Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 9 - Evidence

The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:00 a.m. to examine the present state of the domestic and international financial system.

Senator E. Leo Kolber (Chairman) in the Chair.

[English]

The Chairman: Senators, our witness today is the Governor of the Bank of Canada, Mr. Gordon Thiessen. We have been fortunate over several years to have had the governor accept our invitations to appear before the Standing Senate Committee on Banking, Trade and Commerce. Our meetings have always been useful and informative. As this is the governor's first appearance since I became chairman, I would like to extend my appreciation for his cooperation over the years and my thanks for his agreeing to appear today.

Mr. Thiessen was appointed the Governor of the Bank of Canada on February 1, 1994. I am informed he was born in a wonderful place called South Porcupine, Ontario, and grew up in a number of different towns in Saskatchewan. After graduating from high school, he worked for a chartered bank and studied economics at the University of Saskatchewan. He received his Honours B.A. in 1960 and M.A. in 1961 and then lectured in economics at that university. Following that, he attended the London School of Economics and received his Ph.D. in economics in 1972. He joined the Bank of Canada in 1963 and has been a member of the board of directors of the bank and of its executive committee since his appointment as senior deputy governor in 1987.

Before we commence, I should like to set out some of the ground rules that we have tried to follow in the past and that I hope we will follow today. I will ask the governor to make a short opening statement. I will then take questions from members of the committee. I ask members to keep their questions concise so as to allow the governor to deal with as many as possible. In the first round, I will allow approximately 10 minutes per senator for questions and answers. If there are more questions, we will go to a short second round. We will follow a speaker's list, and I ask for the cooperation of senators in not jumping the queue by asking so-called supplementary questions that are really new questions. Finally, time permitting, I will take questions from non-members of the committee.

I will now turn the floor over to Governor Thiessen. Welcome, sir.

Mr. Gordon G. Thiessen, Governor, Bank of Canada: Mr. Chairman, I should like to introduce to you my colleagues. Malcolm Knight is the bank's Senior Deputy Governor, and Sheryl Kennedy is one of our deputy governors.

Mr. Chairman, I really do appreciate the opportunity to appear before your committee. I should like to use this particular occasion to update you on economic and financial developments as well as to discuss any issues that you wish to raise.

Perhaps I can start by giving you an overview of developments in the past year. When I appeared before this committee last April, you may recall that there was still a fairly high degree of uncertainty in global markets related to the 1997-98 financial crisis in emerging markets and the fall in commodity prices associated with that. The pace of economic activity in Canada had slowed because of these difficulties. However, by mid 1999 our economy was regaining momentum. It was supported by a buoyant U.S. situation, a rebound in commodity prices, and a pick-up in domestic spending.

Over the four quarters of last year, output in Canada expanded by about 4.75 per cent. We had a net increase in employment of 425,000 jobs, and that took our national unemployment rate down to 6.8 per cent, its lowest level in 23 years. At the same time, the underlying rate of inflation in Canada remained low.

Why have we been so successful in rebounding from these external shocks in 1997-98? I believe that it is because Canada's economic policy foundation is stronger than it has been in several decades. This foundation has two cornerstones. One is the improved fiscal positions of governments that have led to a declining ratio of public sector debt relative to the size of our economy, and the second is the environment of low and stable inflation that is expected to persist because it is anchored by the Bank of Canada's targets for inflation control.

[Translation]

Since the early 1990s, Canadian monetary policy has been based on a commitment to explicit targets for inflation control. This commitment has helped to moderate fears of a resurgence of inflation, has assisted the Bank in taking timely action in response to changing economic and financial conditions, and has improved our public accountability. A crucial part of our monetary policy regime is our floating exchange rate. Without that, we could not have Canadian inflation targets.

A good measure of the success of our monetary policy framework based on inflation targets and a flexible exchange rate is that Canadian interest rates have remained lower than comparable U.S. rates, apart from the period of turbulence in 1999. These lower rates reflect Canada's lower inflation rate, and the expectation that low inflation will continue. In the past, a depreciation of our currency has frequently fed fears of inflation and has led to interest rate increases. The difficulties of the past couple of years also illustrate the value of a flexible exchange rate as a shock absorber. The downward movement of the Canadian dollar from mid-1997 to the end of 1998 was largely a response to the sharp decline in world prices of the primary commodities that Canada exports.

Our economy had to adjust to this reality; the exchange rate decline facilitated a shift in activity from the primary sector to manufacturing and other export sectors. It also provided an additional incentive for these sectors to take advantage of a strong U.S. economy. Because of these adjustments, the Canadian economy continued to expand during 1998 and recorded a substantial upswing in 1999.

When I last appeared before this committee, Mr. Chairman, there were a number of questions about Canada's rate of productivity growth and the gap in productivity level with the United States. I am happy to report that there have been some positive developments over the past year. Not only have we had better productivity gains through 1999, but purchases of machinery and equipment climbed 18 per cent during the course of the year. This continues the increase in investment in machinery, equipment and technology that began in 1996 and that mirrors the increase in investment that began somewhat earlier in the United States.

[English]

We are certainly heartened by the better productivity outlook in Canada, but we are not sure how large these gains are likely to be, how long they will last, or by how much they will eventually enhance our economy's productive capacity. This uncertainty raises an important issue for monetary policy, especially since, by some measures at least, the Canadian economy is currently operating at or above full capacity.

Our low inflation environment and the Bank of Canada's commitment to maintaining it give us more room than we have had for some time to explore the economy's full potential. However, because of the current strong momentum of the economy and the high levels of activity, the bank must be careful to avoid approaching capacity limits too rapidly. We do not want to trigger bottlenecks and shortages that can put unnecessary pressure on inflation. Since it takes time for monetary policy to have its full effect on the economy, we can best achieve and maintain full potential if we approach those capacity constraints gradually and carefully.

We had these considerations in mind when we increased our bank rate in November, February, and March. These increases followed similar rate hikes by the U.S. Federal Reserve.

The U.S. actions provided additional evidence of the likely further spillover of U.S. demand into our export sector. Altogether, this suggests to us an overall stronger demand for Canadian output than we previously expected. Under these conditions, it has been essential for the bank to be vigilant.

As I said before, our inflation performance has been good up to now -- in fact it has been somewhat better than we expected. While the 12-month rate of increase in the consumer price index moved up to 2.7 per cent in February, that was because of sharply higher energy prices. When we study these developments and try to see the underlying trends of inflation, our core measure of the CPI was at 1.6 per cent in February. This is within the lower half of our 1 per cent to 3 per cent inflation target control range.

When it comes to that surge in energy prices, let me just say that the bank will be watching closely to ensure that that increase does not show up in higher expectations of inflation. We expect that the more recent decline in world energy prices will persist, bringing the rate of increase in the total CPI in Canada down closer to the centre of our target range by late this year.

I cannot stress sufficiently the importance that we at the bank place on keeping the future trend of inflation in Canada low and stable. This really is the best contribution that monetary policy can make to the expansion of the Canadian economy, and indeed to further productivity gains.

I am now ready to answer your questions, Mr. Chairman.

Senator Meighen: Welcome, Mr. Thiessen, to you and your associates. It is a pleasure to have you back with us. We appreciate your regular attendance at these meetings.

Your opening comments immediately lead me to one question. If we have done so well -- and I think we have on the inflation and other fronts -- if the problems in Asia have largely been rectified, and commodity prices are returning to higher levels, why is it that our dollar still languishes relative to the U.S. dollar?

I think you have implied in past sessions that we need to have patience, and that if we get all the basics right, the universe will unfold as it should. However, the universe of the dollar does not seem to be unfolding as it should. What explanation do you have for that?

Mr. Thiessen: I will be consistent by continuing to say "be patient." One of the most important things that we need to remember is that we always compare our dollar to the U.S. dollar, and that is not just some kind of object standard for comparison. It is the currency of the largest country in the world, and indeed of the country that is performing better economically than virtually every other country in the world by a wide margin. It is pushing hard against its capacity to produce and is virtually bursting at the seams. The United States has also recorded the most remarkable gains in productivity recently of any country in the world and has maintained a very low inflation rate through that process.

