoeuvre. That's an important consideration. That experience has of course been historically quite rare, but now it has happened so everyone has to think about it.

The other side of that discussion is now that we understand that negative interest rates are possible, that also gives us more room to manoeuvre than we thought we had before. So it's those two sides of the coin that need to be assessed. What are the relative costs and benefits about that extra flexibility? What would it buy us? That's the question, especially when we have unconventional tools in the tool box that can be used if need be.

So it's a live question still. We're just at the stage where we'll begin concrete discussions with the Department of Finance in the next month or two.

11:30 a.m.

NDP

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

I know you don't comment on fiscal policy, which I agree with, but we are doing work here that is being listened to by the Minister of Finance—or so we hope. Do you think it would be relevant for this committee to actually study the possible impacts of modifying that inflation target, maybe for advice to the finance department? Is there a lively debate right now that this should be taking place?

11:35 a.m.

Governor, Bank of Canada

Stephen S. Poloz

We would welcome further input on that question. We've had various academic studies and so on that have been prepared. We've added a lot of input on that. I would just say that for me the bar for changing this framework is very high. It has performed very well for Canada for 25 years now, so we won't take this question lightly, but of course, any further input that the finance minister would want to take into account would be very welcome.

11:35 a.m.

Liberal

The Chair Liberal Wayne Easter

Thanks to both of you.

Mr. MacKinnon, please, for seven minutes.

11:35 a.m.

Liberal

Steven MacKinnon Liberal Gatineau, QC

Thank you, Mr. Chair.

Governor, Ms. Wilkins, welcome to the Standing Committee on Finance, and thank you for your very detailed presentation.

In your presentation, you talked about some of the specific challenges Canada is facing in today's world. You attended some meetings of the International Monetary Fund at which macroeconomic trends were discussed. I wonder if you could talk about what came out of those meetings.

Also, after reading your brief, I noticed a certain sense of relief—although I doubt you would like to comment on that—in terms of the Canadian government's efforts to invest in our economy. Generally speaking, what are other countries doing in terms of public investment to generate economic activity?