Finance Committee on May 2nd, 2024

[Tiff Macklem]

I'm not putting any adjectives on. Big, negligible, small, large—I'm just giving you a number. You can decide.

[Julie Dzerowicz, Liberal, Davenport, ON]

No, but unless there is a way to actually further define it for Canadians, it's very hard to understand whether it's big or small.

I'll keep on going, Governor. My next question continues on the price on pollution, which we also call the carbon tax. The Conservatives have also argued that if we eliminate the carbon tax, or the price on pollution, it would bring inflation back within target. It would then lead you to cut rates, in turn easing the pain Canadians may be feeling.

Am I correct in saying that eliminating a price on pollution would not lead to price stability in the economy?

[Tiff Macklem]

It's always a little dangerous getting into things that haven't happened and things that could happen, but in general, if there is a tax change—if the carbon tax were to be eliminated—that would have a one-off drop on the price level. Inflation would drop for one year, and then after that it would go back to where it otherwise would have been.

You know, monetary policy needs to be forward-looking. We know that this a very temporary mechanical effect, so we would tend to look through that. If you want a good example historically, in 1994 the government cut the tax on cigarettes in half. There was a big smuggling problem and they needed to equalize it at the border. That had a big effect on inflation. Inflation was roughly 2% ahead of the tax cut. It went to 0% for a year, and then a year later it went right back up to 2%.

Now, from a monetary policy respect, once the tax cut is announced, you can see the impact on inflation. We know that a year later that will fall out, so effectively we look through that.

[Julie Dzerowicz, Liberal, Davenport, ON]

Okay. Thank you.

[The Chair, Liberal, Peter Fonseca]

Thank you, Ms. Dzerowicz.

We will now move to MP Ste-Marie.

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

Thank you, Mr. Chair.

Mr. Macklem, in your presentation you pointed out that you expect to see the consumer price index, and therefore overall inflation, reach 3% in the first half of the year, 2.5% in the second half and 2% in 2025.

You then talked about the importance of taking core inflation into account in your analyses.

Could the Bank of Canada start reducing its key interest rate before the CPI rate reaches 2%?

[Tiff Macklem]

Yes, and I have often said that.

It always takes a certain amount of time for interest rate changes to affect inflation. That is why we have maintained our predictions about inflation. When we are confident that we are on track to reach the 2% target, it will be time to start reducing the key interest rate. Monetary policy will remain tight, but not as tight as it is now.

We want inflation to stay around 2%. We do not want it to drop below that level. If we hold the key interest rate at 5% until inflation reaches 2%, the latter would probably fall below 2%.

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

That is very clear, thank you.

In your presentation, you said twice that the economy is in excess supply. Is that correct?

[Tiff Macklem]

Yes.

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

If there is excess supply, would that not be a good time to cut the key interest rate?

Don't you think your monetary policy is a bit too cautious?

[Tiff Macklem]

Everyone has their own opinion. In our opinion, the decisions we made were sound and that is why we made them.

We consider various indicators. Yes, the economy is in excess supply on the whole. In the second half of last year, growth was close to zero. So supply has caught up with demand and has even surpassed it now. That is one of the main reasons we are seeing less inflationary pressure.

We expect to see stronger growth this year than last year. Supply and demand will increase at roughly the same rate this year, while the output gap will remain essentially unchanged. Next year, we will see a drop.

Those are the inflation indicators we consider in predicting the direction of inflation. They are not the only ones though. We also consider wages, specifically with regard to productivity. We also consider inflation forecasts and the way businesses set their prices. All of these indicators are pointing in the right direction. Some are changing more quickly than others, but they are all going in the right direction. That gives us good reason to be confident that we are on track.

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

Thank you.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Ste‑Marie.

Mr. Davies, you have the floor.

[Don Davies, NDP, Vancouver Kingsway, BC]

Thank you, Governor.

I want to close off my question on housing.

It appears to be quite clear from the numbers that rental construction has declined since rates started rising. We know that interest rates are higher and that people aren't buying as many homes, but it also affects construction companies' decisions to build.

