Evidence of meeting #82 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.
Liberal
The Chair Liberal Wayne Easter
I'll call the meeting to order. Pursuant to Standing Order 108(2), we are studying the report of the Bank of Canada on monetary policy and welcome before the committee today Stephen Poloz, governor of the Bank of Canada, and Carolyn Wilkins, senior deputy governor.
Governor, the floor is yours and then we'll go to questions. Welcome.
Stephen S. Poloz Governor, Bank of Canada
Thank you, Chair, and good afternoon to you and to the committee members.
Senior Deputy Governor Wilkins and I are delighted to be before you today to discuss the bank's Monetary Policy Report, which we published just this morning.
Taking a look back to the last time we were here, which was in October, at that time I spoke about the factors that were causing us to downgrade our outlook for the Canadian economy. Some six months later, I'm very pleased to say that I can discuss the factors that have led us to upgrade our forecast for the Canadian economy.
For some time, we've been talking about how the oil price shock that began in 2014 set in motion a complex series of adjustments throughout the economy, including a significant restructuring of the oil and gas sector. What we're seeing now is that energy-related activity has stopped declining and is transitioning to a new level commensurate with the current level of oil prices.
Now, because that large negative force is now essentially passed, it's no longer masking the sources of strength that have been at work for some time, particularly the growth in output and employment that is being driven by the service sector.
The expansion over the past six months has exceeded our earlier forecast, and we have revised up our outlook for average annual growth for this year, 2017, to a bit over 2.5%. That's half a percentage point greater than we were projecting in the January Monetary Policy Report. We project growth of just under 2% in 2018 and 2019.
A crucial question for the bank now is whether the stronger economic data we've been seeing recently are signalling increasing momentum. Some of the strength is coming from factors that are unlikely to continue at the same pace. For example, the very strong growth in consumption in the first quarter was supported by a temporary boost from the Canada child benefit.
Housing activity has also been stronger than expected. While we've incorporated some of this strength in a higher profile for residential investment throughout our projection, we're still anticipating a slowing over that projection horizon. The current pace of activity in the greater Toronto area and parts of the Golden Horseshoe region is unlikely to be sustainable, given fundamentals. House price growth in the GTA has accelerated sharply in recent months, suggesting to us that speculative forces are at work.
In terms of the labour market, recent data have been more mixed. Job growth has certainly been firm, but both wages and unit labour costs have grown very slowly. The data suggest that material slack remains in the Canadian labour market, in contrast to the U.S. labour market, which is close to full employment.
At the same time, Canadian exports and business spending are still weaker than you would expect to see at this stage of the business cycle. Companies are telling us that while they plan to raise spending, the planned increases are modest or tied to maintenance rather than expansion. In short, the economy is not yet firing on all cylinders. In addition, Canadian companies are dealing with heightened levels of uncertainty related to U.S. tax and trade policies.
We still do not know what tax changes are coming, or when, and the range of potential trade measures under discussion is even wider now than it was in January. This list includes, first, a border adjustment tax; second, increased tariffs aimed at specific industries or countries; third, non-tariff barriers; and fourth, even broader multilateral measures.
We do not know which of these measures will be enacted; their timing is uncertain and each would affect the global and Canadian economies through a different, complex set of channels. With all this uncertainty, we cannot reliably model the impact of changes to US trade policy. Instead, we have built in an extra degree of caution in our forecast for exports and investment relative to our January projection.
Total inflation has been close to 2% and is expected to dip to about 1.7% in the middle of the year before returning to near its target. However, our core inflation measures are all in the lower half of the target band and have been trending downwards.
This supports the view that the economy continues to have significant excess capacity. Our current base-case forecast calls for the Canadian economy to absorb its excess capacity sometime in the first half of 2018, which is a bit sooner than we projected two months ago.
We are certainly happy to see the recent strength in the economic data, and we want to see more of it to be confident that growth is on a solid footing. We judge that the economy still has material room to grow, and we remain mindful that significant uncertainty continues to weigh on the outlook. Given all of this, we judge that the current stance of monetary policy is still appropriate, and we maintain the target for the overnight rate at 0.5%.
With that, Mr. Chairman, Senior Deputy Wilkins and I will be happy to answer your questions.
Liberal
The Chair Liberal Wayne Easter
Thank you very much, Governor.
We will turn to questions, with five-minute rounds to try to give everybody a chance to get theirs in.
Ms. O'Connell.
Liberal
Jennifer O'Connell Liberal Pickering—Uxbridge, ON
Thank you, Mr. Chair.
Thank you both for being here today.
I want to start by asking a question on a statement of yours that was quoted in the media at the latter end of last year with regard to your thinking that one of the most dangerous risks to the economy was high household indebtedness. We just completed a study on housing looking at high household indebtedness.
If you believe that the recent federal measures will deal with that or if you have any overall thoughts, I wonder if you could elaborate, including if you've seen any trends, or if the policy has been working from the time you made those comments, which I believe was last December.
