Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 12 - Evidence, October 28, 2009
OTTAWA, Wednesday, October 28, 2009
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4 p.m. to examine the present state of the domestic and international financial system (topic: Monetary Policy Report of Bank of Canada).
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: Honourable senators, today we welcome the Governor of the Bank of Canada, who generally appears before us twice a year. He is here today to discuss Canada's monetary policy.
According to the preamble in the Bank of Canada Act, the bank's role is to regulate the following.
[Translation]
To control credit and currency in the interest of the economic life of the nation, to control and protect the value of the national currency on international markets, to use monetary action as much as possible to minimize fluctuations in the overall level of production, trade, prices and employment and generally to foster economic and financial prosperity in Canada.
[English]
The governor will be speaking to us about our nation's monetary policy, particularly as the economy continues its recovery from the global financial and economic crisis.
When Governor Carney was last before us on May 6, the economy was still in recession, although some encouraging signs were beginning to emerge. Today, the recovery is still under way, supported, as the bank notes, by fiscal and monetary stimulus. However, as the bank also notes, ``significant fragilities remain.''
Without further ado, we are pleased to welcome, once again, Deputy Governor Paul Jenkins, who has appeared a number of times before us, and Governor Mark Carney.
Gentlemen, the floor is yours. I understand, Governor, you have a statement. Please proceed.
[Translation]
Mark J. Carney, Governor, Bank of Canada: Mr. Chair, Paul Jenkins, Senior Deputy Governor, and I are pleased to appear before this committee today to discuss the Bank of Canada's views on the economy and our monetary policy stance. While conditions in the Canadian economy may have improved since we met you in May, many of the fundamental challenges remain.
Before we take your questions, allow me to outline some of the highlights from our latest monetary policy report, which the bank released last week.
Recent indicators point to the start of a global recovery. Economic and financial developments have been somewhat more favourable than the bank had expected in July, although significant fragilities remain, as Mr. Chair just pointed out.
In Canada, as expected, a recovery in economic activity is under way following three quarters of sharp contraction. This resumption of growth is supported by monetary and fiscal stimulus, increased household wealth, improved financial conditions, higher commodity prices, and stronger business and consumer confidence. However, heightened volatility and persistent strength in the Canadian dollar are working to slow growth and subdue inflation pressures.
The bank feels that over time, the current strength of the dollar will more than offset the favourable developments since July. Given all these factors, the bank now projects that, relative to the July report, the composition of aggregate demand will shift further toward final domestic demand and away from net exports.
[English]
We now expect growth to average slightly lower over the balance of the projection period. The bank projects that the Canadian economy will contract by 2.4 per cent this year and then grow by 3 per cent in 2010 and 3.3 per cent in 2011. This projected recovery will be somewhat more modest than the average of previous cycles.
Total CPI inflation declined to a trough of minus 0.9 per cent in the third quarter, reflecting large year-on-year drops in energy prices. Total CPI inflation should rise to 1 per cent this quarter, while the core rate of inflation is projected to reach its trough of 1.4 per cent during the same period.
Owing to the substantial excess supply that has emerged in the economy, the bank expects both core and total inflation to return to the 2 per cent target in the third quarter of 2011, one quarter later than we had projected in July.
The main upside risks to inflation relate to the possibility of a stronger-than-anticipated recovery in the global economy and more robust Canadian domestic demand.
On the downside, the global recovery could be even more protracted than projected. In addition, a stronger-than- assumed Canadian dollar, driven by global portfolio movements out of United States-dollar assets, could act as a significant further drag on growth and put additional downward pressure on inflation.
On Tuesday, October 20, the bank reaffirmed its conditional commitment to maintain its target for the overnight rate at the effective lower bound of one quarter of one per cent until the end of June 2010 in order to achieve the inflation target.
The bank retains considerable flexibility in the conduct of monetary policy at low interest rates, consistent with the framework that we outlined in our April Monetary Policy Report and we discussed with this committee this past May.
Our focus in the conduct of monetary policy is on achieving the 2 per cent inflation target. The exchange rate should be seen in this context. It is an important relative price, which the bank monitors closely.
What ultimately matters is the exchange rate's impact in conjunction with all other domestic and foreign factors on aggregate demand and inflation in Canada. To put it simply, the bank looks at everything through the prism of achieving our inflation target.
Mr. Jenkins and I would now be pleased to answer your questions.
The Chair: Thank you very much, Mr. Governor.
I have a full list of questioners. I will take advantage of my position as chair to launch the discussion.
Mr. Governor, you spent most of the last two years dealing first with the fallout of the sub-prime crisis in 2007, and then with the financial crisis of 2008-09. I must say you and Mr. Jenkins and your colleagues at the bank have done so, at least in my estimation, in an admirable manner. I am particularly impressed with the fact that when the governor speaks, the markets — at least, the foreign exchange markets — appear to listen. When I checked before coming over here today, the dollar was down to 92.64 cents. When you first spoke out about this less than a week ago, it was pressing 98 cents. Clearly, the governor is an influential person and we congratulate you for that.
From the perspective of the bank, what lessons can we take from the events of the past two years, both in terms of prevention and in terms of the manner in which governments and central banks can best respond? With the additional powers the bank was granted in 2008, do you feel that you have the necessary tools to play a leadership role in response to another worldwide financial crisis? Would you, as recommended by one of your predecessors, be comfortable with the bank being given a clear oversight and investigative role in regard to broad financial stability matters?
Mr. Carney: How much time do we have for that today?
The Chair: My colleagues will be upset if you take too much time.
Mr. Carney: I will touch on both of those and then we can go into deeper detail.
In terms of key lessons from the crisis in regard to prevention, I would start from the micro-economic or the specific industry regulatory lessons that come from this past experience.
First and foremost, it is clear that the system as a whole had too little capital. One of the reasons the Canadian system did respond so well and weathered the storm as well as it did, was that our main institutions were adequately capitalized, even for a shock as severe as the one we experienced. However, the global system was insufficiently capitalized.
The second point, and this is well-known, is that there were a host of core markets that had developed over time that had insufficient transparency. Once they were under stress, it was very difficult for new investors to come into those markets and pick up what might have appeared as attractively priced assets. The self-equilibrating nature of markets was hampered by deficiencies system in transparency.
A more profound lesson though, and this is a priority for the bank, is that a number of core financing markets are not robust in terms of withstanding a major shock. In retrospect, this was particularly the case outside of Canada. Going forward, it also applies to Canada as well. What do we mean by that?
The core funding markets such as the repurchase market, the repossession market and the securities lending type markets, are principally constructed on a bilateral, over-the-counter basis. We persistently saw throughout the crisis that key institutions, including some that did not necessarily seem ``key'' going into their failures, were deemed to be systemic because of the uncertainty that removing them from these bilateral relationships created for other institutions.
I will use Bear Stearns as the first example. That firm was the sixth-largest investment bank in the United States. It was not the largest investment bank, let alone the largest bank in the United States, but it was an important player in the repossession market. It was the judgment of the U.S. authorities that the uncertainties that would have been engendered by it failing would have had serious knock-on effects on other institutions.
Things can be done about these issues. We can reorganize the way these core markets function. We can use central clearing houses, for example, to rearrange these relationships. That is something that the bank has done a lot of work on internally. We are working with the Canadian industry to see whether this is a viable solution for Canada going forward.
One of the lessons is really the way core markets have been organized. The other core market I will flag — and we can come back to this if members wish — is the over-the-counter derivative markets, which are measured in tens of trillions of dollars. They have significant risk associated with them that are opaque to regulators, that are opaque to other institutions, and include a handful of global institutions at their core that are systemic as a result of that. That is just not a good way to organize the system. It will take some time to reorganize the system, but it is imperative to do that in order to prevent these types of ill-liquidity spirals that we saw at the heart of this crisis.