If you look at three things that tell you a great deal about a currency, such as the pressure of demand on capacity, productivity, and inflation, they will all lead you to expect a very strong U.S. dollar. That is exactly what we have had.

The Canadian dollar has recovered somewhat against this very strong U.S. dollar; but as long as that U.S. economy keeps pushing ahead it is difficult for any currency to make much ground against it. Occasionally, therefore, I recommend that people use the Eurodollar as a standard for comparison, against which we have been rather strong.

Senator Meighen: I wish to turn to your role as a media star, Mr. Governor. Not all Canadians appear to think that you should be on the rubber-chicken circuit. One national columnist panned the performance, but I for one think you should be speaking out and I applaud you for doing that. I notice that you are not the only one who does so. Mr. Greenspan is well known in the United States for speaking out, where he routinely makes pronouncements on monetary policy.

I understand that Mr. Greenspan's mandate is similar to yours. Obviously he has additional supervisory responsibilities that we give to OSFI in this country. However, you and he fill somewhat the same role. I wish to remind you of one statement by Mr. Greenspan that I think received wide publicity, because I want to know whether you agree with him. In 1977, when testifying before the U.S. Senate Banking Committee, he said that the major impact of capital gains tax is to impede entrepreneurial activity and capital formation. While all taxes impede economic growth to some extent, the capital gains tax is at the top of the scale. He went on to say that in his view, the appropriate capital gains tax rate is zero.

I should tell you, sir, that this committee has held hearings recently on the matter of capital gains tax, and I believe I can say without fear of contradiction that the overwhelming evidence was that Canada would benefit from a significant reduction in capital gains taxes. Indeed, the government has moved in that direction in its recent budget.

Senator Oliver: Not sufficiently.

Senator Meighen: That is a matter of opinion, and I would not want to involve the governor in matters of political opinion.

Do you agree with our witnesses, sir, and with me and Mr. Greenspan, that a significant capital gains reduction is an excellent way to promote economic activity in this country, possibly without feeding the fires of inflation?

Mr. Thiessen: Senator, I expect you will not be surprised, from my past appearances, that I always find it rather difficult to get involved in some of those issues that contain an element of political choice. It is very difficult for the central bank governor to get too closely involved in things like that.

I am not sure what Mr. Greenspan would say today, but in 1977 he was not the chairman of the Federal Reserve Bank.

Senator Meighen: Did I say 1977? I apologize, it was 1997.

Senator Angus: You are not off the hook, although it was a good try.

Mr. Thiessen: I thought I had a neat way out.

The Chairman: It is called "entrapment."

Mr. Thiessen: You are not supposed to change the date mid-question.

Senator Meighen: This is recent news, governor.

Mr. Thiessen: I really find it awkward, senator, to get involved in these questions. I would certainly say that issues of incentive are very important. I do not pretend to be an expert on all those incentives, as my responsibility really is monetary policy. It is the macro economy. Thus, I cannot pass myself off as an expert on these things. I would simply say I do believe that issues of taxes and tax incentives are important and must be looked at carefully.

Senator Meighen: Mr. Greenspan can do it, and I know you can. I look forward to your ongoing pronouncements.

Senator Fitzpatrick: Welcome, Mr. Governor. You have been here before, but this is my first appearance at the banking committee so I hope my question is not too political for you. It is a very broad question.

I have a real concern about our level of national debt of more than $550 billion, which I believe is about 60 per cent of our GDP and costs more than $40 billion per year in interest. That may be all right during a period of strong economic growth and no deficit. However, if the economy continues to grow, unemployment declines. If we pursue a policy of increased expenditures that add to economic growth, and we face the threat of inflation -- and I heard what you said about that -- I believe that these issues may lead to increased interest rates. That then increases the cost of servicing the debt, complicates the working of monetary policy, and will perhaps lead to a downturn that causes government revenues to decline, and so on.

In your opinion, are we at an acceptable level of debt, given the current situation and economic forecasts, or should we be paying it down more aggressively to avoid returning to the economic straitjacket that we endured just a few years ago?

Mr. Thiessen: I must admit, senator, that I feel a little more comfortable talking about debt as opposed to taxes. Debt really does have financial implications, and it has implications for monetary policy. In the early 1990s, even as our inflation rate fell from 1991 to 1992, we did not get the full benefit of that because there was a sense, both domestically and internationally, that the Canadian fiscal situation was not under firm control and that debt levels were rising. There was no sense that they would level out at that stage. It was only after federal and provincial budgets of 1995, and the debt-to-GDP ratio in Canada went onto a downward track, that we started to get the full benefits of the decline in inflation. I certainly believe that debt levels are very important.

It is difficult, I must tell you, to provide a simple economic rationale for any particular level of debt-to-GDP ratio. However, it seems to me that it is terribly important for us not to have debt levels so high that when the next international crisis comes along -- and there are bound to be more -- we are not singled out as a particularly vulnerable country where debt levels are high and investors become nervous and may wish to get out of assets denominated in our currency. I would certainly encourage a continued downward movement in debt levels.

I must say that as one looks into the future and sees the baby boomer generation getting older, one sees another strong argument for having low rather than high debt levels.

Senator Oliver: The question that was just asked by my learned colleague was precisely the one that I was about to ask. However, I have a little nuance that he did not ask in his question, and perhaps I could put that to you. The debt now is around $557 billion. If we continue to pay it down at the rate of the surplus this year, another $3 billion, it will take us 192 years to pay it off. Is that fast enough for you?

Mr. Thiessen: Senator, I am not sure that I would advocate paying off the debt unless you believe that there are no long-term assets owned by the federal government that will yield benefits to Canadians over the years. I think you can argue that the counterpart of those long-lived assets should be some debt. However, I would certainly support a lower debt level than we have right now.

Mr. Malcolm Knight, Senior Deputy Governor, Bank of Canada: Senator, it is important to look at the level of the debt not only in absolute terms, but relative to the size of the economy. As the economy grows, the ratio of the debt to GDP declines.

Having said that, it is true that Canada's debt-to-GDP ratio is higher than some of the other G-7 countries. Where there is a risk of interest rates rising, we would feel a little more comfortable if the debt levels were lower.

Senator Oliver: If it is costing $42 billion a year now to service the debt, and if you were forced to raise the interest rate by 2 or 3 percentage points, would we have the capacity to really withstand the increase in the cost of servicing that debt?

There is another kind of debt that I wanted to ask about, and that is consumer debt. Recent years have seen a sharp increase in household debt. It now totals nearly $600 billion, up $40 billion in the last year alone, and has increased by $200 billion since 1993. Indeed, a significant landmark was passed last summer. If you add up all the money that we owe through mortgages, credit cards, students loans, car loans, et cetera, Canadians individually are now deeper in debt than the government. Are you at all concerned, governor, at the current level of household debt, for example? Are you concerned that with such high levels of personal debt, the consequences of interest rate hikes could be more deadly than in the past?

Mr. Thiessen: I must say that that is a very difficult question to answer. Debt levels have been going up gradually throughout the post-war period. It is difficult to get a real sense of what levels of debt would really be beyond the capacity of the household sector to manage, but we have done a number of studies. We compared debt levels to income and to the net worth of the household sector. I must say that when you compare debt levels to net worth, they do not look very bad at all. In fact, if you compare assets and liabilities, the net worth of the household sector seems to be continuing to expand. In other words, people's assets are rising more rapidly than their debts and that gives me a great deal of comfort.

I derive a lot of comfort, senator, from the low level of our interest rates. That is because our inflation rate is low. There may be occasions when interest rates must rise, but they will never rise to the levels of the 1970s and 1980s as long as we keep our inflation rate low. The interest rates that people suffered, say in 1980-81 when mortgage rates went up to 25 per cent, will not happen again as long as the bank is successful in keeping inflation low, and we are absolutely committed to doing so.