Governor, Bank of Canada
Of course.
That occasion in December was when we published our financial system review, which is a biannual exercise. The next one is in June. It's absolutely true that a major risk that we face is that indebtedness in households is at the highest level ever and is continuing to move higher. This is closely associated with imbalances in the housing market, because indebtedness is incurred primarily to buy houses. We are confident that the moves made by the federal government, in about the same time frame, are having the desired effect. That means that people are qualifying for mortgages at a higher interest rate now, and therefore have more of a cushion in their financing plan, should there be either an interruption of employment or a rise in interest rates. There is more resilience in the system, and a growing amount as each new bit of debt is subject to those higher criteria. That's the primary change that's been made.
From the Bank of Canada's standpoint, our primary mission being inflation targeting, that implies bringing the economy back to full capacity. That causes more jobs and income growth, which improves the denominator of the ratio of debt to income and makes the whole situation less risky.
Liberal
Jennifer O'Connell Liberal Pickering—Uxbridge, ON
Thank you.
In recent days questions have been raised in the media around rising interest rates and how much U.S. monetary policy will have an impact on us here in Canada. We have seen interest rates increase in the U.S. Again, I understand the speculation, but how much of U.S. monetary policy affects us here in those respects, especially in terms of interest rates? That's what the average Canadian is going to be worried about, given this high indebtedness.
Carolyn Wilkins Senior Deputy Governor, Bank of Canada
Certainly what people observe, and they've been observing for a very long time, is that the interest rates in Canada are highly correlated with interest rates in the U.S., especially the longer term those interest rates are, for example, the five-year rate, on which a lot of mortgage rates are based. As the Federal Reserve starts to tighten interest rates, we're going to quite naturally import some of that rise. In fact, we have seen that. It's not a large amount, but over the last six months it's been noted.
Whether or not that's translated into mortgage rates is a question for the financial institutions that set them. They've taken a little out of their margins rather than increase rates.
We have an independent monetary policy, and we set our interest rates commensurate with what we think we need to have to achieve our inflation target. If we're at a different point in the cycle, which we are right now, our interest rate paths are going to be different. We do take that into account when we do our projections. Where the curve says the interest rates are and where we think U.S. growth is, is what we feed into our forecast.
Liberal
Jennifer O'Connell Liberal Pickering—Uxbridge, ON
My quick question would then be this. You stated that we independent policies from the U.S., and I get that, but should Canada make maximum employment an explicit goal of the Bank of Canada, as the U.S. has done, or does that also fall into a question of our not being at the same point in the cycle?
Governor, Bank of Canada
In fact, we see no inconsistency in this. For us, with the inflation target being our goal, we need to achieve a position whereby we've achieved a 2% inflation that is sustainably at 2%. Being sustainably at 2% would mean that there is no excess demand or excess supply in the economy pulling it down or pushing it up, so there is in effect a coincidence: that we would also be at maximum employment at that same time.
For us, then, the two are not distinguishable, but I think that having purely an inflation target improves the clarity of the decision-making we have, because of course in the background the economy is working through its adjustment processes. It's very difficult to have two targets with really only one instrument doing that.
Liberal
Conservative
Gérard Deltell Conservative Louis-Saint-Laurent, QC
Thank you, Mr. Chair and colleagues.
Mr. Poloz, Ms. Wilkins, welcome to your House of Commons.
First of all, I would like a little clarification. At the outset, you mentioned the price of oil, which has clearly been major concern in the last four years in Alberta, especially if we consider the terrifying effects we have seen.
You say that we are transitioning to a new price that is commensurate with the current price of oil. In your opinion, does that mean that, in the next year, the price of oil will be stable? Or are you forecasting an increase? If so, what do you see as the target price for a barrel of oil?
Governor, Bank of Canada
For us at the Bank of Canada, forecasting the price of oil is a challenge. As a result, we base our forecasts on a stable price. Then we analyze the other risks.
For the moment, I would say that there is a short-term upside risk because we are going through a period of very low investment in the sector. Sooner or later, demand will exceed supply.
In addition, technological changes alter the supply curve in a very unpredictable way. So I do not really know what the future holds. I am pleased to see the industry becoming more stable, and assuming stability.
Conservative
Gérard Deltell Conservative Louis-Saint-Laurent, QC
Thank you very much.
You mentioned a possible rise in the price of oil. We can understand that this is something that our Alberta companies, and all Canadian companies depending on oil, are hoping and waiting for.
Before I go any further, Mr. Poloz, let me thank you and congratulate you for the quality of your French. We appreciate it greatly.
In terms of interest rates, people are always a little nervous when they are in debt and when deficits are being run. I will not make a political speech such as we have become used to for a year and a half, but, in your opinion, should the interest rate remain stable? Do you foresee any fluctuations in the coming year?
