Finance Committee on Feb. 1st, 2024

[Julie Dzerowicz, Liberal, Davenport, ON]

Thank you so much.

[The Chair, Liberal, Peter Fonseca]

Thank you, MP Dzerowicz.

MP Ste-Marie.

[Gabriel Ste-Marie, Bloc, Joliette, QC]

Thank you.

I'll ask my two questions together, since we have two and a half minutes of speaking time.

Mr. Macklem, in your opening remarks, you spoke about the resilience of supply chains. I would now like to hear your opinion and analysis regarding the incidents in the Red Sea involving commercial ships and the drought in Panama, which is limiting the number of passages through the canal. How will this affect potential inflation in Canada, and how is the Bank of Canada taking this into account?

In your report, you said that the risk premium associated with the price of oil has fallen, since the market considers it less likely that the war in Israel and Gaza will negatively affect global oil supply. I would like more information on this matter.

[Tiff Macklem]

At the end of our monetary policy report, we pointed out that certain risks surround our forecasts. Some of these risks are upward, while others are downward. The upward risks certainly include the war between Israel and Hamas, the attacks on ships in the Red Sea and the lower water levels in the Panama Canal.

So far, we haven't seen a major impact from these incidents. However, if they continue and escalate, and if other countries start to take part in the war, the price of oil could rise sharply. This would have a quick and direct impact on inflation. Transportation costs will also be affected. If there are further issues with supply chains in the Red Sea or the Panama Canal, transportation costs could rise. This could affect the price of a number of goods. There is indeed a risk. So far, we haven't seen much.

Regarding the second part of your question, since the start of the conflict in Israel and Gaza, the price of oil has fallen by around $10. It has remained fairly stable in recent weeks. When we revised our forecasts, our hypothetical oil price was $10 lower than our October forecasts. This factor lowers inflation somewhat in our forecasts.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Ste‑Marie.

MP Blaikie.

[Daniel Blaikie, NDP, Elmwood—Transcona, MB]

Thank you very much.

I know that in an earlier comment you were saying that you would like to be in a position to bring down interest rates. Again, I think that a potential lowering at some point on the horizon raises a question. I know the bank has an inflation target, but is there something that you consider to be an ideal interest rate?

As you think about this moving forward, we know that there are a lot of reasons why we've experienced inflation. Some of them are under government's control; others aren't. We know that difficult economic times are possible, if not likely, in the years and decades to come.

One of the tools the bank is sometimes using in times of slower economic activity has been to reduce rates in order to stimulate economic activity. At what point do you get concerned that it's not a tool in the tool box if interest rates are too low? Do you have an idea of where you want to land in terms of an interest rate in the short or the medium term?

[Tiff Macklem]

I'm not sure I fully understood your question, so you'll have to stop me if I didn't.

Look, we don't have a target for the interest rate. We have a target for inflation. The ideal interest rate is the one that gets us to 2% inflation. What that's going to be, though.... Because the interest rate is the instrument, what interest rate is going to get us to low, stable inflation is going to depend on what happens in the economy.

We do very much worry about the risks on both sides. Inflation has been too high. We've taken forceful action. We've raised our interest rates. We are committed to getting inflation all the way back to 2%. We want to make sure that we do enough. We don't want to drop rates prematurely, realize that we're not going to get back to 2% inflation, and then have to raise them again in the future. On the other hand, we don't want to leave them high for so long that the economy cools a lot more than it needs to. In that case, inflation would probably fall below our target.

It is a difficult judgment. We spend a lot of our time discussing whether we are doing too much or too little, or how much more we have to do. That is really the centre of our deliberations.

[Daniel Blaikie, NDP, Elmwood—Transcona, MB]

If I'm hearing your answer right, does that mean the bank wouldn't really consider a lowering of the interest rate until you feel there is a risk of deflationary pressure? If inflation returns to target and is forecast to be on target for the foreseeable future, would you entertain a lowering of the interest rate? Does that begin to take into consideration factors outside of the simple rate of inflation?

[Tiff Macklem]

As inflation moves towards the target, we shouldn't need interest rates to be as restrictive as they are, because they will have done their work and we're getting there.

In terms of how we think about it, as I've stressed a number of times, there are lags in the effects of monetary policy. What we do now affects the economy over the next year and a half. We don't want to wait until inflation is all the way back to 2% before we start cutting interest rates, because if we did that, we would overshoot. We'd go below 2% inflation. We'd cool the economy more than we have to.

Yes, you do want to start lowering interest rates before you're all the way back, but you don't want to lower them until you're convinced and you're assured that you're really on a path to get there. That's where we are right now. We're looking for that assurance. It's working. We don't think we need to raise rates further, but we need to let it work until we see that assurance.

[The Chair, Liberal, Peter Fonseca]

Thank you, Governor.

Thank you, MP Blaikie.

MP Morantz, go ahead, please.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Thank you, Mr. Chair.