Those were the microeconomic elements, or those are some of the micro-economic elements. I am not doing all of them justice. We would add, though, as Mr. Jenkins and my predecessor persistently flagged for this committee over the years, that macro savings imbalances across the major economies were a real risk to the global economy and they were a contributing factor to these developments. These were the large current account imbalances between major economies and some of the distortions that they introduced into interest rate markets and foreign exchange markets, which helped to build pressure in the system. With 20/20 hindsight one can see the connections more readily because of the other microeconomic failures that are evident.
I will use that as my opening volley on that. I will say that the initiative of the Minister of Finance and the diligence of the House of Commons and the Senate in terms of modernizing the powers of the Bank of Canada in a timely fashion was helpful. Because of it, when the crisis really intensified in the fall of 2008, we were in a position to expand our liquidity facilities quickly in a way that protected our system without imposing additional fiscal risk on the taxpayers of Canada.
We were able to do that in a way that had an important calming impact on the Canadian market and helped prevent further spillovers on Canada. Of course, we did have major spillovers from the financial crisis and the global recession we have all just lived through.
Paul Jenkins, Senior Deputy Governor, Bank of Canada: I have a quick comment on the mortgage market. You drew reference, Mr. Chair, to the subprime mortgage market in the United States. Again, we need to acknowledge the structural differences between our mortgage market and that in the United States. In Canada, we have a requirement for mortgage insurance if loan-to-value ratios are over 80 per cent. We have regulations around loan-to-value ratios amortization. These are issues we cannot lose sight of as being important in terms of the well-functioning of the mortgage market in Canada. Those types of attributes benefited the Canadian economy certainly relative to what we saw south of the border.
Senator Greene: All Canadians wonder every day, when they wake up in the morning, what value the dollar will be. Our exporters worry when it is rising and, a lot of Canadians who are interested in improving their purchasing power vis-à-vis imports like it when it is high.
Do you have an ideal rate in mind or a range that would benefit all Canadians?
Since March or so, the U.S. dollar has fallen against the Canadian dollar more than it has against the yen or the pound or the euro. What does that indicate?
Mr. Carney: In response to your first question, the answer is no. The bank does not target a particular rate for the currency. We target inflation. As you well know, our mandate is clear, namely, 2 per cent CPI inflation. The level of the currency and movements in the currency are important. We take them into account. We watch them closely, but we take them into account with other factors, as I mentioned in my opening statement. Those factors are both external, internal, whether terms of trade, prospects for U.S. growth, global growth, the housing market in Canada, other sources of domestic demand, fiscal policy. We try to bring all those together with an informed view on the perspective impact on inflation and then set monetary policy accordingly.
We do look at the dollar every morning when we wake up as well, along with other Canadians, but we do not have a specific level in mind. The one thing that we all know is that things change the outlook. All those factors will evolve and have evolved since July.
Many of those factors have evolved in a positive fashion since July. Our judgment was that the persistent strength of the Canadian dollar, as noted in our report, was offsetting those positive factors relative to July, on a net basis. We are still projecting growth in 2010, and a mild acceleration in 2011, but overall it was going to be slower and we were going to return later to target on our inflation, which in the end is our mandate.
In terms of the second part of your question, it should be recognized that during the course of the crisis there was exceptional volatility in foreign exchange markets. This was particularly on the immediate heels of the crisis, as there was a repatriation of assets into the United States. There was strength in the U.S. dollar in the fall of 2008 because of the movement of assets into the most liquid markets, some of which are in U.S. dollars. As things were stabilized, part of that unwound, and that was part of what we saw earlier this year. Different currencies have moved at different levels reflecting different prospects for growth and inflation, the analog of the factors I just mentioned for Canada.
It is not surprising that others have moved in different directions. Others have strengthened more than Canada over the course of time and some have moved equally as well.
[Translation]
Senator Massicotte: Mr. Jenkins, your input is always welcome and very enlightening. I would like to follow up a question asked by the committee chair regarding the changes that need to be made. We know that Canada did not suffer as much from the economic crisis as other countries.
In your speech last week in Montreal, you stated that Canada had much to learn from the weaknesses and experiences other countries have faced in the past year. Following your speech, you listed some of the major changes that need to be made. Things are getting better and moving forward quite nicely. Many executives of financial institutions confirm that assessment and are saying that there is a concern about having too much regulation.
My fear is that parliamentarians' focus on and interest in the changes proposed by the G20 will dissipate in the coming months as the economy continues to thrive. I am also afraid that the political will will no longer be there.
Things may be happening that we cannot see, but I do not see much. Yesterday in the United States, President Obama tabled a bill that would restructure the Federal Reserve. Is something happening that we do not know about? Are you equally concerned that our political appetite will disappear and we will stay with the same old system without finding the courage to change our structures?
Mr. Carney: That is a good question. First of all, I would like to make it clear that the G20 plan includes significant changes in the capital, the equity of major financial institutions. As I said in Montreal a few days ago, the first two changes will bring foreign financial institutions up to Canadian standards, meaning there will be an increase in minimum equity. What will be new is the introduction of an anti-cyclical cushion of capital.
[English]
If we do succeed, that will be a major change. A lot of work needs to be done, and we are working closely with OSFI on developing such a counter-cyclical buffer, which is important.
The changes to market infrastructures that I mentioned would be important changes. In the bank's opinion, they should be pursued with real determination. We are just at the start of that process. That means we must work with industry, obviously, but also with provincial securities regulators and the federal Department of Finance to put them into effect. We are doing that and those working relationships are in place. However, it needs attention and focus to ensure that these are done and are not left by the wayside, as you suggested in your introduction, as things improve.
I want to emphasize that we need to look at formalizing our cooperation on macro-prudential issues between the various federal and provincial agencies. At present, the bank has an informal grouping called Heads of Agencies that brings together all the heads of relevant agencies, and it works well. We talk about issues that I just raised, for example, but it is not a formal mechanism. This is the responsibility of the Minister of Finance. He has helped lead the discussions at the G20 level to encourage others to do this.
I know he has thoughts on this that he will share at the appropriate time.
[Translation]
Senator Massicotte: In your report, you state that the high Canadian dollar is hindering economic growth and cancelling out the favourable developments that have occurred since July. Specifically, what percentage of the GDP does a 96- or 95-cent Canadian dollar represent? Compared to the government's tax incentive, what percentage of the GDP does it represent?
There are some experts who say that while the economy is doing better, when the incentive effect of the government's program disappears a year and a half from now, the economy will shrink again because we are overly dependent on artificial incentives from the federal government.
Can you give us a percentage that would indicate how relevant these numbers are? Do you agree that there is a risk of backsliding when the government incentive disappears?
Mr. Carney: The government's monetary stimulus will end in the second quarter of 2011. That is one aspect of our projections. Investment will probably start increasing in early 2011. Our economy currently has plenty of flexibility, and the recovery will be unique compared with other economies.
According to bank executives, there will be an increase in consumer spending, more monetary stimulus, less investment and lower net exports. Overall, the recovery will be smaller, but a recovery none the less. As I said, we are projecting 3.3 per cent growth in the GDP for 2011.
Senator Massicotte: With a fairly high degree of certainty?
Mr. Carney: The level of certainty drops. It is easier to be certain when we are making short-term projections. The level of certainty drops but is still high as the chair said, the situation is still fragile.
Senator Massicotte: What is the percentage of expenditures under the special government program?
Mr. Carney: Government contributions to Canadian growth in 2010 are 1 per cent.
Senator Massicotte: If the dollar is overvalued by 15 per cent, how will that affect the GDP? One percentage point, perhaps?
Mr. Carney: It is hard to say.
Senator Massicotte: Generally?
Mr. Jenkins: It's one of the reasons on the impact of the dollar.
