Finance Committee on April 27th, 2021

[The Chair, Liberal, Wayne Easter]

Thank you.

Mr. Julian, you can have one fairly quick question, so that we get a couple of others in.

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

Thanks, Mr. Chair.

Governor Macklem, at the beginning of this pandemic we asked OSFI to give us an accounting of the overall level of the liquidity supports provided to Canada's big banks. They stated at the beginning of the pandemic—this was in days of the pandemic hitting—that it was $750 billion, which is an astronomical amount, of course.

You have stated that the programs that were providing support have been wrapped up. Can you give us a figure of the overall level of liquidity supports given by the Bank of Canada to the banking sector through this pandemic?

[Tiff Macklem]

As I indicated, there were 11 programs in all that provided extraordinary liquidity support. Ten of those 11 programs have been wound down or we've announced that they will be terminated. The last ones end in May.

In terms of the overall support, there are 10 programs. They each have different supports at different timings. It's hard to give you one number to summarize all of this, but the committee has requested a report on the liquidities and you will be getting that shortly. You'll have all the numbers on all those programs.

[The Chair, Liberal, Wayne Easter]

Mr. Kelly, you can have a fairly quick question, followed by Mr. Fragiskatos with a fairly quick question.

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

Your testimony today has confirmed something that was offered to the committee from an expert witness a while ago, which I think was then speculative. He said, “Both the Fed and the Bank of Canada will tolerate whatever inflation occurs in 2021 as both transitory and salutary” and that inflation would increase to 3% and likely go a little higher than that.

If I understood you correctly, you said that you do expect to hit that outward bound at 3%, come back down to 2%, come up a little bit more and then come back down. It sounds like fairly precise targeting.

I have maybe a two-part question. How much inflation will you tolerate in 2021 and 2022 and keep interest rates where they are?

On which factors does this fairly precise guess about this up and down between 2% and 3% rely?

[Tiff Macklem]

First of all, I want to thank you for highlighting that there is uncertainty around these forecasts. They are forecasts. We do our analysis and we're transparent with Canadians, but there are risks on both sides of these.

I'll remind you that our band is 1% to 3%. We actually had inflation that was well below the band. At this time last year it was negative, actually, for a few months. It has been around the lower end of the band for quite a few months—around 1%. We do think it will go up temporarily, as I indicated, to 3%, due to a number of technical factors, before coming back down.

One of the reasons we put out a forecast and we are so transparent is so that the market and Canadians can see if things are evolving the way we think they're going to evolve. If inflation starts to go higher than we thought, and particularly if that turns out not to be temporary and it turns out to be more durable, it would suggest that the economy is tighter than we thought and that there is not as much excess capacity. We would start to reassess our evaluations.

You can't just look, though, at what inflation is doing. You have to see why it is doing that. When there are temporary technical factors, as your expert witness suggested, we will look through those. Monetary policy takes time to work. It doesn't make sense to overreact to temporary factors that are going to work their way out.

If we saw that inflation was sustainably higher than our forecast and sustainably higher than our target, yes, we would react. We have the tools and we know how to control inflation.

[The Chair, Liberal, Wayne Easter]

Thank you.

This is the last question, Peter. Be fairly snappy, if you could.

[Peter Fragiskatos, Liberal, London North Centre, ON]

Thank you, Chair.

Governor, thank you for being here. You shared with the committee in your remarks that you and the bank are foreseeing very robust economic growth in the year to come.

What are some key sources of potential risk, things that could stand in the way of that, things you worry about?

I know it's hard to predict that, but sources of risk are important.

[Tiff Macklem]

I couldn't agree more, and as I said previously, there is a lot of uncertainty.

As I highlighted in a previous answer, the biggest uncertainty is the course of the pandemic itself. We're assuming this is a very nasty third wave. We are not through it yet. In our base-case projection, we have restrictions being lifted toward the end of May through June. If that gets extended, if there are new variants, if there are problems with vaccines, those will all have consequences for our economic outlook.

Beyond the pandemic itself, there are a number of uncertainties. I highlighted, in a previous answer, that the U.S. economy is doing well. We expect we will get some positive spillover effects from that. That will boost our exports, but there are risks to our exports. To be frank, we've been disappointed in the past.

Certainly, if the Canadian dollar were to be materially stronger, that could undermine the competitiveness of our exports and create a new headwind for our exports. There are also some risks with respect to protectionism. The U.S. has a buy America program. Hopefully, Canada and the U.S. can sit down and work this out, so that we can have an integrated North American market, but if there were new protectionist measures that limited our access to the U.S. market, for example, that would also dampen our exports.

To date, corporate bankruptcies have actually been quite low. That has a lot to do with the various supports that have been provided, but there's no question that there are many companies just hanging on. It gets back a bit to my earlier risk with respect to the pandemic. The sooner we can get through this and we can gradually reopen the economy in a safe way, those businesses can restart, but if that gets delayed, there are risks that bankruptcies could increase.