Thank you, Governor and Deputy Governor. We always appreciate your being here and how transparent the bank is with Canadians during these difficult times.

I went back and had a look at the January 2023 monetary policy report. In there, you said, “CPI inflation is forecast to decline...and to reach the 2% target in 2024”. Today, you're saying that's not the case.

I'm wondering if I could get your thoughts on why that projection changed over the last year and also tie it in with this idea of government spending being at the upper bound, because just three months after that monetary policy report, the government tabled a budget that had $63 billion in additional spending, and then in the fall economic statement another $20 billion. I'd like your thoughts on whether those budgets interfered with the projection you made in January 2023.

[Tiff Macklem]

There are a couple of points. If you go back to the start of last year, we were forecasting that inflation would be around 3% last summer and then from there, it would gradually go back down. On the first part, actually, that projection proved to be pretty accurate. Inflation was 2.8% in June.

What's happened since then? It's a combination of a lot of things. The first thing is that oil prices went back up. That was the main factor that put inflation from 2.8% back up to 4%. The second thing we've seen is that there has been more persistence in core, underlying inflation. Core inflation has been running at around 3.5% for six months to a year now—

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Because I have such limited time.... I apologize, Governor.

To be more specific, was the increased government spending in the budget and the fall economic statement last year a factor in inflation not meeting the projection you set?

[Tiff Macklem]

If you look at government spending at all levels in 2023, it roughly grew at about 2%. It's not helping to relieve inflationary pressures, but it's growing roughly in line with the economy's potential population growth. It's not adding new ones.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

That's fair enough.

During the press conference last week, you said government spending is at the upper bound of what's manageable. You said, “If governments were to add more spending on top of what they already planned...it certainly could start getting in the way”.

You stand by that statement today, I presume.

[Tiff Macklem]

Yes.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

The government is going to table a budget in a couple of months. If you see large spending increases, will that make your job more difficult?

[Tiff Macklem]

If there are large spending increases, yes, that could start to get in the way of getting inflation back down to target in the timeline we've laid out. Not all spending has the same effects on inflation, so we'd have to look at exactly what the spending is. Spending that really stimulates demand at a time when we're trying to let supply catch up with demand and relieve inflationary pressures would be particularly problematic.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

I want to ask you the corollary of that. Let's say some miracle happened and this government decided to become fiscally responsible, brought in a plan to bring the budget back into balance and actually got its spending under control in the upcoming budget so that, in fact, spending increases were not in the upper bound, but maybe in the middle bound or the lower bound, as you might define that.

Would that make your job easier?

[Tiff Macklem]

If government spending turns out to be slower than we expected, yes, there will be fewer demand pressures from the government. That means the economy growth will probably be lower, the unemployment rate will be a bit higher and inflation will come down a bit sooner.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Those are my questions, Mr. Chair.

[The Chair, Liberal, Peter Fonseca]

Thank you, MP Morantz.

Now we're going to hear from MP Thompson, please.

[Joanne Thompson, Liberal, St. John's East, NL]

Thank you.

Thank you for being here today.

I wanted to ask a question on climate change. I come from the east coast. Clearly, sea levels, rising temperatures and extreme weather events are very significant in my area of the country, and we've certainly seen that across the country.

When we speak about the increased costs for Canadians, like food and shelter, do we not also need to include the impact of climate change? One example of that is carbon pricing, which is really intended to help combat our net emissions and bring us to the intended targets.

An analysis from Stats Canada published last November linked droughts, heat waves, flooding and heavy rainfall to increased food prices for meat, fruit, vegetables, sugar and coffee. In June, an economist from RBC reported that while food price inflation was expected to slow, a return to prepandemic levels was unlikely due to extreme weather events. There was the link between weather and food costs, given that extreme weather events are predicted to be more frequent.

Are the costs of climate change included in your analysis of risks to the inflation outlook?

[Tiff Macklem]

It's a difficult question to answer.

Let me back up to the first part. I would agree—we're already seeing it—that the more climate events we have.... One of the places where those will show up most directly is in food prices. We've seen more volatility in food prices and more variability in harvest depending on what the weather is in different parts of the world. That is causing more volatility in food prices. That's probably not going away.

We do not have climate effects built into our main models at the moment. We have done some work. The senior deputy governor is closer to this, looking at the potential financial stability implications of climate change if there is a big repricing of assets and how that would affect the financial system.

We are now starting to work on building climate change into our main macro models so we can start to evaluate those types of questions. I have to say, this is a large undertaking. We are putting our heads together with other major central banks on how to do this. In a world where there is potential for more supply disruption, this is something we'll need to understand.

Monetary policy has neither the mandate nor the tools to address climate change, but this is going to be a major force in the economy, so we're going to have to understand what that means for the economy and for inflation.

[Joanne Thompson, Liberal, St. John's East, NL]

Thank you.

I want to go back to an earlier question on the soft landing. Do you feel that the actions you've taken at the Bank of Canada on the economy have led to a soft landing and avoided a recession?