Senator Massicotte: Perhaps the impact of the dollar will offset almost exactly the impact of the federal stimulus. Perhaps the Canadian dollar will be stalled by economic growth.
Mr. Carney: Your question basically concerns the growth rate in 2011, and it is actually the Bank of Canada's job to meet the inflation target in 2011. So if we're in a situation where we are going to miss our target, we will change our policy, provide more monetary stimulus; that's our job.
[English]
We will take fiscal policy as it is given. If there is a factor, whether confidence, U.S. growth, terms of trade, or the level of the currency, or if there is a combination of those factors, including changes in fiscal policy, that mean we are unlikely to meet our inflation target or be below our inflation target, and if we view those factors as persistent, we will adjust our policy.
Senator Massicotte: If our dollar goes up, the inflation factor goes down. Is that right?
Mr. Carney: All else being equal, yes.
Senator Massicotte: If the dollar stays high and everything else stays equal, then the inflation target goes down and it will not be met.
Mr. Carney: Yes.
Senator Massicotte: However, you are probably at the lowest level of interest rates you can set. What will you do to get there if the doom and gloom proposed by some analysts is realized?
Mr. Carney: In April, we outlined our framework for a policy of low interest rates for exactly this reason. We have options, if they are necessary. We have considerable flexibility. Those options include credit easing and quantitative easing, or a combination of both and, as Mr. Jenkins reminds me, our conditional statement.
We have given the conditional commitment. We have a time horizon on that conditional commitment. We can adjust that. We could pursue either quantitative or credit easing or a combination of the two if it were required. The message is clear: We would do that, if necessary and only to the extent necessary. We would do any combination of those in order to achieve the target.
Senator Gerstein: If there is one thing that Canadians are never happy with, in addition to their local hockey teams, it is the value of the Canadian dollar. It is hard to believe that almost a decade ago, the Canadian dollar was flirting with U.S. 62 cents, which I suspect was a record low. Many lamented the future of the loonie. If we fast forward to today, we find some Canadians are now fretting about a strong dollar, which has both costs and benefits. The costs are very real to those who export manufactured goods and forestry products. At the same time, a stronger dollar reduces pressures.
Does the Bank of Canada have any estimates to indicate what effect of the higher dollar will have on Canadian consumer prices? Our dollar going up is a reflection, to some degree, of the U.S. dollar going down. I suspect that the lower U.S. dollar will stimulate sales out of the United States. Does the bank expect any spill over effect from the additional business that might be done in the United States to Canada as a result of their dollar?
Mr. Carney: The issue of the direct impact of currency movements, whether up or down, on the rate of inflation, is commonly known as the pass-through of changes in exchange rates on inflation. Direct pass-through occurs with some products, such as food products and direct commodity imports, and is virtually 100 per cent and quite quick. Direct pass-throughs are important. I would underscore that core food items are part of our core measure of CPI. One sees that directly. On energy prices, it is less than full, but it is substantial.
On a broader range of goods and services, the level of pass-through is smaller. There is much controversy over how small is small and over what time frame small is realized. In fact, a colleague of ours, John Murray, gave a speech on this about 18 months ago. I would be happy to circulate a copy for the committee if it is of interest. It moves to the order of single-digit percentages around 5 per cent over three years in terms of the ultimate pass-through once you get to the broader basket of goods. It is important, but it is not one-to-one. We can recognize the reasons. For example, a variety of elements in the consumer basket are domestically produced, for which there is no import competition, such as a number of services.
Mr. Jenkins: The other point I would make in terms of the price impact from a movement in the exchange rate that the Governor is talking about, is what we refer to as the direct price level impact. If the dollar were to go up or down, there are certain prices in U.S. dollars that would reflect that movement quickly, such as fruits and vegetables. The other element is the impact of an exchange rate movement on aggregate demand, which is the other part of your question. This goes back a bit to Senator Massicotte's question. In terms of analyzing that, it is important to ask why the exchange rate is moving. If it is moving because of factors in the Canadian economy, that is one thing. However, if the exchange rate moves simply because of a generalized weakness in the U.S. dollar, with no Canadian offset of any kind such as higher or lower commodity prices, then it has very different implications. We have models to help us work this through. When there is a movement in the exchange rate, we are able to think through the implications on U.S. demand and back onto the Canadian economy. I do not want to be seen as ducking the question, but these relationships are many in number and go in both directions. Our task is to add all of that up.
Senator Gerstein: Does the Bank expect any spill over into Canada from increased U.S. activity?
Mr. Carney: Your question is very on point. One of the unfortunate realities of the U.S. recession is that it was particularly difficult for Canada. The sectors that mattered the most for Canada and the U.S. economy were hit the hardest. Obviously, everyone knows about the housing and auto sectors. Those are two examples but there are broader examples.
The good news is that going forward for a period, not to overplay it but it is a net positive, those sectors having fallen so far have begun to stabilize and come back. Relative to the level of U.S. growth in 2010, the bank projects 1.8 per cent growth for the United States in 2010. This is a modest recovery given how far they have gone down. U.S. activity will be stronger than that. We have a U.S. activity index. We gave the detail of it in the July Monetary Policy Report. U.S. activity will be stronger than GDP, and a recovery of that nature is better for Canada.
If U.S. housing starts dropped into the low 500,000 level, those coming back to 750,000 or 800,000 starts in 2010, which is consistent with our expectations, has a bigger impact here. Remember that about 1.6 million was an average prior to the crisis, and it reached as high as 2.1 million as its peak.
Your point about U.S. activity is dead on. That is one of the positive factors we have seen. For even those components of U.S. activity that matter for Canada, our U.S. projection has not changed much, but a bit of the composition has moved in our favour. That is one of the many positive factors we have seen, net with the currency where we have assumed it, at 96 cents. That is a backward-looking assumption, making no value judgment, but simply looking at where it was.
Senator Moore: Thank you, gentlemen, for being here. Who are the auditors for the Bank of Canada?
Mr. Carney: They are PWC and KPMG, but we rotate one of the auditors every three years.
Senator Moore: So you always have continuity.
Mr. Carney: Yes.
Senator Moore: Reading through your recent speeches, I keep hearing more about the Bank for International Settlements and the Basel Committee on Banking Supervision. I do not think Canadians know anything about that. That seems to be the structure under which you are working to achieve your macroeconomic goals, and hopefully to get some stabilization in the financial sector. I just looked at the website, and it says the voting power is proportionate to the number of BIS shares issued in the country of each member represented at the meeting. Are you a director of that bank?
Mr. Carney: I am a director, yes.
Senator Moore: What is our voting power, and how many shares do we have? Is that the way it works?
Mr. Carney: I will get back with the precise number of shares, but it is in the order of 8,200. I am an elected director of the BIS and a member of its audit committee. I want to get to the thrust of your question, which is who is making these decisions about regulation and the future of regulation.
Senator Moore: How many shares were issued total?
Mr. Carney: Off the top of my head, I do not know. We would be in the middle of the pack, ninth or tenth. We will come back with the full shareholding. The BIS was founded in the 1930s originally to deal with war reparations, and the core share holding banks at that time were the Belgian central bank, the Swiss, the Bank of England, the New York fed.
Can I get to the thrust?
Senator Moore: Yes. I would like you to tell us what its role is and how you get to participate and the cooperation that you are getting from your fellows.
Mr. Carney: I will say that being a member of the board of the BIS is of tremendous use because the G7 governors, plus the governors of Switzerland, Belgium, Sweden and the head of the New York fed, meet every six weeks in private. There is an extremely open dialogue about the state of the world and the state of the financial system. Over the years, as Mr. Jenkins knows as well, having participated in a number of these, there has been extraordinary cooperation in times of strain. During this crisis, those relationships were drawn upon consistently.
As to the substance and the business of the BIS itself, it is a bank for central banks. The regulatory agenda is being set, if I could walk through the governance of the regulatory agenda, because I think it is important.
