Finance Committee on May 2nd, 2024

[Tiff Macklem]

With respect to the guardrails, this—

[The Chair, Liberal, Peter Fonseca]

We may have to go to the guardrails later, Governor. We're well over time.

[Tiff Macklem]

Okay. I'm sure there will be more questions on fiscal policy.

[The Chair, Liberal, Peter Fonseca]

Who knows? MP Ste-Marie may be asking about guardrails.

MP Ste-Marie, the floor is yours.

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

Thank you, Mr. Chair.

Hello, Ms. Rogers and Mr. Macklem. Thank you for being here.

I'm sorry, but our committee chair is very strict and does an excellent job managing our time.

I have some questions about the latest budget, but before we continue on that topic, I have a question for you.

You are often quoted by this committee for your analyses of the impact of the carbon tax on inflation. When you appeared before the committee on that topic last fall, you gave the example of Ontario. If possible, could you please provide the committee with the results of your calculations, for each province, regarding the impact of the carbon tax on inflation?

[Tiff Macklem]

We can certainly provide that information.

As you know, the various provinces have different policies and approaches to the carbon tax. In estimating the impact of that tax on inflation, we look exclusively at the three elements with the most direct impacts in each province. We then collate all of that data to arrive at an estimate for the country as a whole.

We can certainly provide the committee with our calculations for each province if you wish.

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

Thank you very much. That information will be very useful.

I want to get back to the budget now.

From your answers to Mr. Baker's questions, I understand that the in-depth analysis of the impact of the federal budget on your monetary policy as a whole will be completed in July, but at first glance it seems the impact will be relatively neutral or similar to that of the fall economic statement, given that the deficit is offset by new revenues and that will be sustained. Is that correct?

[Tiff Macklem]

Yes.

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

Later on, we will be voting on the ways and means motion in the House. We have started examining it, and the announced increase in the capital gains tax is not included. The day before yesterday, the Minister of Finance said that will be the subject of a separate bill.

If that increase is not presented, we can expect the budget to fuel inflation. Is that correct?

[Tiff Macklem]

It's a bit hypothetical.

That being said, if we remove a source of revenue, so the deficit will be larger and that will have a stimulative effect.

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

Thank you.

I would like to move on to something else now.

I would like you to talk to us briefly about the importance of the Bank of Canada's independence in managing its policy, specifically in inflationary times.

We have seen the decision from the U.S. Federal Reserve. Analysts are saying though that Joe Biden is hoping to see interest rates drop before the end of the presidential campaign to increase his support in the polls.

Do you feel the same kind of pressure here? Various columnists are considering the possibility that the current Prime Minister might step down, that there could be a leadership race and that economic conditions might improve, specifically as a result of lower interest rates, perhaps by the summer. Do you feel that kind of pressure in your decisions?

I want to stress the importance of independent monetary policy.

[Tiff Macklem]

First, the answer is no. There is a good reason for having a central bank that is independent from the government: It is precisely to avoid that kind of situation.

Monetary policy does not have immediate effects in a fiscal cycle. It takes time and it is important to stay the course. That is precisely why big countries have an independent central bank.

So no, there is no pressure. I was very clear about that yesterday: Elections are elections, and monetary policy is monetary policy. Our mandate is clear and monetary policy will be managed to fulfill that mandate, period.

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

Thank you for that information.

I would like to pick up on some of the conversation you had at the Senate committee with my colleague Clément Gignac. Although he is a senator, I can certainly see that he has other qualities. He pointed out that, up until the pandemic, your monetary policy and that of the U.S. Federal Reserve were pretty much in sync, but since the pandemic, we have seen a growing gap between the Canadian economy and the U.S. economy in terms of core inflation indicators.

Please tell us again about the possibility of having a monetary policy that differs from that of the U.S. Federal Reserve and explain how you take account of interest rate variations in that analysis.

[Tiff Macklem]

To begin, let me point out that our mandate and that of the U.S. Federal Reserve are similar, as are the two countries' economic situations. First and foremost, we experienced similar shocks during the pandemic. Monetary policy in the two countries was similar, but not exactly the same. As I said, the inflation rate was a bit higher in the United States, and their federal funds rate was a bit higher than the key interest rate in Canada. Broadly speaking though, it was quite similar.

More differences have emerged in recent months. As I told the Senate committee yesterday, it seems that monetary policy has more traction in Canada, and there are a few reasons for that.

First, it is probably because our mortgage market does not have the same structure as the American one. In the U.S., mortgages are typically for a 30-year term, while here mortgages are renewed every five years and sometimes even more often. More people in Canada have already renewed their mortgages, and those who have not done so will do so soon. Consumers know that their mortgage will have to be renewed, and they are probably saving more money for that.

Secondly, household debt is higher in Canada. So an interest rate hike has a greater impact on Canadian households, and that is reflected in GDP growth: Our GDP growth is weaker than that in the United States.

