Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 16 - Evidence - October 29, 2014
OTTAWA, Wednesday, October 29, 2014
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:15 p.m. to examine the present state of the domestic and international financial system.
Senator Irving Gerstein (Chair) in the chair.
[English]
The Chair: Good afternoon and welcome to this meeting of the Standing Senate Committee on Banking, Trade and Commerce.
Today the committee has one of its biannual meetings with the Bank of Canada, at which the Governor has traditionally commented on the bank's monetary policy as well as its projections for the Canadian economy. It is always a pleasure to welcome Governor Poloz to the committee. He is accompanied today by Carolyn Wilkins, Senior Deputy Governor.
Ms. Wilkins was appointed to her position in May 2014. This is Ms. Wilkins's first appearance before the committee. Prior to her appointment, Ms. Wilkins was an adviser to the Governor and served as Secretary to the Bank's Governing Council. In addition, she was Chief of the Bank's Financial Stability Department. Welcome, Ms. Wilkins.
Governor, the floor is yours.
Stephen S. Poloz, Governor, Bank of Canada: Thank you very much. Good afternoon, Mr. Chair and committee members. It's delightful to be with you today and to introduce you to Carolyn Wilkins, who assumed her post on May 2 and has set the place on fire. Before we take your questions, I'll give you a few of our highlights, but briefly.
I draw mainly on our Monetary Policy Report from October, which was published a week ago, and reflect back a little further, since it's been some time since we last met. I would like to touch on some new advances in our thinking and talk about how the environment is driving an evolution in the way that central bankers conduct monetary policy.
[Translation]
Our outlook for the global economy continues to show stronger momentum in 2015 and 2016, but the forecast profile has been downgraded since July. The good news for Canada is that the U.S. economy is gaining traction, particularly in sectors that are beneficial to Canada's exports. And our exports do appear to be responding, with some additional help from a lower Canadian dollar. Our conversations with exporters indicate that they are seeing a better export outlook from the ground.
[English]
It is clear that our export sector is less robust than in previous cycles. Last spring, as you may recall, we identified which non-energy sub-sectors could be expected to lead the recovery in exports and which ones would not. We have since investigated in much more detail the sub-sectors that have been underperforming. After sifting through more than 2,000 product categories, we found that the value of about one quarter, or 500 export categories, had fallen by more than 75 per cent since the year 2000. Had the exports of these products risen instead in line with foreign demand, they would have contributed about $30 billion in additional exports this past year.
By correlating those findings with media reports, we could see that many were affected by factory closures or other restructurings. In other words, capacity in these sub-sectors has simply disappeared. This analysis helps us to understand a significant portion of the gap in our export performance.
[Translation]
Our research also tells us that most of the sectors expected to lead the recovery in non-energy exports still have some excess capacity. Our business outlook survey interviews indicate that, while companies plan to invest in new machinery and equipment, few are planning to expand their capacity, at least so far. This helps explain why business investment might be delayed relative to what would be expected in a normal cycle.
[English]
This research has very important implications for Canada's employment picture. We know that when companies restructure or close their doors, the associated job losses are usually permanent. If companies can meet increased export demand with existing capacity, the associated employment gains can be fairly modest, with most of the increase in output coming in the form of higher productivity. The bigger employment gains will come later, when we enter the rebuilding phase of the cycle, when companies are sufficiently confident about future export demand that they begin to invest in new capacity and create new jobs.
These considerations enter our estimation of the output gap — that's the difference between GDP and potential GDP — and that's the key macroeconomic determinant of the outlook for underlying inflation. When the economy moves into a position of excess supply, inflation declines. When it moves into a position of excess demand, inflation rises.
[Translation]
There is no single preferred measure of capacity in the economy. Traditionally, we have put the most weight on measures based on output, or GDP. Each October, we do a full analysis of the determinants of potential output and its future trend. We have done so in this MPR, but in future, we will update this analysis in every MPR.
This time, we also offer a special technical box that considers the dynamics of excess capacity in longer business cycles like this one. The reasons this is important is that, in such long business cycles, the restructuring or closing of firms reduces potential output while creating permanent job losses.
This means that the output gap can appear smaller than the labour market gap, which is our current situation. This difference persists until after the rebuilding phase of the recovery I discussed earlier, when the excess capacity measures eventually converge.
[English]
Our judgment is that we have considerable excess capacity and that continued monetary stimulus is needed to close the gap and bring inflation sustainably to target. We take account our uncertainty, around the degree of slack, by considering a range of possible slack estimates in our deliberations.
Another important building block of this policy framework is the neutral rate of interest. The neutral rate is the rate of interest that should emerge once all the dust has settled: inflation is on target, the economy is operating at its full capacity, and all the shocks have been worked out. Carolyn discussed this subject in an important speech last month. There is also a discussion paper available on our web site and a special box in this MPR. The neutral rate is also uncertain. We estimate that it now lies somewhere between 3 and 4 per cent. That's where we would end up when things all settle. That is well below pre-crisis levels. However, since the difference between current interest rates and our estimate of the neutral rate is our best estimate of how much monetary stimulus is in the economy, understanding the risks around this is also very important.