There are a number of upsides, as I mentioned. There are a lot of accumulated savings. That creates some upside risks. The U.S. economy is strong, but there are downside risks, and we're certainly weighing both of those. We will be assessing how those evolve going forward. I look forward to coming back to the committee and updating you.

[The Chair, Liberal, Wayne Easter]

Thank you very much, Governor. That last question shows what we appreciate about your leadership and the bank's leadership, and that is your frankness. We appreciate that very much, and we do thank you for the leadership of the Bank of Canada and for answering our questions today.

We hope that the next time you appear before this committee, this pandemic will be behind us. We all want to see that, regardless of what political differences there might be.

Thank you for appearing today.

We will have to suspend and go to our next witness.

[Tiff Macklem]

Thank you for having me. Good afternoon.

[The Chair, Liberal, Wayne Easter]

The meeting is suspended for about one or two minutes.

[The Chair, Liberal, Wayne Easter]

We will reconvene the meeting, and call the meeting to order.

On this panel, we are looking at the economic and fiscal outlook.

From the Office of the Parliamentary Budget Officer, we have the Parliamentary Budget Officer, Yves Giroux; director of fiscal analysis, Trevor Shaw; and senior director, economic and fiscal analysis, Chris Matier.

Welcome, Mr. Giroux, I assume you have a few opening comments. I read them earlier, in fact.

The first one up on the question round will be Mr. Fast, followed by Mr. Fragiskatos, shared with Mr. McLeod.

Mr. Giroux, the floor is yours.

[Yves Giroux, Parliamentary Budget Officer, Office of the Parliamentary Budget Officer]

Thank you, Mr. Chair.

Good afternoon, Mr. Chair and members of the committee.

Thank you for the invitation to appear before you today to discuss Canada's economic and fiscal outlook. I am also pleased to highlight some key issues arising from budget 2021, tabled on April 19.

I am joined today by Chris Matier and Trevor Shaw, who will help respond to your questions.

We released our pre-budget outlook on March 31. Our outlook showed a significant improvement in the economy owing to the earlier-than-expected arrival and administration of effective vaccines, higher commodity prices and a stronger U.S. recovery.

While the more recent surge in new COVID-19 infections presents a near-term risk, the resilience and adaptability that the Canadian economy exhibited during the second wave—combined with increased vaccination—should limit the economic impact of the third wave. Nevertheless, we will continue to closely monitor developments.

Our outlook, of course, did not include the new measures that were announced in last week's budget. Nor did it include the up to $100 billion in stimulus spending earmarked in the government's fall economic statement.

Our outlook showed the level of nominal GDP and budgetary revenue returning to their pre-pandemic paths over the medium term. On a status quo basis, we projected the budget deficit to hit 16.5% of GDP, or $363 billion, in 2020-21 and then decline to 0.7% of GDP over the medium term. The federal debt-to-GDP ratio was projected to peak at 49.8% of GDP before gradually declining over the medium term to 45.8% of GDP.

As noted in our report, uncertainty surrounding the outlook remains high. That said, setting aside the government's earmarked stimulus and budget 2021 measures, we judged that risks to our economic and fiscal projections were roughly balanced.

I will now turn to budget 2021.

Key issues in budget 2021, from our perspective, are, first, the fiscal guardrails. In our December report we judged that the $70 billion to $100 billion earmarked in stimulus spending could be miscalibrated if the focus was solely on returning selected labour market indicators to pre-pandemic benchmarks.

Given the improved labour market outlook, our pre-budget report reiterated this assessment. Based on our projection of the guardrail indicators, the government identified in its fall statement, almost all of the ground lost in the labour market due to the pandemic will be made up by the end of 2021-22. To be clear, we're not referring to temporary COVID-19 measures, but rather, as the fall statement indicated, to targeted stimulus to jump-start the economy. Moreover, measurers could be fully justified based on policy objectives other than providing economic stimulus.

In budget 2021 the revision to the private sector economic outlook and fiscal developments provides $109 billion in terms of new fiscal room over six years; that is, before any new measures were introduced, the budget deficit would be over $100 billion lower on a cumulative basis than forecasted in the fall statement.

This new fiscal room is used to finance over three-quarters of the $143 billion in measures detailed in budget 2021. While the budget refers to all these measures as “investments”, $37 billion is tied to COVID-19 spending. Up to $69 billion over the next three fiscal years could be construed as stimulus spending.

Budget 2021 also estimates the economic impact of $126 billion in recovery plan measures over the next three fiscal years. These estimates, however, likely overstate the impact of stimulus spending on the economic outlook presented in budget 2021.

The impact of $25 billion in measures from the fall statement should already be reflected in the March 2021 private sector survey. The recovery plan also includes $32 billion in additional COVID-19 supports, which are not, per se, stimulus measures. Moreover, some of the remaining measures were anticipated by economists and would also be included in their forecasts as the government had clearly signalled its intention to spend $70 billion to $100 billion in the fall statement.

We will be providing our own estimate of the economic impacts of the $69 billion in budget 2021 stimulus spending in a future report.

