Thank you very much, Mr. Chairman.
It's a tremendous pleasure for Paul and me to be here this morning and to meet with you. It really is an honour to be invited, and I hope we can be of some help to you in your examination of the challenges facing the Canadian manufacturing sector.
Members of the committee, as far as I am aware, it's the first time a governor or a senior deputy governor of the bank has actually appeared in front of this committee. Certainly it's the first time for a long time, so I thought it would be appropriate to start with a very brief description of the framework within which the bank conducts monetary policy. I'll then talk about the global forces that are posing challenges for our manufacturing sector and what they imply for the economy as a whole. Finally, Mr. Chairman, I thought it might be useful to share with you some of the evidence we've gathered from Canadian manufacturers about how they are adjusting to the challenges.
Let me start with the first part, then. The Bank of Canada Act calls on us to:
mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada.
That has remained our charge since we were formed in the mid-1930s.
Over time it has become clear that the best way for us to fulfil this mandate is to keep inflation low, stable, and predictable. Specifically, we aim to keep the annual rate of consumer price inflation at 2%, which is the midpoint of a 1% to 3% band.
To meet these objectives, we try to keep the economy operating at its full capacity. By this, I mean that we aim for balance between total demand and total supply in the economy. Simply speaking, if strong demand for Canadian goods and services were pushing the economy as a whole against the limits of its capacity, and if inflation were poised to rise above the target, the Bank of Canada would raise its key policy interest rate. This, in turn, would push up other interest rates and help to cool off demand, thus keeping supply and demand in balance and inflation on target. On the other hand, if the economy as a whole were operating below its production capacity, and inflation were poised to fall below the target, the bank would lower its key policy rate to help stimulate demand.
By maintaining low and stable inflation, monetary policy helps to keep the economy operating at full capacity and promotes greater stability in economic output. This point is crucial in helping the economy adjust to global economic forces. A key element of our monetary policy framework is the floating exchange rate.
Let me be clear: we do not have a target or preferred exchange rate for the Canadian dollar. But it is an important relative price in our economy. In terms of the bank's monetary policy, exchange rate movements give us information about economic developments that may be having a direct impact on demand in the Canadian economy. And the movements themselves have their own effect on demand, by changing relative prices for Canadian goods and services and by shifting demand between domestic and foreign products.
The challenge for the bank is to evaluate these movements, together with other data, and set a course for monetary policy that works to keep demand and supply in balance and inflation on target.
When the Canadian dollar rises or falls, we try to determine how much of that movement is due to changes in world demand for our goods and services, and how much is due to other unrelated factors.
It is important that we understand the causes of exchange rate movements, because the implications for the economy — and the appropriate monetary policy response — depend on the cause of the change. We set out a fairly detailed explanation of this in our January 2005 Monetary Policy Report Update, which is included in your package.
Mr. Chair, that's a very quick look at our framework.
We can come back to any of this in the discussion, but what I want to do is apply that framework to our current situation, because I'm sure the members of the committee are well aware of the global forces affecting not just Canadian manufacturers but our entire economy and indeed the entire world.
In the past few years, we've had an extraordinarily strong global economic growth. There's also been an unusually high amount of liquidity in the global economy, which central banks are now in the process of removing.
Meanwhile, we've seen a persistent and growing current account deficit in the United States, mirrored by large and growing account surpluses elsewhere, especially Asia. These imbalances reflect the financial flows associated with mismatches of savings and investment on a global scale.
We've also seen the emergence of China and India as economic powerhouses. The strong growth of these countries and other emerging markets has led the sharply higher prices for many of the products Canada produces. At the same time, the intense competition from their manufacturers has led to lower prices for many consumer durable and semi-durable goods.
Now all of this taken together has resulted in improvement in our terms of trade and in higher incomes for Canadians in general, but particularly for producers of commodities, metal products, energy products, building materials, and machinery, to name a few.
We've also seen a rapid rise in the external value of the Canadian dollar. This gain will largely, although not entirely, effect a stronger global demand for Canadian goods and services.
Against this backdrop, Canadian manufacturers have been getting more efficient. Indeed, we've seen a tremendous rebound in manufacturing productivity. Output has increased, even while the number of jobs has been reduced.
Now this has been very difficult for many workers in the manufacturing sector who have lost jobs as a result of these changes, and it's difficult for the sector's entrepreneurs and managers. We all recognize this, but we also have to recognize that in part this reflects the fact that many firms are taking advantage of the strong Canadian dollar to invest in machinery and equipment in order to improve productivity.
These productivity gains bode well for the future. Improved efficiency helps improve our international competitiveness and our ability to withstand shocks.
Indeed, we see businesses across the country working hard to adjust to an increasingly competitive environment. We've been tracking this adjustment through our regular communication with business groups, manufacturers, and exporters, as well as through the bank's business outlook survey. You'll find a copy of our most recent business outlook survey in your package.
Our surveys have highlighted three areas that are posing problems for manufacturers: labour shortages, appreciation of the Canadian dollar, and competition from Asia. Let me say a couple of words of introduction about each.
First, our surveys have shown that the key problem for some manufacturers—such as firms in other sectors, by the way—has been a shortage of skilled labour. Despite the difficulty in attracting skilled labourers, our most recent survey shows that hiring intentions remain strong across most parts of the manufacturing sector and across all regions. Many of the workers who will be hired to alleviate labour shortages in expanding sectors of the economy are those who are going to be released from sectors that are growing less rapidly.
Second, since 2003, when the Canadian dollar began to appreciate, we regularly asked businesses how they've been adjusting to that appreciation. Roughly half of the firms surveyed say they've been adversely affected by the rise in the Canadian dollar, and those firms are largely concentrated in the sectors exposed to international trade, including manufacturing.
Finally, many firms we surveyed also said they felt the effects of increased competition from Asia, in addition to significant increases in their input cost, particularly higher energy and metals costs.
In response to these three challenges, many firms have undertaken a profound restructuring of their businesses. Indeed, some 80% of manufacturers we surveyed reported changing their operations. Many are repositioning themselves to specialize in higher value-added production. Many have abandoned at least some of their more labour-intensive mass production in favour of small lots and customized products. Many are improving the quality of the products they make, and others have transformed labour-intensive production offshore but have kept and developed their highly skilled high value-added operations here in Canada.
Members of the committee, let me make one last and very important point. From our discussions and our analysis of the data, it is clear that manufacturing is not a monolithic sector. There is no single strategy that will work for every manufacturer, because every business is unique. Some manufacturers face sector-specific challenges; others face booming demands and have difficulties meeting the demands. But while each business is unique, most of them are working very hard to find ways to adapt to and thrive in these challenging times.
Mr. Chairman, I hope that's been useful to set the scene. We're now looking forward to your questions.