Senator Moore: This is how you are trying to achieve the international standards and stability?
Mr. Carney: Yes. At its top are the leaders of the G20 countries, who have met several times and issued detailed communiqués and instructions to their ministers of finance and central bank governors and regulators. There is an organization that reports to the G20 ministers of finance and central bank governors called the Financial Stability Board, which is comprised of regulators, central banks and ministries of finance.
Senator Moore: Is the Financial Stability Board is a unit of the BIS?
Mr. Carney: It is not a unit of the BIS. It is an independent body. In Pittsburgh last month, it was given an independent charter. It is an independent body.
Senator Moore: Where does it get its research and information, or does it do its own?
Mr. Carney: It gets some research from the BIS and some funding from the BIS, but its substance comes up from below from various standard-setting committees, which was my next level on the chain. Then there is IOSCO, the international securities commission, and for bank capital, the Basel committee, which you referenced, which is a standard-setting committee for bank capital comprised of central banks and regulators. OSFI is a member of the Basel committee, and the Bank of Canada is a member of the Basel committee, and we each have a member. That committee reports to the relevant central bank governors and regulators. The Superintendent of Financial Institutions, Julie Dickson and myself, and all the members of the G20 countries are members of that.
We have been given instructions, starting from heads of government, including Canada's Prime Minister, to come up with a new capital regime. I referenced some of the elements of that. We fully intend to implement those instructions. Ultimately, the financial stability board, ministers and governors of the G20 and leaders of the G20 will decide whether we have fulfilled those instructions in the spirit of the proposals that will be coming forth in 2010.
The message I had in Montreal to the financial institutions was: ``Make no mistake; if the leaders have got together and decided they will make these changes, they will be implemented.'' We are working extremely diligently and hard to make these changes, and they are profound changes to capital and the structure of markets.
Senator Moore: Back in May when you were here, I asked you about the moral hazard inequity of a bad decision being rewarded when public money is involved. You said at the time that you could assure all senators that moral hazard is a term used more frequently in the Bank of Canada than virtually anywhere in the country. I also asked you about the importance of the upturn in the U.S. and U.K., at least the stabilizing of their systems, in order for Canada's financial situation to move upward, and you said that was absolutely critical.
I think of your remarks the other day when you said that we are awash in moral hazard and if left unchecked, it will distort private behaviour and inflate public costs. You went on to say:
the Bank of Canada has a strong preference for principles-based regulation and reliance on the judgment of people, rather than blind faith in the security blanket of excess capital. But this approach requires a sensitivity from the industry, which has been absent in recent months. Relief is in danger of giving way to hubris.
When I think of hubris, I think of the forecast $140 billion that 23 Wall Street financial companies will share this year. Were you talking to the international audience, or were you talking to the Canadian financial sector and our banks when you made those remarks? Are you speaking as one of the team from the BIS financial stability group in trying to get the message out?
Mr. Carney: Thank you for the question. The last is the right answer. I am speaking as a member of the G20, trying to get across to the global financial system the seriousness with which we are taking these changes. I am expressing a level of disappointment with the seriousness with which the industry is treating some of these changes.
In terms of the point on moral hazard, the issue is clear: A series of institutions were saved, because it was judged that they had to be saved during the crisis. There is no quibble with those decisions that others had to take — not in Canada. However, the behaviour will return if it is left unchecked and if we do not change the systems so that firms cannot fail and so that shareholders, management and bond-holders can bear the consequences of bad decisions going forward.
My comments were consistent with comments in recent days from other G10 central bank governors on the same subject.
Senator Moore: I have one last short question.
You mentioned global competition is substantially reduced due to the combination of failure of institutions, a decline in cross-border banking and, most importantly, the collapse of most of the shadow banking system.
I read some things about that. I do not pretend to know a lot about it. It was scary; internationally and financially it was.
Were any Canadian banks involved in doing shadow banking?
Mr. Carney: No. Briefly, shadow banks are institutions that were not regulated as banks in a variety of jurisdictions that effectively carried out bank-like activities. A classic example of this would be what were called structured investment vehicles, SIVs. They would borrow money in the commercial paper market and then lend that money long term by buying longer-term, very opaque, difficult-to-structure assets. It turned out to be a great strategy in the boom when no one was focusing on detail. It was a terrible strategy at the first signs of stress.
The other important leg of shadow banking was finance vehicles of some major corporations.
Senator Moore: They were off their books.
Mr. Carney: Effectively, they were off their books. They were deconsolidated financial entities. It is another way of saying what you just said.
Those vehicles, and some of the markets they supported — structured product markets and securitization markets — did have the effect of providing some competitive discipline. Their exit, and the exit of some major cross-border banks from activities in certain jurisdictions, has meant that the level of competition has gone down.
Senator Moore: You are interested in having these derivatives on some kind of an exchange, right? Are you not talking about central clearing?
Mr. Carney: We all know what an exchange is. A clearing house does not have the posted prices and is just a mechanism for crossing or settling the trades. It is used in a variety of markets. That is an idea we have been sympathetic to, and we were pleased that leaders endorsed the idea and have directed that back through this chain of command to investigate it. We are signalling that this is important.
Senator Moore: You are signalling to the international community, you mean?
Mr. Carney: Yes.
Senator Oliver: My question relates to the last point you made in your prepared statement. You said: ``To put it simply, the bank looks at everything through the prism of achieving our inflation target.''
On two occasions today, you have said that our mandate is the 2 per cent. I want to challenge that mandate. The Bank of Canada conducts monetary policy by adjusting the target for the overnight interest rate in order to keep inflation at this rate.
Is the explicit targeting of inflation the best framework, in your mind, to use in ``promoting the economic and financial welfare of Canada,'' as outlined in the Bank of Canada Act. That is the language from the act, from which you would get your mandate. Alternatively, does such targeting lead to rigidities in the determination of monetary policy in Canada?
What would the implications be of targeting price levels, rather than inflation rates for price stability? What are the main upside and downside risks of the banks on the inflation projections?
I ask these questions because, on October 8, 2009, Mr. Jenkins said to the Vancouver Board of Trade that you are studying some new targets. He said the bank is looking at two questions: What are the costs and benefits of a lower inflation target than the 2 per cent you said is your mandate, and what are the costs and benefits of a price level target?
Mr. Carney: Thank you for raising this issue. First, to remind committee members, the bank and the Government of Canada enter into an inflation control agreement that sets the specifics — the price stability. What is price stability? What is the bank targeting? What are we trying to achieve?
Our most agreement runs to the end of 2011 and has explicitly, as you know, the 2 per cent inflation target in there.
However, we believe it is our responsibility to continue to determine the answer to your question; namely, whether that is the best monetary framework for the country.
Senator Oliver: Because that is part of your mandate.
Mr. Carney: Yes, because it is part of our mandate. We want to be sure whether this is this the last word on what we should be doing.
Obviously, it is not our sole decision, but it is our job to think through what would be best for the country. We have been conducting an extensive research program, both internally, with external experts and with other central banks. That is in midstream on exactly the issues you noted. I will pass to Mr. Jenkins in a second to talk a bit more about that.
The issue of whether price level targeting is superior to inflation targeting is a complex one and one that has to be given a great deal of thought, both theoretically and practically.
I will finish my bit of the answer by saying that it would be our intent later in 2010 and into 2011 to discuss price level targeting versus inflation targeting. We would welcome the opportunity to come back to this committee to discuss in more detail the issues around price level or lower inflation target. We have provided some public research, including our most recent Bank of Canada review, as well. There will be more research coming forth and we welcome the opportunity to discuss that in a bit more detail.
Since you referenced Mr. Jenkins' speech, I would ask him to provide more information.