Senator Oliver: We know that, Mr. Governor, from your past experiences.

Senator Grafstein: I am delighted to be back in this committee. I am not a member, but I have been invited from time to time to attend and, specifically, exchange some thoughts with you.

I want to remind you, Mr. Governor, that Senator Bolduc and I raised the question of the Euro several years ago and the Senate's prediction was that the Euro would be weaker than the American and the Canadian currency. That prophecy by a Senate committee has now been fulfilled, to the benefit of the European trading community. I thought I would remind you of that because we had a very interesting exchange at that time. You might want to comment on that, although that is not my question.

My question is twofold. It relates to the new economy and the confusion of some of us who are more comfortable with the old economy. There seems to be a problem of almost a division between allocation of economics in the new economy versus the old economy. Has the new economy changed the bank's conduct of monetary policy, having in mind specifically what Mr. Greenspan has said on this question? Are you surprised by the ability of the Canadian economy to maintain a low rate of inflation and high rates of capital utilization? In other words, is there a risk that monetary policy is responding more to the old economy than the new economy?

Mr. Thiessen: Of course my answer is no, it is not responding inappropriately.

No doubt there are some interesting things happening out there. There is no question, as I mentioned in my opening statement, that levels of investment in machinery, equipment and technology in Canada have risen sharply as a percentage of our GDP, starting around 1996. If you look at it on a chart, it looks remarkably similar to what happened in the United States around 1992. While the level of investment is still lower in Canada than in the United States, it is similar to where the U.S. was at a similar point.

We certainly know that that level of investment in the United States ended up producing some remarkable productivity gains -- not right away, but a little later on. They now, a few years later, appear to be getting the benefit of those investments. That certainly leads me to believe that something rather special is happening.

However, I must tell you, senator, that currently, while our productivity and performance appear to have improved through 1999, they are not so strong as to suggest that there is something quite evidently new happening.

All of this is still forward looking; but it is something that my colleagues and I are monitoring very carefully, because there is no doubt that we want to ensure that this economy gets a chance to take full advantage of those potential productivity gains. This is an area where our inflation targets really do work rather well for us. If the inflation rate is lower than we expect, in the bottom part of our target range, then we are more inclined to accommodate a rapid expansion of our economy than we would be if the rate was high and pressing the top of our range. That inflation rate tells us something about what is happening out there.

You are right. We are seeing better inflation numbers than we had expected and that is an interesting sign. We are following this as closely as we possibly can. We are following every indicator we can lay our hands on to be sure we get a good fix on what is happening. I think the real gains are still to be made in the future.

Senator Grafstein: My supplemental question is related to the deployment of capital in the new economies in order to create greater efficiencies. Without naming names, we have read recently in newspapers about organizations with large accumulations of capital, such as pension funds, that may or may not be making appropriate decisions based on economics. I am concerned that perhaps there is too much power now in the hands of some of these funds. I wonder whether or not you would like to comment on that? I will understand if you choose not to.

Mr. Thiessen: I find it difficult to comment on that, senator. There is no question that there are large accumulations of funds now that are not as important as they used to be. I must say, however, I do not see it as a problem so far. Whether it will be in the future is a good question, but I really do not have a view to express on that, senator.

Senator Angus: Good morning, Mr. Governor, and welcome. It is particularly timely that you folks are here today in light of all that is going on. I was interested to see that your opening remarks addressed my favourite subjects head on, so I do not need to deal with them, namely, the fundamentals of the Canadian economy continue to be very good, according to you. Obviously, you are not in favour of pegging our dollar to the U.S. dollar, although I believe there are some views to the contrary.

I will go therefore to a more contemporary state of affairs. I think one would be remiss today if one did not ask you something about the market activity that has been going on in the last few days. I should like to ask you, do you anticipate any significant economic consequences, either good or bad, from the frenzied market fluctuations of the past few days?

I notice Senator Grafstein used the phrase "new economy", which seems to be bandied around a lot. Yet I have read some fairly interesting comments recently from learned economists asking, "What is meant by the new economy? There is only one economy." Inasmuch as this market activity and these wild fluctuations seem to be related to Internet stocks and things that are categorized as new economy, perhaps you could answer in that context.

Mr. Thiessen: The notion that somehow there was an old economy and now there is a new economy, and what is old is bad and what is new is good, does not really make much sense. However, there is no doubt that there is a major technological change going on in the world and certainly in Canada. It appears to be very significant indeed. There are many companies, new and old, who are in the midst of taking advantage of this changed technology. However, because it is a rapidly changing situation, it is very difficult to predict the future stream of earnings that these companies will generate -- either old ones taking advantage of new technology, or new ones. That will lead, by definition, to fluctuations on the stock exchange, because every new piece of news may tell you something about that future stream of earnings that you are discounting to get a value of that stock. Therefore, I am not at all surprised to see fluctuations. From that point of view, a correction of the sort that we have seen is sometimes a very good thing. It causes people to reassess that future stream of earnings and ask themselves one more time: "What is the present value of that and what am I prepared to pay for it?" That is a really good thing to do.

Does this all have economic implications? It certainly does if we are to end up with a rapid rate of productivity growth of the sort that the Americans have seen. That will be important indeed. It will lead to rising standards of income, something that we have not had a great deal of in the recent past.

At times, there are some hints that remind me a little of the 1950s, where we really did have a huge technological change, as people in Canada, and indeed around the world, made peacetime use of the technology that had been developed during the Second World War. We ended up with some very rapid productivity gains during that period.

The crucial thing from the monetary policy point of view is to be careful about assuming that these gains will actually happen. If we make a mistake and end up running a monetary policy that is too easy, in the anticipation that we will get these wonderful gains, but they do not materialize, then we could find ourselves back into an inflationary situation. Then we will see interest rates rise -- not just the interest rates that we effect, but the whole spectrum. That will act as a major discouraging force on new investment and we do not want to be there. We must be very cautious in the way we approach all of that.

I must tell you, senator, there is something happening. Whether you want to call it a new economy or not, we are certainly in the process of major technological change. If we in Canada take full advantage of it, then we will see some productivity gains and increases in income, the like of which we have not had for awhile.

Senator Angus: It is interesting that you would answer in that fashion, sir, particularly your last phrase about Canada taking full advantage of this technological change. We have had discussions with you in the past about the "lag", if you will, between Canada and our neighbour to the south in introducing and taking full advantage of the new economy and these measures. Indeed, we have heard evidence in this committee over the past year that Canada may be lagging by as much as 18 per cent or more behind the U.S. in terms of taking advantage of the Internet and commercially related aspects thereof.

Where, in your view, are we at the present time in this regard? Do you feel that we are improving in Canada? It raises the issue that you and I talked about last year, and you talked to my fellow senators about -- whether or not Canada has a commodity-based currency. They seem to me to be interrelated, and I would like your views.

Mr. Thiessen: I must admit that I find it difficult to tell. There are no statistics to which you can turn that are all that helpful.

The statistics on access to the Internet certainly suggest that Canada is second only to the U.S. and well ahead of others, at least other large countries. I am not sure what you can make of that and whether it really gives you a good fix on the extent to which we are taking advantage of this new technology. It seems, and I put emphasis on the "seems", senator, that the big gains are likely to be in terms of business-to-business relationships, at least at this stage. It is very difficult to get a picture of the extent to which it is happening in Canada and whether it is lagging significantly behind the United States. No doubt every one around the world is lagging behind the U.S., which is right out at the forefront here. I guess the question is whether we are lagging much more than we ought to be and that is hard to get a fix on.

Senator, I can mention the anecdotal information that I gather through talking to companies. They are all talking about what they are doing and how they will take advantage of changed technology.

Senator Angus: I find that a very helpful answer and I appreciate it.

Senator Furey: I have a very quick question, governor, a follow-up to Senator Angus's question. People have told us that we are so far behind the U.S. in e-commerce that we cannot catch up. I would like you to comment on that.

Perhaps you could also just make a general comment on how the Canadian venture capital market can be improved.