Finally, concerning the fiscal anchor, budget 2021 sets out a fiscal anchor, which is reducing federal debt as a share of the economy over the medium term and unwinding COVID-19-related deficits.

Over the medium-term horizon, the government projects the federal debt ratio to decline marginally to 49.2% of GDP from a peak of 51.2%, and remain well above its pre-pandemic level of 32.1% of GDP. Long-term projections presented in the budget also show the federal debt ratio remaining above its pre-pandemic level through 2055.

This suggests that the government has decided to effectively stabilize the federal debt ratio at a higher level, potentially exhausting its fiscal room over the medium and long term. This means that any substantial new permanent spending would either lead to an increasing debt-to-GDP ratio, or have to be financed through higher revenues or spending reductions in other areas.

With that, we'll be pleased to respond to your questions.

[The Chair, Liberal, Wayne Easter]

Thank you very much, Mr. Giroux.

We were a little late starting so I'm going to hold the subcommittee on agenda and procedure report until the next meeting, because we do have a hard stop at six o'clock, Ottawa time.

We'll go to the six-minute round, started by Mr. Fast, followed by Mr. Fragiskatos.

Ed.

[Ed Fast, Conservative, Abbotsford, BC]

Thank you very much, Mr. Giroux. It's good to see you at committee.

There are some who have suggested that we shouldn't get our knickers in a knot about the size of the debt because debt servicing costs are so low. However, there are some fears that the Bank of Canada rate may rise earlier than expected, perhaps some time in 2022.

Can you speak to the risk of rising interest rates, and has your office modelled what each 1% increase in rates would mean for the debt that the federal government has incurred over the last six years?

[Yves Giroux]

Yes, I have heard that very often, that it's not a concern to be had about the increasing level of debt because the current debt servicing costs are very low, which is true. However, that's taking the point of view that because the cost to service that debt is low now, the debt that will have to be supported by the government over the next decades does not matter as much as it used to, which is taking the point of view, I assume, that interest rates will never rise.

We have done calculations and what we call “sensitivity analysis” and the cost of a 100 basis points shock to interest rates—so a one percentage point increase in interest rates—has an impact in the first year on public debt charges of increasing them by $4.5 billion. That rises as the debt needs to be refinanced. By year five, the additional debt servicing cost amounts to $12.8 billion per year. That's when interest rates rise by one percentage point.

[Ed Fast, Conservative, Abbotsford, BC]

Do you see this as being a significant risk to the sustainability of the budgetary deficits that the government is running?

[Yves Giroux]

It is indeed a risk, and we saw that in the government's budget.

The government's budget assumes slightly higher interest rates than we have assumed, and that has led the interest cost of the government to increase by about $17 billion over a five-year horizon, compared with our own outlook for the same period. Just because the government forecasts slightly higher interest rates than we at the PBO have done, that leads to $17.7 billion, I think, over five years, in additional debt servicing costs. That's the same medium-term perspective.

For example, due to an international financial crisis, for example, or just rising interest rates because the economy is picking up speed, that could lead to additional spending on debt servicing costs alone.

[Ed Fast, Conservative, Abbotsford, BC]

Thank you.

To be very clear, you have said that the $100 billion-plus of federal stimulus that was supposedly spent in this budget, that there's a good chunk of this that was not stimulus. Is that correct?

[Yves Giroux]

Yes, indeed.

Some of it is support measures for COVID-19, so it's not stimulus per se. When we heard the Minister of Finance in the fall economic statement, it was to be $70 billion to $100 billion additional to kick-start the economy. That was understood, at least by me, to be distinct from COVID-19 support measures. However, the measures that were announced in last week's budget....

What the government has quoted as $101 billion in economic stimulus also includes COVID-19 support measures, an extension of previously announced measures for the most part.

[Ed Fast, Conservative, Abbotsford, BC]

I had the same understanding as you did—that the stimulus spending wouldn't include those emergency measures—but, in fact, that was all included in that $100 billion.

Let me ask you something. One of the finance officials on budget day suggested that all government spending is stimulus. Do you agree with that assessment?

[Yves Giroux]

I would say that most government spending leads to increased economic activity. It's a matter of magnitude as to what the different impacts are of different government investments or spending. For example, if you're sending money or providing income support to individuals, it has a different economic impact than if you are providing economic supports that are then spent on imports.

You could say that all government spending leads to some level of economic activity; however, it's to varying degrees.

[Ed Fast, Conservative, Abbotsford, BC]

Could you comment again about the rigour of the fiscal anchor that the minister chose in her budget?

We're really not talking about much below 50% debt-to-GDP over the next five years. Is there anything in the budget that would signal that there's a plan to return to balance at some point in the future?

[Yves Giroux]

I haven't seen any indication to that effect in the budget.

We have seen the fiscal forecast until 2025-26. Even over that horizon, the government shows a decreasing deficit, but it's still a deficit of about 1% of GDP, if my memory serves me correctly. This would lead to a debt-to-GDP ratio that is barely decreasing from the peak that it's supposed to reach in the next year.