Senator Oliver: Are you leaning towards, perhaps, lower inflation targets now? Is that where your research is seeing —
Mr. Carney: I would say it is too early to come to any conclusions. The price-level targeting research merits continued focus.
We will continue to invest in it, but it is too early to come back leaning one way or another. It would be irresponsible for us at this point to give an indication.
Mr. Jenkins: Back in November 2006, when we updated the renewal with the government concerning our 2 per cent inflation target, the bank launched this research agenda to address these two questions. The bank wanted to do that right away so that we could use the full stretch of the five years of the agreement to look at these issues. They are complex issues and they involve a great deal of research.
We have been fortunate that we have been able to draw in other researchers from other central banks to look at these issues. We have set up a wiki website to encourage discussion and debate on these issues. Our researchers at the bank have made good progress but, as the governor indicated, it is certainly too early to draw conclusions.
The other question you asked was in the context of risks around our inflation forecast. Very much in the spirit of the 2 per cent target being our mandate, when we put our projections together, we do so in such a way that we see risks being balanced around our inflation outlook. In our Monetary Policy Report projections, we see risks on both the upside and the downside, and we try to balance those off. From our point of view we present our best guess in the MPR. We see the risks as being balanced in terms of us being able to return to our 2 per cent target which, in this case, would be in the third quarter of 2011.
Senator Oliver: Is the fact that we are in a recession making some of your research more difficult now?
Mr. Carney: No. Actually, there are advantages. I was about to say that we are fortunate to have had this experience, but I will not go there, so if we could strike that from the record. It is too late now. I see ``Public Broadcast'' sign up there.
A number of things that happened in other countries during this crisis are relevant to this research. One small but not totally irrelevant point is the relationship between price and financial stability. That is something we have looked at which would have to be integrated into any recommendation or view that we have on the relative merits of price level versus inflation target, for example. The core issue is around the best definition of price stability, not theoretically, but practically. That very much turns on how Canadians would react, how expectations are formed and how the bank would communicate. It is a very important research agenda for the bank. In fact, it is our top priority. I appreciate that question.
Senator Massicotte: You were talking about price levels and inflation. Obviously, your focus is inflation, which is more consumer oriented. Yet, within the last week you made some comments about housing price levels being a bit too high. Would that not suggest that you are now getting to the area of asset pricing?
Mr. Carney: Yes.
Senator Massicotte: Are you suggesting that the Bank of Canada should now consider asset pricing and its target inflation, or will you remain consumer-based?
Mr. Carney: I am glad you asked that. Allow me to clear up a couple of things. First, I did not make a comment, and nor did any of my colleagues, about the level of house prices in Canada. That might have been a question, but that was not validated by anything we have had.
Second, with respect to housing, one advantage that Canada has is that housing enters directly into our consumer price basket. Shelter as a whole is a little more than 22 per cent. The more direct elements that can be attributed to housing are around 16 per cent. That goes through rent, mortgage costs, et cetera.
The effective house price appreciation or depreciation is still net on most indices. It is down in Canada year on year. That is something that gets lost in this discussion. The advantage is that it enters directly in, so we must take that into account in the setting of monetary policy.
We have done and continue to do research. We are not fans of using monetary policy to swing between targeting consumer prices and targeting other asset prices. We continue to view focusing on what matters to Canadians, namely, the consumer price basket, which is our mandate, as being the most effective.
On the overall issue of asset-priced targeting, we would change the topic, if we could, to credit formation and credit growth. Is credit growth too fast or too flow, is it exacerbating cycles? That is where most elements of this macro- prudential agenda come in and the counter-cyclical capital buffers that we have referenced a couple of times. That is part of what they are trying to get. It is not to target an asset but to begin to lean into the wind of credit growth, whether positive or negative, that amplify economic cycles.
[Translation]
Senator Dawson: In this fine committee, the right questions have often been asked. Senator Greene asked what an ideal rate would be. What would be ideal for a deficit? $50, 60 or 70 billion? Because Senator Massicotte's question is perhaps that after a while, we will fall back into our old habits. We get used to things and they change our habits.
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``When the governor speaks, the people listen. It is an old expression that comes from E.F. Hutton. They used to say in their advertising, ``When E.F. Hutton speaks, people listen.'' The problem is that E.F. Hutton does not exist anymore.
Mr. Carney, people obviously listen to you on the dollar. You had a strong influence in the past week, but they might stop listening because E.F. Hutton no longer exists. You have also had influence on the economy. I hope that people continue to listen because we do fall back into habits, be it deficit financing or banks abusing their privileges.
How long do you think people will continue listening to you? What is a decent level at which we have to stop thinking that we can continue funding this stimulation by deficits of $50 billion, $60 billion or $70 billion?
Mr. Carney: I hope that people will listen to us for another five years and four months.
It is important that people remember that we are just focused on our target. It is a democratically set target, but we have been given a mandate and we remain focused on the target.
Second, we must have a clear policy framework for delivering that target, including considerable options if we must supply additional monetary stimulus to the economy because of some persistent external shock so that we have the ability to achieve our inflation target. In the last six months people have sometimes downplayed that a bit too much. We have a framework. It is not a question of cleverly chosen words or interventions. We have a framework, and every day we look at how to best apply that framework to meet the inflation target. We will do it because we have a clear mandate.
One of the great benefits of inflation targeting is that in the end our objectives are simple. It is very clear. You will be able to tell if we have achieved them. We do not get an out if there are problems in the United States or elsewhere or if there is a boom elsewhere. We still have the means, with a floating exchange rate, to achieve our inflation target and we are held accountable for that by yourselves, by the House of Commons and by Canadians.
On the deficit, clearly it is important in every country, including Canada, that we have a sustainable medium-term fiscal situation. That is necessary. We all lived through the 1990s and know what it took to get there. This committee knows the demographic situation probably better than most, and we know the need to have our fiscal house in order to meet those demographic challenges.
There was a need, in the teeth of this crisis, to supply considerable stimulus to help start and move to the recovery. That was in the judgment of not just the Government of Canada but also the Bank of Canada and many external observers, the IMF and other members of the G7.
I would remind you that fully one third of our growth next year, according to our projections, will come from the continued stimulus provided by government spending, federal and provincial, in 2010.
We expect that that stimulus will be withdrawn in 2011. Those are decisions of government and we will deal with whatever decisions the various governments take, but, based on all that, it comes together. The country will need to return to a sustainable fiscal track. It will depend on how the economy evolves, but there are difficult decisions that need to be taken, without question, for budgets after 2011.
Senator Frum: Governor, my question is about pent-up consumer demand and debt. On page 21 of your latest Monetary Policy Report, we are told that ``continued robust growth in narrow money reflects the desire of both households and firms to keep money in liquid assets until it is clear that the recovery is taking hold.''
In this context it is interesting to note that total household credit grew during each and every month of the downturn, yet now we see the Bank urging prudence. We heard you state in your press conference that consumer borrowing cannot grow faster than the economy forever.
That brings me to two related questions. First, does the rather large amount of cash that Canadians have sitting in bank accounts hold the potential to fuel a faster-than-expected recovery as confidence returns?
Second, could you elaborate a bit as to the reason for the bank's concerns regarding the growth in total household credit? Is the run-up in household debt a factor that would weigh upon any decision to increase interest rates, given that doing so would reduce the funds available to consumers for other spending?
Mr. Carney: Thank you for those questions.
First with respect to the liquidity in the economy, monetary aggregates, as you referenced from our report, it does bear noting that narrow money, M1 ++ in particular, is at the highest levels that have been seen, period. That is consistent with what we have seen, which has been a tremendous precautionary demand for the most liquid assets. That is not surprising for households, given what happened to other asset markets and past experience, given uncertainties about the job market and other uncertainties about global outlook.