Mr. Thiessen:To say that we are so far behind that we will never catch up seems to me to be rather extreme. There is no question that every one is running behind the U.S., but I do not accept the notion that because you are behind you can never catch up. I do not think it is true.

These days, people do not know exactly what the future nature of all this will be. We are still in the midst of enormous change and a process where people are discovering new ways to take advantage of the Internet. What you might have thought was the future of e-commerce 12 months ago may not be so today. I think it is very difficult to make these sorts of statements.

On the venture capital area, I do not know that I have a solution for you, senator. One of the great strengths of the U.S. has been their flexibility in providing financing to start-up companies in the high-technology area. Much of that has to do with the so-called "angels" in Silicon Valley, people in the high-tech industry who have done rather well and then have been prepared to reinvest in the industry. We see that going on in Canada as well, but of course we do not have as many successful entrepreneurs.

Another thing that also seems to have happened in the U.S. is that some parts of the financial institution sector have gone into partnership with the angels, "feeding off" their inside information, so to speak. I do not know the extent to which that is happening in Canada, but I think there is something in that.

Certainly it is very important to look carefully at the financial system, because you do not create the kind of successful economic performance that the Americans have in a very complicated economy without a very well-functioning financial sector, albeit sometimes informal, like the angels. It must function well.

Senator Tkachuk: Welcome, Mr. Governor. The weakness of the Canadian dollar still bothers me, and I think many of us who live in importing regions of the country.

There has been a debate in academic circles in recent years about a North American currency. The argument is often made in Canada that we cannot do that because of sovereignty and symbolism. I would like you to set that aside for a moment and give me your views on what the effect would be of a North American currency on the average Canadian citizen. If we used the U.S. dollar here, how would it make life better or worse for the average citizen?

Mr. Thiessen: There is no doubt that once you eliminate currency differences, all cross-border transactions become slightly simpler. You do not have to worry about translating prices or your own means of payment from one currency to the other. It certainly reduces the costs of any cross-border transactions. That is, of course, the main attraction of a common currency.

On the other side of the coin, frequently in Canada the situations affecting us are somewhat different from those affecting the U.S. Even when we are both hit by the same event, it has a different effect on our economy than the U.S. economy.

I made reference in my opening statement to the Asian financial crisis and the effect it had on commodity prices. While primary commodities are a declining share of the Canadian economy, they still are a significant part of our exports. When commodity prices fall by 20 per cent, as they did for Canadian-produced primary commodities from mid-1997 to the end of 1998, that still has a severe negative effect on our economy. It has a particularly negative effect on those areas still highly dependent on the primary sector -- Western Canada, B.C., Northern Ontario, and some parts of the Maritimes as well. When those prices fall, Canada is worse off.

It is also true that our export receipts decline because we are not receiving as much for the exports of our primary commodities. If we have a deficit in the balance of payments, it gets bigger. We have no choice but to adjust to that. We must adjust to this lower standard of living and to the fact that some of our exports are no longer as profitable as they once were.

As it did in 1997-98, our flexible currency falls to reflect this new reality. That then encourages a shift in our economy out of the primary commodity sector into the manufacturing and other sectors. In Canada, when we got hit with that shock, there was a shift in our economy toward increasing exports of manufactures and other goods, particularly to the U.S., which compensated for the other losses.

If you do not have that incentive to shift that the lower currency provides, then the adjustment process takes a lot longer. Wages and salaries in general must come down in Canada until we are more competitive and can export more of other goods abroad. That can be a very painful process. Typically, you only get declines in wages and salaries with a recession. With our flexible currency, we managed to avoid a recession in response to that shock. As I said in my opening statement, we found ourselves in 1999 with an economy that was really taking off quite nicely.

As long as we have a situation where these shocks that hit Canada are different from those in the U.S., or affect us differently, then I think there is great value in having a flexible currency.

Senator Tkachuk: I am not sure that you answered my question. The dollar difference between ourselves and the Americans really keeps capital in industries that are in bad shape. In other words, when commodity prices drop and the dollar drops, you still develop a level of exports to the United States that has economic advantages for Canada, rather than creating a shift in capital to new forms of the economy. Perhaps the short-term adjustment may be more painful, but I believe it would not be so for the long term.

I think that is why we are all a little confused about this. Everything is going so well, yet our dollar is at 68 cents. Perhaps we have a permanent subsidy here, and we are investing in the old economy while the world is moving on, and since our dollar is at this difference, we are falling further behind.

Mr. Thiessen: You need to imagine a case in which we have a fixed exchange rate through this period. We get hit with this shock, the prices of our exports go down, our current account deficit widens and there is great downward pressure on the Canadian dollar, but we are committed to its being fixed. This means that the bank must raise interest rates in order to keep the dollar at parity with the U.S. That puts you into a recession in this country, and I would suggest that that is not an easy situation for people to respond to either. With high interest rates and recessionary conditions, it takes some time before individual companies will say, "Right, we have to respond to this." In the end, the process is more difficult.

I do not accept that somehow, if we just had this fixed currency, we would manage to adjust quickly and get on with our lives more effectively. I do not see it happening that way.

Mr. Knight: Mr. Chairman, I wish to add one thing on Senator Tkachuk's point on the redistribution of capital. I think 1998 to 1999 is a good example of that, because we had a situation where commodity prices fell. It is true that the depreciation of the exchange rate cushioned earnings in the commodity exporting sector relative to what they would have been had the exchange rate stayed fixed. However, because the price of manufactured goods did not decline during that period, at the margin it did give a very considerable incentive to shift resources into manufacturing. Our manufactured exports increased quite significantly in 1999. That was part of the strength of the economy and that led to a redistribution of capital and investment toward those sectors.

[Translation]

Senator Poulin: Like Senator Meighen, I want to congratulate you for being so accessible to Canadians, despite criticism from certain journalists and a newspaper that will remain nameless. Canadians want to understand the impact of monetary policy on the dollar that they are working harder and harder to earn.

My question deals with the new economy. A few months ago, I tabled a report in the Senate entitled: "Wired to Win", which analyzes Canada's position in the new world of communications.

[English]

We heard from all the witnesses on the impact of these new communications and the falling of the geographical barriers and the adaptation required. I was about to ask you what your vision was of Canada's participation, but I felt you answered Senator Angus's question so well that I do not need to.

I should like to return to productivity and employment. I am thinking in terms of the young entrepreneurs, such as in Northern Ontario where I am from, who have the creativity and the motivation to start up new companies and offer goods or services to anywhere in the world. How is the monetary policy encouraging, helping, or sustaining this new way of doing business? These young people are well trained and really want to work from their own community, not necessarily move to a bigger city. How is our monetary policy helping us to be more international?

Mr. Thiessen: Monetary policy, of course, has very broad national effects. Where I do think it is helpful, senator, is in keeping interest rates low. As long as we keep our inflation rate low, we keep our interest rates low. That means that the cost of borrowing -- but also the cost of issuing new equity -- is lower than it otherwise would be. That is a terribly important facet of encouraging entrepreneurial activity. Very few entrepreneurs can finance all of their activity. They do need access to financing. If you are in a period of high inflation and high interest rates, you will find that most lenders -- indeed most investors and most ordinary savers -- get very nervous. You are so concerned about the value of your savings being undermined by future price rises, you are less willing to invest, and you are certainly not willing to take very many risks in those circumstances. Thus, you find very high interest rates and very high inflation rates. To that extent, monetary policy is indeed helpful. It is not absolutely by accident that what has gone on in the U.S. has gone on during a time of low inflation and low interest rates.

Senator Poulin: My colleagues, Senators Furey and Grafstein, alluded to the venture funds. How can you systematize the willingness of those involved in venture funds to go with these new companies within this new economy? We do not want you to become the guardian angel necessarily, but we do expect the right policies and right economic structure.

Mr. Thiessen: I do not know of anything specific that monetary policy can contribute in this area, frankly. To some extent, it is a matter of learning. For every successful start-up, you have another investor who is prepared to take risks in this area. That is what happened in the U.S. in Silicon Valley to some extent. It was not something that just suddenly burst onto the scene, it developed over time. Every success generated another investor willing to take some risks. I do not see any way around that, quite frankly.