In your judgment, what has been the impact of higher interest rates on residential rental construction?

[Carolyn Rogers]

Higher interest rates are one of the costs that go into housing construction, so the rate of construction has been lower. There have been a number of incentives introduced to try to build back that construction activity.

Certainly, monetary policy has had an effect on housing starts. We have seen that.

[Don Davies, NDP, Vancouver Kingsway, BC]

Thanks.

I want to turn to unemployment.

In a speech in November 2022 to the Public Policy Forum, Governor, you said that Canada's unemployment rate, which was then 5.1%, was too low. Now it's 6.1%. Is unemployment too low today? What is your unemployment target? How high does unemployment have to go before you think it's too high?

[Tiff Macklem]

Let me first be very clear: We don't have an unemployment target; we have an inflation target. Our mandate is to control inflation.

We look at the labour market, really, through two lenses. The labour market is an important indicator of the degree of excess demand or excess supply in the economy. When I made those comments, the economy was clearly very overheated. The labour market was overheated. There were widespread reports from businesses that they couldn't find the labour they needed. Wage growth was picking up. Those are all signs that the labour market was out of balance.

Since then, the unemployment rate has risen from 5.1% to 6.1%. In practice, we look at a broad range of labour market indicators. On our website, we have this all laid out in quite some detail. You want to look at vacancy rates, the employment rates and the participation rates. You want to look at men, women and youth. When you look at them all together, what you see is a labour market that has certainly moved into better balance.

We're also starting to see wage growth—which has been too high, relative to productivity—start to moderate.

Those are all signs that inflationary pressures should be coming down.

[Don Davies, NDP, Vancouver Kingsway, BC]

You anticipated where I'm going next; I want to talk about productivity.

Deputy Governor, you said, according to a CBC article, that if Canada's recent productivity record is compared with that of other countries, what really sticks out is how much we lag on investment in machinery, equipment and intellectual property.

I've done some research. Spending on machinery and equipment by businesses, and on R and D and innovation, has been falling as a share of GDP in Canada for many years, dating back to the beginning of this century, after the corporate tax cuts that Paul Martin introduced. It's kind of ironic, because those corporate tax cuts were supposed to spur more business investment, not less. Even though we have rapid job creation and population growth, business capital investment has not kept up.

The C.D. Howe Institute did a comparison of the U.S. and Canada. In 2014, investment per worker in the U.S. was $20,700. It was $14,400 in Canada. In 2023, the U.S. has gone up to $27,800. We're at $14,500. We've gone up $100 in 10 years.

Could you outline what strategies could be more effective in increasing capital investment in Canada, given that the entrenched trickle-down theories, like tax cuts for corporations and the wealthy, clearly haven't worked as intended?

[The Chair, Liberal, Peter Fonseca]

MP Davies, that's a great question, but I need a super-short answer. We're well over the time, but there may be more opportunity in the final round to follow up on that. If you want a condensed, 20-second—

[Carolyn Rogers]

I can be quick.

You've outlined the problem very well. You've been clear that it has stretched over time, that it has stretched over different tax regimes. That tells us that there isn't a single, clear solution. There isn't a magic measure that's going to fix this. It's going to take more than one thing.

We're not tax experts. We're not even productivity experts.

I'll leave it there, Mr. Chair. I'm sure we'll come back to it.

[The Chair, Liberal, Peter Fonseca]

I'm sure you'll be able to elaborate in the next round, but we're going to MP Morantz now for five minutes.

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

Thank you, Mr. Chair.

Governor, it's always a pleasure to see you.

I'm going to ask you a pretty straightforward question. If inflation today was 2.1% or 2.2% instead of 2.8% or 2.9%, would that make your job easier in terms of a decision to reduce the policy rate?

[Tiff Macklem]

If we thought it was going to be sustained at that level, absolutely, yes, it would.

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

Earlier in this meeting you testified that the incremental increase in the carbon tax from $65 to $80 represented 0.1% of inflation and that if it hadn't happened, inflation would be 2.8%.

Is that correct?

[Tiff Macklem]

That's correct.