Also importantly, one of the unfortunate difficulties of this period has been that it has been tough for small- and medium-size businesses to get credit. That is often the case in a recession. To go back to the exchange on the shadow- banking system, it probably has been accentuated in this case, in part, because some of the suppliers of credit to smaller and medium-sized businesses were finance companies that have exited the market in Canada. There has been a restriction of the availability of credit. Not surprisingly, enterprises that can are maintaining very high levels of liquidity so they are not caught out.
We expect that to diminish gradually. We are watching this closely. There are imperfections in the amount of information that you get from crude monetary aggregates. We are watching these and others closely, and supplementing the aggregates with surveys and other analyses.
With respect to household debt, the point of your question is whether we would swing our focus of monetary policy from achieving our CPI inflation target to targeting household debt. The answer is no. We have to keep our focus. We have one instrument, which is our overnight rate, and we have one objective.
We have watching closely, though, the developments in the household credit. We are doing a series of analyses about improvements in the position of various household cohorts and we will be releasing some of that analysis in our financial stability report in December.
We think it bears stressing that rates are exceptionally low right now — not just our rate but a number of rates. For example, five-year mortgage rates and floating-rate mortgages are low. Over the lifetime of a mortgage, for example, they will normalize as you refinance. It is only prudent that people look through the life cycle of rates to ensure that they are borrowing appropriately. It is also only appropriate and prudent that financial institutions on the other side of the relationship take that into account as well.
All of that said, debt-servicing ratios for Canadian households remain below historic averages. We welcome the discussion of this issue because it is anticipatory. People are anticipating a potential vulnerability as opposed to looking in the rear-view mirror and seeing a vulnerability that is already here. That is one of the ways that one prevents that.
The last word I have on this is that if we are not going to use our interest rate and if this were to persist and we maintain our focus on CPI, as we rightly should and are mandated to do, there are other options. The housing market is subject to considerable regulation and policy influence. The institutions that supply the credit are regulated; mortgage insurance is regulated, and we are in open dialogue with those regulators.
If it were appropriate — and I am not saying it is at this stage, the first line of defence should be adjustment to those prudential regulations and standards in conduct to have sustainable housing finance in this country. I have every reason to expect that that will continue to be the case. Speaking hypothetically, that would be the way to approach it.
The Chair: Governor, you referenced the overnight rate. Did you attribute any significance to the fact that, as I understand it, the gap between the private sector's prime lending rate and the overnight rate has increased from 1.75 to 2 per cent? Is there anything to be read into that?
Mr. Carney: I do not believe that is the case. What was the case recently was that, within the past month, the five- year fixed mortgage rate for a number of institutions was raised, which reflected movements up in the five-year government bond yield in Canada. It was an understandable move.
On page 20 of the MRP we give, as of October 16, the various rates. We have not seen a move in prime. In fact, what we have seen — going back to Senator Frum's point — in the actual variable mortgage rate, at 2.25 per cent, those rates on the mortgage side have come consistent with prime.
Senator Harb: Thank you for your excellent presentation.
I have a follow-up to one of Senator Oliver's questions dealing with inflation. You use a slightly different measure for that. You use the Consumer Price Index but you do not include in it about seven or eight volatile items or indirect taxes. Why do you do that?
Further, if you were to use the same principle as the Consumer Price Index that is being used, what would the inflation rate be? Would it be more or less?
Mr. Carney: We do target the Consumer Price Index. We also look at other measures of inflation that are good predictors of the CPI and core inflation. That removes the eight most volatile items. They are not cherry picked from the CPI basket. This is a better predictor of future CPI than CPI itself. That is the case for Canada. It is an established empirical relationship.
One could even take the situation we are in right now, as I referenced in my opening remarks. Total CPI inflation was negative 0.9 per cent in the third quarter. Core inflation is running about 1.5 per cent in the most recent measure.
What is the bank's judgment of underlying inflation in Canada? It is not negative 0.9 per cent. It is consistent with the core. If we look at the other measures, what we expect to see — and we will all find out — is that as this big year- on-year effect from high gas and energy prices comes off, total CPI inflation will move up to one per cent next quarter. It will then start to converge towards core. We then see both figures moving toward two per cent in 2011.
There should be no uncertainty about what we are ultimately targeting. We are targeting two per cent of CPI inflation. That is how we should be measured. What is the best way to look at it and to understand the underlying inflation pressures to avoid being swung around by these eight most volatile items? That is why they are adjusted for. You would have greater volatility otherwise.
Mr. Jenkins: From an empirical point of view, as the governor indicated, the total CPI, which is our target, converges over time to this core measure as these volatile components either are offset or no longer have influence on the total consumer price index. If you are hit by a large energy price shock, either up or down, it will have an influence temporarily. However, the total CPI will return to the core measure. This is why we look at both. As the governor indicated, total CPI is our target.
Senator Harb: How are other G8 or G20 countries doing it? What sort of measures do they use? Do they use something similar to Canada? Is there a standard that everyone follows?
Mr. Jenkins: The inflation-targeting central banks would all use a total consumer price index. There are differences in terms of the basket of goods and services included in one country versus another. In the Canadian context, we feel the CPI, the basket, is very representative. It includes house prices, which has served us well from a monetary price point of view. Likewise, the quality of the measure of the CPI in Canada is very good. This is something that we need to preserve because that is what we target in the end.
Senator Harb: Do we or should we measure world inflation rates like we measure world economic growth?
Mr. Jenkins: We absolutely follow it. Four times per year we put together a world economic outlook. We need to know what is going on in China, the United States and Europe for their influences on commodity prices. We look at both real growth and inflation from a global perspective. We track that closely.
Senator Harb: Governor, you said you have a number of means at your disposal to stabilize the market and to ensure your goals and objectives are met. Could buying U.S. dollars be one of the things you do to chase speculators who are driving up the dollar somehow? Is that something you should do or consider?
Mr. Carney: We should only use the tools we have, which include foreign exchange intervention, in a manner consistent with achieving the inflation target. That would be the objective of any policy action we would take. The range of tools does include that.
[Translation]
Senator Hervieux-Payette: I looked at your report, and on page 20 you comment on Figure 17. My colleague spoke earlier about household credit and you are talking about business credit, which continues to decline, and on page 25, you state that you except business investment to recover in 2010.
I wonder, considering all the problems the financial sector has experienced: is it business credit that is weak? We regularly hear that businesses are having trouble financing their line of credit, their working capital, and so on. Do you talk to the banks to ask them why, when people have been in business for 20 years and have always met their obligations, they are so skittish when it comes to advancing funds, both short- and long-term loans?
Mr. Carney: Yes, we have a lot of discussions with our banks and not just Canadian banks, but also foreign banks that operate here and other credit providers in Canada.
The current experience with business credit in Canada, it's pretty much normal for a session of this scale, more or less, is just a bit lower, yes, probably its lower for small and medium-size businesses. For big businesses in Canada, now, for several months, the recovery or perhaps I can say reopening of capital markets, the corporate bond market, has created a more normal situation, almost normal, for credit.
What I mean is that now, for the past month, it is now public, it is after this report was released, business credit started to grow again in Canada in September. And every aspect improved in September.
So the situation may be hard, but a recession is hard on businesses.
Senator Hervieux-Payette: Can we conclude that there was no problem in terms of the banks having cash to lend but they were more hesitant after writing off losses, not necessarily in the banking industry, but in other subsectors of the securities industry? Since the Bank Act was amended in 1995, banks have been allowed to acquire most investment firms in the securities sector. Since the act was amended, I get the feeling that they are more interested in the financial growth of the securities industry than the banking industry per se.
Mr. Carney: Yes, but there will be changes to the rules on bank holdings, the amount of holdings for stock market transactions, capital market transactions, will be doubled in 2010. That is a Banking Committee decision which we discussed.