Ms Sheryl Kennedy, Deputy Governor, Bank of Canada: I would like to comment on something that is getting somewhat removed from monetary policy, although not entirely. When you go into some of these communities across Canada, as you say, where you see some new technology start-ups, you see that many of the people involved have deep local roots. However, there has been mobility in the economy. When we look at what has happened over the last while -- and traditionally -- in the U.S., there is a great deal of mobility in the economy there as well. It appears that venture capital can also be more mobile. People leave a firm here and go to work at a certain large firm there, and when they return to communities they also bring back their contacts and those sources of venture funds which, as the governor said, are ultimately the marrying of the more traditional sources with these individuals angels or entrepreneurial venture capital. Together with the low inflation and the low interest rates, it makes people willing to invest and you start getting those sort of "magnets" forming.

Senator Kelleher: Welcome once again. Mr. Governor, I noticed in your opening remarks you touched on a theme that you and I touched on last year when we discussed the gap in productivity.

One of the arguments of those in favour of a monetary union with the United States is that they feel that Canadians have been using devaluation of the Canadian dollar as a shield against the market. They argue that the low dollar is masking a low level of productivity, especially when compared with our major trading partner to the south. The Business Council on National Issues made that argument on Tuesday of this week.

Mr. Governor, do you believe that there is a relationship between a weak Canadian dollar and a lack of international competitiveness? Is there any evidence that some firms or sectors of the economy hide behind a low dollar to protect their domestic market share against imports or to gain market share in the United States?

Mr. Thiessen: I must say there is certainly a relationship between the value of the dollar and productivity. However, I think it goes in a different direction from the one you were describing, senator.

If our productivity is not growing as rapidly as it is in the U.S., that does cause the U.S. dollar to be stronger relative to the Canadian dollar. It is not the other way around. It is not the dollar that has productivity effects; it is productivity that has effects on the dollar.

I have a lot of difficulty with the argument that devaluation is a shield that is masking a low level of productivity. If it is happening, I must tell you that is a very sad commentary on our business community. I believe that our business community and its interaction with the global economy is sufficiently strong that there is competition in most markets. In a competitive environment, there is no way that you will say, "Well, the dollar is low. I am an exporter. I accept the international price, and now my price in Canadian dollars is a little bit higher because the Canadian dollar has gone down. That is giving me a little bit more profit, so I will not work as hard to increase productivity and will not work as hard to reduce my costs."

My goodness, if you did that and I was on your board of directors, I would be down on you like a ton of bricks because I would be worried that your competitor next door is not doing that. If you are looking for productivity gains, as you should be in a competitive environment, and if you are looking to reduce costs, you will find yourself with a declining market share and your board of directors will be seriously unhappy with you. I do not think the business community works that way, and it certainly does not work that way in a globalized environment.

Business people will all say to you, "Boy, it is tough out there. The competition is ferocious." The incentive to look for those productivity gains and find them as fast as you can is certainly there, and I do not think that anyone can hide behind the dollar.

[Translation]

Senator Hervieux-Payette: Mr. Governor, I had promised to ask some tough questions, but that was a joke. At the start of the week, some events that could perhaps have been predicted unfolded. The impact of the American court decision in the Microsoft case rippled to the Canadian and American stock markets. In a single week, a 30-billion-dollar loss was registered. We know that most of our pension fund portfolios have stocks in Microsoft. There will be a final decision on whether the company has to be dismantled.

Some people even bought on margin, by borrowing to invest in a company. The return on the investment in a company that might be dismantled would not be very high for these investors. I am considering that from a global perspective. This is a mega-corporation that, although it is not the result of a merger between two large companies, is swallowing up all the small players. The trend is moving toward concentration in telecommunications, in pharmaceuticals, for example. This move towards greater concentration requires huge injections of capital that is not invested elsewhere and that does not improve corporate productivity. My concern -- and I wonder if you share this concern -- is reliving the scenario we witnessed in Japan. The situation is not identical. It seems that they abandoned traditional standards and that they were not cautious. What advice would you give parliamentarians in light of this tendency to create mega-corporations in vital sectors such as high tech, telecommunications, and pharmaceuticals, where Canada is investing heavily in this new economy? Will the June decision on Microsoft have an impact, or a harmful ripple effect on our economy, and will it lead to higher interest rates and more trouble for the Canadian and North American economies?

Mr. Thiessen: It is hard to say whether or not mergers are effective, if they will create productivity gains or not. However, the cost of technological change is enormous. I fully understand why companies want to be quite large to be able to invest in new technology. Are these mergers necessary? I do not know. In the case of Microsoft, I think the American government will look very closely at whether or not dismantling this corporation is a good idea. I am not at all sure that it is. I think they will try to limit Microsoft's activity somewhat, or limit the corporation's ability to create small monopolies. I think that dismantling the corporation would be very risky.

It is difficult to answer your question, because when you look at the situation throughout the world, there are mergers everywhere. It is very difficult for us to say if they are necessary or not. I am not sure.

Ms Kennedy: We have just talked about start-ups in high tech. There are two trends: on one hand, we have those in favour of concentration where you need economies of scale to make large investments, but on the other hand, we have to ensure there is innovation and develop new ideas, and realize that small corporations in these fields are also very important. Determining the strengths and weaknesses of these mergers is not the only difficulty. However, we have noted these two developments.

You also mentioned on margin stock market investments. Our statistics from the end of 1999 show that in Canada, Canadians put about 1 per cent of their personal disposable income in an equity portfolio. Institutions have some restrictions and they ensure that people who play on margin have a fairly diversified portfolio. That makes risk management easier. In Canada, it is about one third of one percent of disposable income, and it is 3.6 or 3.7 per cent in the United States for the same period.

[English]

The Chairman: What do you mean by a margin of 1 per cent?

Ms Kennedy: One per cent of personal disposable income that is invested in the stock market is on margin, and is 1.2 per cent of the total assets of individual Canadians' equity portfolios.

The Chairman: Including homes, et cetera?

Ms Kennedy: Of their equity portfolios, 1.2 per cent is on margin.

[Translation]

Senator Bolduc: You say in your brief that:

[English]

This uncertainty raises an important issue for monetary policy, especially since, by some measures, the Canadian economy is currently operating at or above full capacity.

[Translation]

I have some doubts about that statement. You seem to be taking for granted that the participation rate in the economy is a set rate, whereas since 1960 in the United States, the labour market participation rate has increased by 2 per cent each decade. That means it went from 58 per cent of workers to 68 per cent today. This phenomenon occurred in Canada as well, but the participation rate is not the same. If I remember correctly, I think we are at 66 per cent, or 2 per cent lower than in the United States. That is huge. That is why we do not have a problem with inflation. There is no imminent danger of inflation because of that.

Given this situation, you said that in 1999, there was rather marked productivity growth. In fact, we are following the Americans without having caught up to them. I would point out that this phenomenon has not gone unnoticed over the past year. It was different before. There is a big gap between us and them. If the exchange rate is 68 or 69 cents, that means it is more expensive to import machinery for new investments. Since it costs us more to import because the dollar is low, can we obtain a productivity rate that comes for the most part from these acquisitions, with the rest coming from a more skilled labour force?

Mr. Thiessen: Of course potential profits on an investment in high tech are very high. With low interest rates and even with a low exchange rate investors can still import the necessary equipment and machinery. I do not think that will preclude investment.

Senator Bolduc: If we do not have a problem with increasing our productivity on this side, that means it is a question of venture capital management. In the United States, we often see specialized banks for General Electric or Microsoft. The people managing this capital already have experience working in these companies. There is a kind of network that we do not have in Canada. Should we try to improve the situation on that side?

Mr. Thiessen: I think such a network does exist in Canada. Is it as developed as in the United States? Probably not, but it exists in Canada.

As for the participation rate, you are right. If we have a higher participation rate, we can have a higher economic growth rate. But we are unsure of the optimal potential growth rate.