Governor, Bank of Canada
I am not going to forecast interest rates. As we said earlier today, we are essentially in a neutral situation in terms of interest rates. The forecasts we made this morning are based on an inflation rate of 2% in this period and on an output gap that will be closed in the first half of next year. Those data tell us that the interest rate today is appropriate. We will have to monitor all the data all the time in order to get a sense of the situation next year.
Conservative
Gérard Deltell Conservative Louis-Saint-Laurent, QC
Okay.
You say that the economy is not yet firing on all cylinders and that there is uncertainty about the United States. The American president has talked about tweaks in trade relations between Canada and the United States. Tweaks for the Americans means a major impact on Canada, as former Prime Minister Brian Mulroney so rightly said two weeks ago at the meeting he attended in Ottawa with some federal ministers.
In your opinion, which sectors of the Canadian economy are most at risk if those tweaks have a major impact on Canada? What impact could that have on the economy as a whole?
Senior Deputy Governor, Bank of Canada
When we did our analysis, we saw a number of possible scenarios. As a result, it is difficult at the moment to provide a precise answer to your question.
In our report on monetary policy, we tried to identify the channels of change that could affect the Canadian economy. If there were tariffs, for example, the impact would certainly be felt more on the industries directly involved. If a tariff affected some industries specifically, it would have a different effect across the country. Actually, that is what we can see at the moment in forestry.
There are also other channels of change, like the oil price shock, which has implications on broader sectors. For example, workers may have to move in order to find jobs in other provinces or other sectors. There are also capital investments in other industries. Changes like that will require an adjustment that could take time and, basically, result in productivity rates that are lower than they are at the moment. This is because of the global value chains that have been built during all these years of globalization. Those chains are effective, but if they start to become unravelled, we will once more have production chains that are less productive.
That is why we are saying that, if it happened, the effects would be very negative, but at the moment, it is not possible to say specifically whether it will happen.
NDP
Pierre-Luc Dusseault NDP Sherbrooke, QC
Thank you, Mr. Chair.
Thank you both for being here today.
First, I am going to ask a question that perhaps you were not expecting today.
Some time ago, a number of observers and even economists said that the mandate of the Bank of Canada changed in 1974 and, since that time, it can no longer lend money to the Government of Canada. I would like to give you the opportunity to reply to the questions that have been raised many times in public debate, as to why the Bank of Canada no longer lends money to the Government of Canada. Perhaps that would enlighten all those who have written about the subject.
Senior Deputy Governor, Bank of Canada
There is a difference between what we have the legal right to do and what we prefer to do in practice.
A central bank sets itself apart by virtue of its independence, its well-established target and its requirement to be accountable as a result. The monetary policy framework that we have chosen targets the rate of inflation. That is an understanding that the Bank of Canada has renewed with governments over the last 25 years, and we have just done so once more. That is the best way for the bank to promote a macroeconomic environment that favours investment and a stable economy for households and businesses. If we added direct money loans to the government to that mix, we would change the objectives and the mandate of the central bank. That could result in less clarity about our inflation rates and would, at the end of the day, be detrimental to our financial stability.
NDP
Pierre-Luc Dusseault NDP Sherbrooke, QC
Thank you for that answer.
In your presentation, you said that wages and unit labour costs have grown only slowly.
Do you think that wages are likely to improve in the coming years?
Could you tell us why wages have stagnated in recent years and whether the situation is likely to improve?
Governor, Bank of Canada
There are two factors. First, we went through a period of slow growth, starting in 2008. In that period, there was quite a wide output gap, particularly in the labour market. That is what explains the long period of stagnation.
As well, the price of oil fell. That is the second factor. Just when the economy was growing strongly, we received that second shock, which required a major adjustment to the economy. That is a long process. Specifically, it represents an annual loss of income of $60 billion for the country. An impact like that does not just affect the people in the sectors that are directly involved. It affects almost the entire economy.
For those two reasons, there were downward pressures on the inflation rate and also on wages. We are expecting that the output gap will close again in the first half of next year and that wages will eventually see a little more growth. That is a sign of progress. At the moment, it is clear that growth has not really taken hold. It’s a little uneven. The foundation is not solid. According to our forecasts, however, it will become stronger and more stable.
Liberal
Francesco Sorbara Liberal Vaughan—Woodbridge, ON
Thank you, Mr. Chair.
Welcome, Governor and Senior Deputy Governor. It's always a pleasure.
Reading through the Monetary Policy Report this afternoon, I note two great things. One, obviously, is the stronger than expected growth, as you revised up this year's growth. The other is the output gap closing earlier than expected—although from reading it, I understand there is going to be some remeasurement or re-examination of how we look at and measure output gaps.
One thing I wanted to talk about quickly is exports and business investment, the two points of contribution to GDP that haven't recovered as strongly as we would have expected from an economic crisis or in a cycle. Could you give us some more detail on what the bank looks at in those two areas of contribution to the economy?