In my view, in our view, banks think it is better to extend credit to households than to businesses. Now it is obvious, and it is one aspect of the situation that we just discussed with Senator Frum.
[English]
I would say that the balance here will change a bit, because of what I had mentioned. The situation is not that unusual, given the severity of the recession and the strain some sectors are under. The situation is starting to move. That said, we do follow this closely, senator. The availability and cost of credit, within the context of all these other factors, is one of the reasons why our policy is where it is. It is to take these strains into account.
[Translation]
Mr. Jenkins: One of the more positive things for businesses lately is the strength of capital markets where the cost of borrowing is very low and the level of activity is stronger. In the past, when the crisis was at its peak, capital markets by and large were not an option for most businesses.
Senator Hervieux-Payette: One last question that does not pertain to businesses and credit; when you revamp the system, are you going to look at the way credit rating agencies are regulated so that subprimes do not eventually get a triple A rating and informed investors and consumers alike know that when a credit review is being done, they can get the truth? There are no rules now, not for Moody or for Standard & Poor or for other agencies, I am not aware of any. With colleagues in other countries, they operate in many countries, do you plan to look at how these agencies can be trusted, which at the end of the day play a very important role in the finance sector and essentially backed many financial products that were very bad?
Mr. Carney: That is one of the causes of the crisis. If someone invests in a bond, any bond, a corporate or ``secured'' bond, a credit review has to be done, that part obviously can't be outsourced.
There are new principles, standards for credit rating agencies now. They require authorities to reduce automatic use of ratings, for example in capital rules; almost everywhere, we have to sever the links between the two, between the rules and the decisions made by rating agencies. Public authorities have strengthened those links and the central positions of rating agencies.
Senator Hervieux-Payette: I would like to clarify one thing. At the beginning of the year, several banks issued different types of bonds that were not shares rated with the same rating as the bank. Six months later, the same rating agencies, claiming the banks were weaker because of the quality of the mortgages they held, our Canadian banks' instruments were downgraded two levels. I say this because if individual Canadians with small savings who were definitely interested in getting a 5.5 per cent or 6 per cent return on their capital if they need to take out their money, they won't because they won't get $100 dollars for every $100 they invest. There will still be 5.5 per cent interest. I tried to get an answer to that question. How is that I didn't hear you say at some point that our banks were in trouble and six months later, the same financial instruments were rated lower by the same agencies, meaning their value decreased and people with small savings incurred substantial losses.
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Mr. Carney: We are not aware of any material difficulties in our financial institutions. Obviously, life goes on and they will take decisions going forward. The Superintendent of Financial Institutions will continue to monitor them. As governor, as a member of the Financial Institutions Supervisory Committee, I, along with the federal Department of Finance, the chair of CDIC and the head of the Financial Consumer Agency of Canada, will participate in those discussions. However, I would not want to leave a misimpression in my response to your question.
That said, individuals who purchase securities, whether they are shares or bonds, take risk. They should be under no illusion that they are taking a risk. That is what a capital market is. The only guaranteed risk-free Canada dollar securities are securities of the Government of Canada, or guaranteed by the Government of Canada. The vast majority of Canadians are mature and sophisticated enough to recognize that investment in capital markets involves risk, and our system is founded on that.
I go back to my earlier point at the start of this discussion that institutional investors and professional investors do need to have independent ability to judge credit. They do need to do their homework. It will take a little more time. It will be a little more cumbersome, but it will pay off in the end. Overall, I think that is a better world for Canadian finance than the previous world, which relied on outsourcing of credit decisions. That is because, in relative terms, in our opinion, the Canadian financial industry is pretty good at credit judgment and risk management, and that is one of our potential advantages going forward.
Senator Merchant: Governor, my question addresses whatever the Swiss and the Chinese, to give two examples, call their currency exchange approach.
Since 1998, Canada has allowed markets to decide where our currency should trade. Your near zero overnight rate and the extent of pumping reserves into the banking system are unprecedented. The usual tools of currency nudging are unavailable to you. The fear is that a hollowing out of our industrial base will occur when resources drive our dollar up.
Some countries choose a middle course between a fixed exchange rate, which would peg us to the U.S., and our market-driven rate. China has steered its currency often just with threats of intervention, because speculators, knowing that the government will intervene in the market, back away.
Even a bastion of free-market principles, Switzerland, intervened successfully this year to stop the franc's appreciation against the euro.
Is non-intervention since 1998 government policy so you are not permitted to impact our dollar by entering into the market? Other than China and Switzerland, are there other nations whose monetary policy you admire, who intervene but rarely? Where is the problem in a float with rare interventions in extraordinary circumstances?
Today, for example, with mid-range resource prices, there is speculation about their increase. We have the worst of both worlds, since we are not generating big resource incomes but speculators are driving our dollar up with the attendant damage to the industrial side of our economy.
Mr. Carney: The Bank of Canada and the Government of Canada have a policy on foreign exchange intervention. It is freely disclosed on our website. Intervention could be contemplated and exercised in situations where there is a breakdown in foreign exchange markets. For example, if there is gapping, if the market becomes thin, if it is not operating properly; or if movements in the currency, up or down, are such that they call into question the economic outlook and growth in the country.
There is not an absence of a policy. There is a policy, but that policy is twinned with the mandated objective of the Bank of Canada, which is to achieve the 2 per cent inflation target. It has to be seen in that context. There is the separate issue with market breakdown, the first element, but the second element is consistent with achieving our inflation target. In that context, floating exchange rates play an important role in helping to deliver that target.
I would take severe issue with your depiction of Chinese monetary policy. It is an entirely different story than Canadian monetary policy. China has a closed capital market. China does not engage in verbal intervention. China engages in persistent actual intervention. They have built over $2 trillion of foreign exchange reserves in doing so. They are running great risks with this policy. It is a cause of some of the imbalances in the global economy. It is a contributing factor to some of the vulnerabilities that have existed and were realized and are going forward. It is a top priority for all policy-makers to work with the Chinese and develop a suite of policies across all major economies, including China, that are consistent with moving away from this policy.
With respect to the Swiss National Bank, the Swiss National Bank was in a position, if I may give a shorthand depiction, of being at their effective zero lower band, as the Bank of Canada is. In their judgment, with inflation outlooks such as they are for Switzerland, meant missing their inflation target because of disinflation or a prospect of deflation. Given, in their judgment, the small size of their domestic bond markets, both government and corporate, they decided to pursue a policy of quantitative easing through foreign exchange intervention as the mechanism to improve financial conditions. I would refer to the intervention of the governor of the Swiss National Bank, Mr. Roth, at the April IMF meetings, which is available publicly for a description of that policy. Those are different situations than the situation that we face.
To restate, we have a clear mandate. We have options. We have a suite of options. We will use those options as required to achieve that mandate. That should not be underestimated. We will use options as needed and we will achieve our mandate.
Senator Ringuette: My first question is in regard to a question that was asked by Senator Moore in regard to who does your auditing. You said that KPMG and Price Waterhouse alternate.
Mr. Carney: Just to be clear, both of those firms audit us at the same time. We have them staggered. I do not want to shock one of them to say that they are the one maturing, but next year one of them matures and then another firm will come in and work alongside the existing firm for three years. We have two firms at one time and we draw from a broader pool. The Minister of Finance has to appoint the auditors.
Senator Ringuette: Why are you not audited by the Auditor General?
Mr. Jenkins: The Bank of Canada Act has set up the administrative structure of the bank to be independent from the rest of government. We have a board of directors that has corporate oversight for the responsibilities of the bank. For that reason, we have two external auditors.
Senator Ringuette: I did not know that the Auditor General could not audit the Bank of Canada. Is there any other similar structure that you know of in government, any institution that has this independence from government?
Mr. Jenkins: This is unique to the Bank of Canada, absolutely.
Senator Ringuette: Mr. Carney, would you say that the current liquidity of our Canadian banks is on a normal basis?