Senator Bolduc: Optimal?

Mr. Thiessen: We do not know what it is. It must be examined closely, but it is not a good idea to put forth a hypothesis that it will increase.

Senator Bolduc: With the tax system in Canada, you admit that there is not much in the way of corporate or personal incentives to get people to work.

Mr. Thiessen: We must always look at incentives, yes.

[English]

The Chairman: I have one brief question. You probably will not answer, but I think we would be remiss in not asking: Does the Bank of Canada have any reaction to the fusillade of comments made by the BCNI?

Mr. Thiessen: Probably not, Mr. Chairman. Certainly, without commenting specifically on what the BCNI or anyone else has said, it is terribly important to realize that an economy is a very complex mechanism. There are seldom simple solutions to make it work better, and there are certainly never miracle solutions. You really must look at the whole range of issues. We need to do that. Taxation is very important. Incentives, as you just mentioned, are also extremely important. There are a whole host of other things that are important as well: The training and flexibility of your labour force, the entrepreneurial skills, the willingness to take risks. I react a little negatively to any suggestions that there are really simple solutions here.

The Chairman: Would it be safe to conclude that a less adversarial posture between business and government might be a salutary thing?

Mr. Thiessen: There is no doubt that business and government, and indeed ordinary Canadians, do need to think of all of this as a partnership. If we are to take advantage of this new economy, all of us will need to adjust and change to a certain extent. We all ought to be in the business of thinking about how we can do that and get on with it.

Mr. Knight: I was able to attend a meeting of the BCNI yesterday and hear much of the discussion.

The Chairman: They allowed you in?

Mr. Knight: Yes, sir. I was very impressed to see that the business community seems to be very conscious of the challenges created by the Internet and of the fact that the development of venture capital and these networks of firms are creating productivity growth in the United States. I heard a lot of evidence of an awareness of the need for the structures of production and the way firms are organized and financed in Canada to progress considerably in order to achieve the kind of productivity gains that they have been seeing south of the border. That is a good sign.

[Translation]

Senator Meighen: Mr. Governor, I should perhaps ask my questions in French, because like Senator Angus, I have the impression that you are more direct in French.

[English]

I will not though, because I do not know what "productive capacity" is in French.

My question does centre on productive capacity. We have heard much about it this morning in a number of your answers. You referred to it in Halifax, in New York, and again at the time you instituted the last interest rate increase. It is obviously very important.

Mr. Thiessen: Yes.

Senator Meighen: Indeed, it is critical that we get it right. If we do not measure production capacity accurately, then we could have higher-than-necessary interest rates, et cetera.

Two things strike me. First, that it is critical, and second, with great respect, I wonder whether our measuring tools -- and I would like you to tell me what they are -- are accurate. You yourself have said, in a number of quotes: "we are not sure"; "runs the risk"; "perhaps"; and "maybe". What are the tools, and how accurate are they in judging production capacity in this country in your estimation?

Mr. Thiessen: That is a very good question, senator. You really worry me when you tell me that I am more frank in French than in English. That makes me even more concerned about what I say.

There is a real challenge here, but not only for us. If you ever have occasion to read what Alan Greenspan says, you will find he frequently refers to the same issue. We do not know whether big productivity gains will continue. Thus, we used to have a situation where, traditionally, productivity gains were reasonably slow and stable, and you could assume that the productive capacity of the economy was growing gradually over time. Monetary policy focussed on spending demands relative to that production capacity. Now we are in a situation where production capacity is changing and in ways about which we are not absolutely certain. We need to be particularly cautious here.

As I was saying earlier, our inflation targeting regime is really rather helpful here. If it is true that production capacity is growing more rapidly than we anticipate because we are getting productivity gains, we will see some downward pressure on inflation rates and prices. People will tell us there is simply no possibility of pushing ahead with cost increases and that they are in fact worried that prices will fall rather than rise. We have to monitor those things carefully.

On the other hand, if it is the other way around and we are not getting productivity gains, then we will see those upward pressures. We will see complaints about bottlenecks and shortages, prices going up here or there, and labour markets getting tighter. Those are the kinds of trends we must follow. In periods of high inflation where everyone is scared to death, it does not work very well. The moment there is the slightest sign of inflation, everyone runs for cover. Interest rates go up; wages go up; people push prices up. Then the central bank has to deal with that. One of the great attractions, senators, of this low inflation rate and people believing that the bank will keep it low is that we avoid that sudden, knee-jerk reaction. Thus, we have a little more room in which to manoeuvre here. If we get it a little wrong on the easy side, we will find out and respond to it, and similarly on the other side. I think this stable inflation environment really does allow us to operate even when we do not know exactly what is happening to production capacity.

Senator Fitzpatrick: Mr. Governor, this may be a bit more difficult for you than my first question, but it is supplemental to it and a fair question, I think. It has to do with the Canadian system of government.

We talked about the debt question and the progress that has been made in reducing the national debt. The same progress has not been made by the provincial governments yet, particularly British Columbia and Quebec. Does this not complicate or put an extra burden on the efforts of the national government in achieving the target debt-to-GDP ratio, given the size of the economies of some of the provinces, and the fact that other governments do not have our federal system? Are there ways and means by which we can achieve these targeted debt-to-GDP ratios?

Mr. Thiessen: Certainly, senator, you must look at both the provincial and federal situations. I must say that we always look at the combined total, and there is no question that is coming down. Some provinces are moving more rapidly than others. Of course, some got themselves into more difficulty than others. In a sense, they are forced by the market to move more rapidly.

The same principles apply everywhere. These are the good times. If ever there is a time to run up a surplus and reduce your debt, it has to be now. All governments should be taking advantage of that.

Senator Oliver: My first questions were about consumer debt, and I would like to follow up with another question about that. When we talked about the federal debt, we talked about the ratio to GDP. In 1995 it was 72, and now it has dropped to 57 or 58. What is the optimum? What would you like to see in regard to inflation targets and interest rate policy?

You said you are not concerned about rising consumer debt because Canadians have a higher net worth. Yet Canadians are saving less and less each year. Does that not concern you?

A number of articles in The Wall Street Journal and other papers in the United States have been saying in the last two or three weeks that Mr. Greenspan has not been successful in eliminating inflationary expectations in the United States with his little adjustments of a quarter of a point, and perhaps he should be looking at one point. If he moves rates up one point this May, what affect will that have on you?

Mr. Thiessen: I cannot tell you, senator, that there is an optimum debt-to-GDP ratio.

Senator Oliver: Is it lower than 57?

Mr. Thiessen: There are also various ways of measuring it. If you measure it in terms of the traditional budgetary accounts, you get something more like 90 per cent federal plus provincial. That is indeed very high. There is no question that we do have to get that down. We do not want to be the outsider in this. Even though I cannot tell you what is precisely the right level of debt to GDP, I think being an outsider is a bad place for a smallish economy like ours to be.We want to get it down and be in a situation where international investors do not see us as the sore thumb that immediately sticks out.

You are right about savings rates being very low in Canada. We are also getting the benefit of some expected improvements in future earnings that are reflected in the stock market, and Canadians are factoring that into their sense of their own net worth. That is perfectly legitimate to a certain extent. You need to be wary of exaggerated stock market values, but certainly the likelihood of some improvement in productivity, and low interest rates that lower the discount rates used to value that future stream of earnings, really do justify some increase in stock market values. Canadians can quite legitimately factor that into their sense of their wealth and decide what they will do about it. In those circumstances, they may choose to save less of their current income than they otherwise would.

Senator Oliver: As a conservative governor, does that not concern you?

Mr. Thiessen: There is still a positive savings rate, but it is quite small. Obviously, senator, it cannot go on for ever. Whether it has really pushed the limits is hard to say. If you look, for example, at the debt service to personal income ratio, you will see that it is still very low because interest rates are low, and it is way below where most of these individuals were through the 1970s and 1980s.

Senator Oliver: I asked about an increase of one point in the United States in May.