So it is not surprising that inflationary pressures are weaker in Canada. If the dynamics of our economies, and particularly the dynamics of inflation, differ between the two countries, so will our monetary policies.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Ste‑Marie.

Now we'll go to MP Davies, please.

[Don Davies, NDP, Vancouver Kingsway, BC]

Thank you, Mr. Chair.

Thank you, Governor and Deputy Governor, for being with us today.

Governor, in its most recent deliberations, the Bank of Canada's governing council listed corporate pricing behaviour as one of four key indicators of underlying inflationary pressures. In November 2023, in an article by the CBC, you were quoted as saying:

When input prices have gone up...those are getting passed through much more quickly to final goods prices. So households are bearing the full inflationary impact much more: that's what we can see pretty clearly in the data.

In your view, Governor, why have increases in input prices been passed through to final goods prices more quickly in recent years than in previous decades?

[Tiff Macklem]

We've actually been doing quite a bit of work on this. Perhaps the senior deputy governor would like to comment on that.

[Carolyn Rogers, Senior Deputy Governor, Bank of Canada]

Sure. In fact, in our most recent monetary report, there is a box that goes into this in a fair bit of detail.

Directly to your question, I think the reason we saw companies were quicker and more inclined to pass through costs is that demand was high, so they were able to pass costs through and it wasn't affecting their sales. People were still paying.

When inflation is high, that is one of the dynamics we watch very closely. As inflation is coming down, demand is coming down and is more in balance with supply, and companies think carefully about whether they can pass through their cost increases.

[Don Davies, NDP, Vancouver Kingsway, BC]

Thank you.

In a February 2024 report, James Orlando, director and senior economist at TD Economics, said:

The Bank of Canada’s inflation problem is mostly a housing issue. With shelter inflation accounting for more than half of overall inflation, this has become the biggest hurdle preventing the BoC from cutting rates.

Governor Macklem, do you agree with that assessment?

[Tiff Macklem]

I would agree that housing cost inflation is the biggest contributor to overall inflation, and it is an important factor that is holding inflation up.

[Don Davies, NDP, Vancouver Kingsway, BC]

On that point, Stats Canada says year-over-year inflation in March, excluding mortgage interest, was 2%. That's exactly the bank's target. Higher mortgage interest has added close to one full percentage point to CPI inflation since last May.

Is there something counterproductive in the Bank of Canada trying to reduce inflation by using a policy tool that is increasing inflation by close to a full percentage point?

[Tiff Macklem]

If we hadn't raised interest rates, inflation and everything else would be higher, and overall inflation would be higher. We are well aware that when we raise interest rates, this increases the cost of borrowing. That is impacting Canadians. In fact, that's how monetary policy works. It restrains spending to get inflation and everything else down.

The CPI includes mortgage interest costs. That is a major cost for households, so it should be in there. We're well aware that's the part of the CPI that we have the most direct effect on. When we raise rates, mortgage costs go up. Everything else being equal, that pushes inflation higher. In the conduct of monetary policy, we also know that when we reduce our policy interest rate, inflation will come down. That is something we can look through as we conduct monetary policy.

You'll notice we've talked a lot about how we're very focused on core inflation. One of the reasons for that is CPI-trim, which trims out the things that are going up the most and the things that are going down the most. It has systematically been kicking out or removing mortgage interest costs because they are up a lot. By focusing on core, we're effectively looking through the impact of mortgage interest costs on inflation.

The other thing I would say about our measures of core inflation, though, is that our two measures of core—one is 3.1 and one is 2.8—are still well above two. What that's telling you is that yes, if you just pull out the thing that's going up a lot, mortgage interest costs, what's left is going up much more slowly, roughly 2%. If you systematically take out the things that are going up and the things that are going down a lot, you're still well above 2%. That's what we're focused on: getting that down.

[Don Davies, NDP, Vancouver Kingsway, BC]

I wanted to raise some unintended consequences.

We know that high interest rates have prevented many Canadians from purchasing a property. Obviously, if mortgage rates are high, not as many people buy. People are telling me that this is keeping people in the rental market.

Would that demand for rental properties have anything at all to do with the rapid rise in rents?

[Tiff Macklem]

Yes.

There's a lot of pressure on rents. I would agree that there probably is some effect. With higher interest rates, people are delaying buying a house and they need to rent for longer.

I think the bigger effect, though, is that we have had a tight rental market combined with a big surge in immigration. Many of those immigrants are entering the rental market. We've seen a big increase particularly in non-permanent residents. That is putting a lot of additional pressure on the rental market. Rent inflation is around 8%.

[Don Davies, NDP, Vancouver Kingsway, BC]

Yes.

I think CMHC is clear in saying that supply is not forecast to keep up with demand, leading to higher rents and lower vacancy rates in the coming years. Would you agree with that assessment?