Mr. Carney: The liquidity levels of Canadian banks have considerably increased over the course of the last 18 months. Relative to the old normal, liquidity is quite high at Canadian financial institutions. I would add that one of the issues that this Basel committee that we keep coming back to is looking at is standards for liquidity globally. Ultimately they will have to abide by those standards, which will be overseen by the Superintendent of Financial Institutions.
Senator Ringuette: If that is the case, that the current situation of Canadian banks' liquidity is high, why is the Minister of Finance extending the purchase of secured mortgages and loans?
Mr. Carney: They are not entirely unrelated. The Insured Mortgage Purchase Program, IMPP, to which you refer is a mechanism for providing liquidity.
Senator Ringuette: That is my question. If the current liquidity of our Canadian banks is high, how can we justify the decision of the Minister of Finance to extend buying? We are roughly over $60 billion.
Mr. Carney: There has to be judgment in these facilities on the right time frame. First off, there is an overall judgment in terms of underlying liquidity of markets, then there is a judgment in terms of the right time frame to manage these facilities and mature these facilities and run them off. The judgment of the minister, and it is consistent with our view, is that, given residual strains in markets, a tapering off of these programs makes sense at this stage.
Senator Ringuette: It is also understood that in the last month alone there was an increase of 14 per cent in household bankruptcy. This includes mortgages that the Canadian taxpayers is buying back from these banks that already have a high liquidity situation. I find that it is very hard to understand extending that liquidity policy.
Mr. Carney: If I may, senator, it obviously is the policy of the Government of Canada, but I think it is important to point out that the Canadian taxpayer has already insured these mortgages.
Senator Ringuette: At the tune of 80 per cent.
Mr. Carney: The mortgages that are being repurchased already are exposure of the Canadian taxpayer because they have been insured. The government is providing liquidity at a cheaper rate. It is taking out a spread through this facility that actually ends up returning net money to the Canadian taxpayer in order for these institutions to have liquidity.
The Canadian taxpayer, for absolute clarity, is not assuming additional risk because of IMPP purchases; in fact, the taxpayer is net making money. That is a market failure, but the government is taking advantage of it.
Senator Ringuette: That portfolio of liquidity and buying loans includes car leases, would it not?
Mr. Carney: Not in the IMPP program. It is strictly mortgages.
Senator Ringuette: Which program would include the lease purchase?
Mr. Carney: The government has a program that is managed by the Business Development Bank of Canada, BDC.
Mr. Jenkins: It is an additional facility, a Canadian credit facility that is managed by BDC. You are right, there was $12 billion allocated to that. I believe it is still the case that that money has not yet been utilized.
Senator Ringuette: On page 21, chart 17, it shows the growth of household credit that remain robust. Your comment was that it was more attractive for the banks to provide loans to households.
Mr. Carney: Yes.
Senator Ringuette: Why would that be?
Mr. Carney: It is revealed preference in this case. These are loans that are being made. They are decisions of institutions whether they deploy their capital to lend to enterprises or households. In relative terms they are lending to households. They are judgments about the relative creditworthiness, obviously, of households.
I am leaving out a large component of this here. It is also a question of demand. There is household demand for credit. Corporate demand for credit — and this is consistent with our surveys as well — has gone down and is actually quite low. There is corporate demand for rollover of credit, but there is not strong corporate demand for credit. This is consistent with our forecast for corporate investment and our outlook for even corporate inventories, which would be demand for short-term credit.
I am not saying there are not corporations who are concerned about refinancing existing credit, but one of the realities of the current situation in our economy, and it does bear emphasis, is that there is a tremendous amount of slack. We have had a sharp recession. There is a lot of spare capacity. Firms are unlikely to accelerate investment in the near term, and that has an impact in terms of corporate demand on credit.
On the other side, on the household side, confidence is coming back. There is some pent-up demand for durable purchases. There is attractive affordability. There are some government programs that are encouraging household investment and we are seeing the impact of that.
Senator Ringuette: If you look at table 2 on page 20, at the last item, in October 2009, the five-year mortgage rate is at 5.84. The long-term corporate bond rate is at 4.17. There is a difference there of more than 1.5 per cent.
Mr. Carney: Yes.
Senator Ringuette: I am one of those who believe that our Canadian banks are extremely smart. If you can loan the same dollar and get 1.5 per cent more then that is what you will do with your liquidity. By golly, if you can get 24 per cent with a credit card, you are even better off.
You say that our banks have a high liquidity. Some senators were asking about the business community trying to get bank loans. We had the government that had to give billions of dollars to BDC to help our small- and medium-sized businesses in Canada, and yet our Canadian banks are providing more credit to Canadian households at a higher interest rate than they will provide for our business community. There lies the situation. There is an inequity here.
The Government of Canada had to intervene to do the job that our Canadian banks, to which we gave high liquidity — you just said that we provided them with high liquidity, should do by providing the businesses of Canada the credit that they should be getting in order to function and get this country back on the wheel of growth.
I have made a lot of statements, but my question is: What, in your mandate, can you do about it?
Mr. Carney: Let us give our depiction of the situation, which is that financial conditions in Canada are superior to those in virtually any other country, certainly any other major country. Access to household credit, for example, in the United States, is falling at a rate of about 5 per cent. It has grown, as you noted, in Canada. Business credit is falling in most major economies. It is now growing again in September, but let us say it is flat in Canada.
From our discussions and analyses, and consistent with other recessions, largely that is a product of demand as opposed to supply. The relationship that you referenced is between long-term corporate borrowing rates and household rates for mortgages. Remember that long-term corporate borrowing rates in this case are for the double-A- rated corporations in Canada, so the strongest corporations in Canada. That is being compared with individual household mortgages. While there is a term ``safe as houses'' there is risk in mortgages. People do sometimes default on mortgages.
Senator Ringuette: There is not a lot of risk when the Government of Canada also guarantees mortgages.
Mr. Carney: It does not guarantee all those mortgages and it costs money to get that guarantee, which is also part of the imputed rate, which should not be left aside.
The Bank of Canada's role — and the reason we publish this and we publish more information on credit conditions on our website — is to take into account all of these elements of financial conditions in Canada, and look at the impact of that on activity and, therefore, inflation, and then calibrate policy appropriately.
It has been the case, because of the crisis, that conditions have been tightened severely, over the course of the crisis, and we had to adjust policy. We expected overall financial conditions to improve. They have improved. We are on track for what we expected in developments in markets.
I would respectfully disagree with the characterization of credit being unavailable in Canada. There are issues. Those issues, though, are far less than they are elsewhere.
The last thing I would say is that there is a difference between liquidity, which is used for precautionary purposes for managing a financial institution, and capital and availability of loans. Availability of loans is a product of capital not liquidity and the Government of Canada has not provided any capital to our financial institutions. That makes us virtually unique in the developed world.
Mr. Jenkins: From that table you can also see that the effective variable mortgage rate is at 2.25 per cent, which is a post-war low. It is the same as the corporate prime lending rate. Indeed, the majority of mortgages are being financed at that point.
The Chair: Thank you very much indeed, Governor Carney and Senior Deputy Governor Jenkins. We have had an excellent discussion. We appreciate your participation today and your expressed willingness to return. Perhaps one of the reasons is that we try hard to maintain our timetable and let you out at the pre-advertised time. We hope that perhaps in addition some of the other factors might be the questions you are asked and the atmosphere that reigns here in a genuine effort to seek answers and to find out how you view your responsibilities. I believe we have succeeded today, due in large part to your frankness, openness and willingness to have this dialogue with us.
The thanks of all committee members go to you both. We look forward to a return, perhaps in the spring when, hopefully, the fragilities that are inherent in our recovery will have largely vanished.
Mr. Carney: Thank you very much.
(The committee adjourned.)