Mr. Thiessen: Very large interest rate increases occur when you have really fallen behind the curve on inflation; or when you are starting out with a serious inflationary situation. We used to have larger interest rate increases at times during the 1970s and 1980s for that very reason. Now, with inflation relatively low, the chances that you will need really large increases are not that great. That does not mean you cannot have increases of more than one quarter of a point. However, really large increases will be unusual. They would imply that something more dramatic is happening. You will not be surprised, senator, if I cannot tell you what we will do.

Senator Grafstein: Mr. Governor, I want to return to the topic raised by other senators in connection with the BCNI, our senior business leadership group in Canada. I read the reports in the newspapers and some of the comments on the speeches made there. It appeared to me, and I do not believe the media took this out of context, that heavy blame was laid at the doorstep of the federal government. I then asked myself whether or not that is an appropriate criticism, and I turned to the Internet as an example. I have examined our infrastructure in Canada. We have a higher connectivity rate in Canada than does the United States. We have a higher per capita computer utilization rate in the home. We have more accessible networks and lower transmission costs. All of this is due to entrepreneurs, as well as government policy. Yet, those business leaders did not turn the mirror on themselves.

Is not one of the fundamental problems in Canada a "digital divide" between the old managers, represented by the BCNI, and the new, entrepreneurial class of younger people who cannot get small cap starts in this country because the old managerial class does not understand what is going on because the goalposts and the playing field are changing so swiftly? Is it fair to say that the managerial class should take a look in the mirror and perhaps reflect on the inherent problems they have in grasping the new economy?

Mr. Thiessen: I have some difficulty in replying to that question, senator, because I do not know if that is the case. I certainly do know that it is very instructive to look at what is happening in the United States, where they have had a quite extraordinary performance over the last six years, and over the last three years in particular. It is in all of our interests -- not only in Canada but elsewhere -- to look carefully at what is happening and ask ourselves whether there are some processes, some attitudes, and some ways of doing things that we ought to consider. I do not know that I can comment beyond that, sir.

Senator Angus: Governor, speaking about the new economy, about an hour ago, a member of my staff handed me an Internet copy of your remarks before the committee here this morning. I think it is great to see that the bank is right up to speed in the new economy.

I would like to get back to the issues of your mandate, and monetary policy specifically. When I first joined this committee and you appeared before us, the interest rate spread was positive. In other words, our rates vis-à-vis the U.S. were in a band that was substantially higher than theirs. Since the end of 1995, the reverse has been the case. I understand that perhaps one of your reasons for keeping it this way has been to shield Canadians from the effects of the tightening money supply. It seems to me that the other side of that coin is that that is one of the reasons our dollar has been kept low. I would like to know what your current plans are.

It seems to me that perhaps it is time to reverse that and get back to a positive situation. In other words, we should return to a point where the Canadian rates are higher. I think this would nourish your own first love of keeping inflation very much in check.

Mr. Thiessen: Senator, the objective of Canadian monetary policy is to hold inflation in this 1 per cent to 3 per cent target range, which is what we have to do.

Senator Angus: Is that the only objective?

Mr. Thiessen: That is most certainly the means for creating the best performing economy that monetary policy can help to provide. That does not allow you, senator, to have objectives for the exchange rate. You can take account of the exchange rate and its effects on our economy, but it is impossible with one instrument, this overnight interest rate of ours, to both target a low inflation rate and a particular value for the Canadian dollar. Sometimes they may be consistent; many times they will not be.

I suggest to you that the reason our interest rates are lower than American rates is that we need lower interest rates to keep our inflation rate low. That reflects the fact that their economy is bursting at the seams. Ours is not. It also reflects the fact that when you get high productivity gains and your economy is growing rapidly, you also get some interest rate increases. Their economy is growing more rapidly, pushing harder against capacity, and their productivity gains are higher than ours.

In those circumstances, they need higher interest rates than we do to keep their inflation rate low. I suggest to you that we do not set out to say, "Right, we will keep interest rates low for Canadians." We set out to say, "We will keep the inflation rate within our target band agreed with the government, and that will bring in its train lower interest rates than others and a more stable economy than otherwise." I think that has to be our focus.

If suddenly the Canadian economy starts to pick up rapidly, or perhaps we get productivity gains or inflation pressures, then you will see Canadian interest rates respond. In those circumstances, we could end up with higher interest rates than the Americans.

As long as our inflation rate is lower and our outlook for keeping inflation low is better in Canada, we are likely to have lower interest rates.

I should also say, senator, that while I like to take credit for things, I cannot really take credit for those 10-, 15- and 30-year interest rates. Those are really determined in the market. They reflect those issues I was mentioning to you. They reflect what investors, Canadian and foreign, think about our inflation outlook and what will happen in Canada. They are not just influenced by the one-day interest rate that the bank controls.

Senator Furey: Governor, recently in Halifax you spoke of the steps taken by the bank to increase accountability and transparency in monetary policy. I certainly commend you for that. It also appears that you have taken both the time, and indeed the money, to implement measures to achieve that goal. How is it working? Is it helpful to you? Is it helpful to the general public, or is it creating problems that you would not have had to deal with normally?

Mr. Thiessen: No. I think it is helpful, senator. When you are in a process of change, you can run into a few difficulties along the way. There is no doubt -- and this is not unique to the Bank of Canada, I must tell you -- that central banks around the world have come to realize that a greater degree of openness is in the interests of good monetary policy. Therefore, we are all in the process of changing.

I must also admit, if you went back some years, you would find central banks rather closed places, where they felt that they had to maintain the mystery of monetary policy. I think we have come to understand that that is not a good idea, and not only will markets respond better to what you are doing, but you will find more understanding generally in the general public about what you are trying to do.

Therefore, there will be more understanding when you must take what would otherwise be unpopular actions. I most certainly believe that we need to be out there explaining what we are doing and why. We also need to be out there listening because -- and this is perhaps because I come from Saskatchewan -- I am aware that not everything happens in Ontario and Quebec. It is a good idea to spend time in the rest of the country as well and understand what is happening there.

Monetary policy cannot be geared to any individual region. It must be geared to the national economy. However, you need to understand very clearly the elements that make up that national economy and you can only do that if you get out and talk to people who involved in it. There are two sides to this process -- explaining, but also listening.

Senator Tkachuk: I am still a little bothered by your answers on the exchange rate and our relationship to the American dollar. In 1998, when the dollar was dropping through the floor, the bank was taking action, or at least attempting to take control of the value of our dollar in relation to the American dollar in the short term. I believe the bank was buying dollars and trying to prop up the Canadian dollar so it would not fall below the 60-cent level.

From your comments today, unlike last year, you seem to be happy with where the dollar is now. That bothers me. If you are happy with where the dollar is now, is the bank deliberately keeping the dollar at this level to ensure that we continue this particular policy?

Mr. Thiessen: Absolutely not. As I was saying, we do not have a target for the dollar and I would be happy if it were stronger than it currently is. I do know that if the dollar were stronger than it is, that would also reflect the fact that a lot of things were going very well in our economy; that we were, perhaps, getting some huge productivity gains and that all this investment that I was talking about had started to pay off. I would be delighted with that.

Perhaps what you are noticing, senator, is the fact that the U.S. dollar is extremely strong these days. We are keeping pace with the American dollar, but we are not gaining ground on it. That is a standard of measure that is going up. The fact that we are keeping pace with it says something about the Canadian dollar. As I said, partly in jest, if you compare us to the eurodollar, the Canadian dollar is indeed looking quite strong.

If you are comparing us with this burgeoning U.S. economy, you cannot be surprised if we have gained a little less ground than we might like. I can assure you that we are not setting targets for the Canadian dollar and most certainly we are not holding it down. We are trying to keep inflation in this economy in the middle of our target range. Sometimes that will mean a strong currency and higher interest rates, and other times it will mean a somewhat weaker currency and lower interest rates. In the long run, that is the best thing monetary policy can do for this economy.

Senator Poulin: My question is a follow-up to my colleague's, Senator Tkachuk.

You spoke about productivity gains in your opening remarks. We all remember the 1980s, when every organization restructured and re-engineered. That has continued into the 1990s, with the additional fusion that we read about every day. Therefore, I was quite elated to hear you say that there had been such productivity gains. Yet later on in the conversation, you said that productivity gains are directly linked to the value of the Canadian dollar.

Why is that relationship so slow in showing up if those productivity gains have already begun and had begun a while ago? There is something here I do not understand.

Mr. Thiessen: I certainly said that the dollar would reflect productivity gains, but everything is relative when you are talking about a currency. When we are talking about the Canadian dollar, typically we are comparing it with the U.S. dollar.

Senator Poulin: Unfortunately, so are the Europeans and the Asians and the Africans.

Mr. Thiessen: They are. Then, if you are looking at the effects of productivity gains, you also need to compare those to the U.S. When you look at currencies, everything must be relative. It is not the absolute productivity gain in Canada that matters; it is how rapid our productivity gain is relative to that of the Americans. They have recently had extraordinary productivity gains. In the fourth quarter, their measured productivity gain is 6.4 per cent at an annual rate. We may be up to 2 per cent for the year as a whole. Therefore, we are still running behind.

Senator Poulin: What are the key factors that account for the big productivity gains in the United States?

Mr. Thiessen: One is the enormous investment in machinery, equipment and new technology that started back in 1992. I am suggesting that a similar process just started in Canada in 1996. We are running four years behind. It took quite a few years before the Americans saw the big payoff from that investment. They went through a long period where they were investing and investing, and the productivity gains were not coming. They are now coming through, particularly in these last three years. I am hopeful -- so be patient -- that we will see some of that down the track.

Senator Kelleher: It has long been held that fiscal policy and monetary policy ought to complement each other. Presently, your monetary policy appears to be aimed at price stability and at slowing down the growth of the economy so that it does not get out of control. In your release, in which you defend the recent quarter-point hike in interest rates, the Bank of Canada told Canadians that the strengthening pace of economic expansion has been rapidly absorbing production capacity and runs the risk of putting excessive pressure on capacity limits.

Yet the government's most recent budget announced a new infrastructure program. Government infrastructure programs have traditionally been carried out in the name of stimulating the economy. By embarking upon this program, along with numerous other new spending initiatives, is the Government of Canada now pursuing a fiscal policy that may be at odds with the bank's monetary policy?

Mr. Thiessen: There is no question that fiscal and monetary policy must be closely interrelated. You can have a situation, although it is not a very good one, in which you have a fiscal policy that is really unable to control budget deficits, such as we had during the 1980s and early 1990s, and a successful monetary policy that not only gets inflation down -- as we did -- but also delivers the benefit of low interest rates. To that extent, there really is an interaction.

When you are in those extreme circumstances, it matters a great deal. When you are in less extreme circumstances, I do not think it matters as much. Then, monetary policy really does need to take responsibility for the macro economy, for how rapidly the economy is growing relative to capacity.

I hope, senator, that as governments undertake various fiscal and expenditure plans, it is because they believe they are good things in and of themselves, as opposed to because they are required to stimulate the economy.

[Translation]

Senator Hervieux-Payette: In your opening remarks, you said that the unemployment rate was down to 6.8 per cent. One factor that is often forgotten is the workforce participation rate. When we do a rough comparison of productivity with the United States, there is about 5 per cent unemployment. But there is a 5-to-8 point spread between Canada and the United States in terms of labour market participation. That is not often mentioned in the reports. Everyone is happy with the 6.8 per cent.

I want to go back to the comment made by our friends from the BCNI on reducing social spending. The way people are treated has a direct social impact. If, at the end of the day, these people do not want to work for the minimum wage or if they do not have benefits, they will not participate in the workforce.

In your studies, do you look at the participation rate versus productivity? What factors might explain why the participation rate is so low in Canada?

Is it because of our social programs or are there other reasons?

Mr. Thiessen: You are right. Several factors influence the participation rate. Our study shows something very important. Young people need a longer training period at school. That is very important. It is not a bad thing in and of itself. If our young people want to stay in school longer and obtain more useful training, it would be a very good thing. It is certainly possible to have a higher participation rate in Canada.

At the Bank of Canada, we must examine that very closely, because when the economy is doing well, you can have a growth rate with a participation rate that increases at the same time. Can we achieve the same participation rate as in the United States? I do not know.

Two countries can have different social values. For example, over the past six or seven years, Australia has had a very high economic performance, but the participation rate was much lower than ours. That is very interesting.

Mr. Knight: I would like to add to the Governor's comments in this area. It is very interesting to know that at the end of the 1980s and during the economic decline in the 1990s, the participation rate in Canada and the United States dropped. In the United States, strong growth in production and low unemployment encourage workers to return to productive sectors. For us, that would be a very positive sign. By maintaining growth in the long term, we can anticipate such positive signs.

Senator Bolduc: I read in a study by Pierre Fortin, a professor at the Université du Québec à Montréal, that Canada's monetary policy had been too tight in 1990 and that today, its ratio tends to be 1 to 3. In his opinion, a ratio of 2 to 4 would be better to promote growth. What do you think about that?

Mr. Thiessen: I think he is wrong; that is not true. The notion that we can encourage people to work harder and accept lower wages with higher inflation is not credible.

[English]

The notion that people will say, "I will accept a lower salary after inflation because I do not understand it," is not credible. It is just not credible. The notion that somehow you can get a lower unemployment rate out of more inflation just is not true. It implies a degree of stupidity on the part of Canadians that I do not accept.

Senator Tkachuk: We wanted him to be more frank, and I think he was.

The Chairman: I have one brief question. Why has there been a bias, or apparent bias, in monetary policy toward keeping the core inflation rate in the lower half of the target band? Is that totally obvious, or is there some reason for it?

Mr. Thiessen: We have been in the lower half of the target band with respect to the core inflation rate, Mr. Chairman. It really reflects the fact that we were hit by a major shock in 1997-98. While, as I suggested, we coped rather well with it with our flexible exchange rate, we were still hit. Anyone who spent time in British Columbia during that period will know very well how painful it was. That was not just true there, but in other primary commodity industries. We ended up with a weaker economy than we had expected, and that produced a lower inflation rate.

Senator Angus: I was confused when we were talking about the difference between the U.S. and Canadian interest rates. It seemed to me you were saying that to maintain lower inflation in Canada, we had to maintain a lower interest rate, at least in recent years. If that is true, I find it hard to understand why we have been following, apparently in lockstep, the U.S. Federal Reserve Bank in approximately the last five rate increases. It looks to me as if we are inextricably tied up with the U.S. monetary policy.

Mr. Thiessen: That is not so. Our interest rates are low because our inflation rate is lower. We have not needed higher interest rates to keep our inflation rate down relative to the U.S. That explains why they are indeed lower.

As I was trying to point out in my opening statement, we have quite a momentum building in this economy right now. While we think that we will get some productivity gains, we cannot be sure to what extent. Supply capacity is increasing, although we are not sure by how much, and demand is really moving. If we have a situation where demand hits that supply capacity ceiling too hard, we could be in some difficulty.

I might point out that we have only followed the last three of the last five American increases. Prior to that, we moved rates downward twice on our own. We have been following them recently because every time the Federal Reserve Bank has met, they have concluded that demand in the U.S. economy is stronger than they thought it would be. We know that demand is spilling across our borders and into our export sector. This is new information for us and something we had better take into account. In those circumstances, it seemed sensible for us to move the following day, as opposed to leaving everyone in uncertainty about how we view that new information.

The Chairman: Ms Kennedy, Mr. Knight, Governor Thiessen, thank you so much for being with us. It was a good, productive session and we appreciate your presence.

For my part, this being my first time as chairman when the governor has appeared, I am exceptionally proud to be the chair of this committee and have such erudite men and women ask questions. Because of space requirements, we are donating this room to the governor for a press conference following this meeting, so we should get out of his way.

The committee adjourned.