At this time, after weighing these considerations, it is our judgment that the risks around achieving our inflation objective over a reasonable timeframe, are roughly balanced. Accordingly, we believe that the current level of monetary stimulus remains appropriate. Just as our analysis of the economic forces has been evolving with the events as they transpire, so is the way in which we conduct monetary policy, adapting in real time to the changing environment.
Today, there is much more emphasis on the incorporation of uncertainty into the actual policy decision making and we published a discussion paper on this subject just last month.
[Translation]
We have begun putting our growth and inflation forecasts in the form of ranges rather than points, and have given even more prominence to uncertainty and risks in the MPR. We have refined our analysis of financial stability risks and raised the profile of our financial system review.
And we have begun to offer a more fulsome description of how those risks are entering our policy deliberations, particularly in the opening statement that precedes our press conferences.
[English]
These changes have brought more transparency to our decision making, and our policy narrative has shifted from one that is traditionally seen almost as mechanical engineering, to one now characterized as risk management. One powerful risk management tool that monetary policy makers have in their toolkit is so-called forward guidance — that is the ability to provide markets more certainty about the future path of interest rates. This takes uncertainty out of the market and places it firmly on the shoulders of the central bank. There are costs, as well as benefits, to using this tool. We've decided that forward guidance will be reserved for times when we believe the benefits to its use are clear: periods of monetary stress, periods when traditional monetary policy tools are constrained, and so on.
Most of the time, we let markets do their job, which is to deal with the daily flow of new information and grind out new pricing, without specific interest rate guidance from the bank, but supported by the increased transparency around our outlook for inflation and the risks that we are managing.
With that Mr. Chair, Carolyn and I will be pleased to answer your question.
The Chair: Thank you, governor, for your opening remarks. We will start with Senator Black, to be followed by Senator Massicotte.
Senator Black: I have two questions for the governor. First of all, Ms. Wilkins, welcome, and it's lovely to see you here. Thank you very much for the contribution you will undoubtedly make to the bank and to Canada.
Over the past few years the Canadian economy has been bolstered by the strong dollar and the high price per barrel of oil. The global price of oil is currently hovering in the mid $80s, or below, which is a drop of more than 25 percent this year. Can you offer any views as to at what price per barrel would you start to worry about the overall effect on the Canadian economy?
Mr. Poloz: Let's begin with the premise. It's true that for over 10 years, we've had a pretty steady rise and then a maintained high oil price. I've described in public that the relationship between oil prices and the Canadian dollar is much like a dog on a leash that stretches out from time to time, but generally it comes back and the master and the dog still exit the park together. They have tracked along each other reasonably well. It's not the only thing that drives the dollar, but they go together.
That led us to a point where last year, nationwide, I would have said approximately 7 percent of the nation's income is from the add-on that happened nationwide since the price of oil was around $30 and up to around a benchmark of $100. Of course, the Canadian dollar went along for that ride.
What we have now is a decline in the price of oil. We assessed that it's both due to supply effects — primarily the marginal increase in supply that is coming from the shale oil-play in the United States, but there are other geopolitical developments that are adding to supply and also to demand. In China, there is a bit of a slow down or some moderation. In Europe, and globally, there has been a downgrading of the world outlook. That combination of both lower demand and higher supply has given us this combined effect.
At this stage, we would estimate that net effect on Canada would be to perhaps take a quarter point off of Canada's 2015 GDP growth. This is sufficient for me to think about it and to be concerned about it.
When we're predicting growth that is somewhere in the 2 to 2.5 per cent range and we need more than 2 per cent growth to help to close our output gap and create those jobs that I talked about in my opening remarks, then a quarter point matters quite a lot in that context.
At this point, we really don't know whether this price will be sustained. In our forecast, we simply assume that it will be for the sake of giving us something to work from, but we don't actually make a judgment on that. It has been a hard thing to do, so it's better for policy makers to say, ''Let's assume this, and then we'll play with different oil scenarios in our analysis about how those risks present themselves to the Canadian economy.'' Hopefully that gives you enough of a metric to put the size on it.
Senator Black: That's very helpful; thank you.
I have one other question that's on a completely different topic altogether. I noticed an interesting statistic this week, which is that Canadians spend more per capita than Americans on Halloween. I'm wondering, Governor, what does that say to you?
Mr. Poloz: That question is so scary that I think I will pass it on to Carolyn.
Carolyn Wilkins, Senior Deputy Governor, Bank of Canada: It could mean we like each other a lot, because we like to get out on October 31 and visit our neighbours. As a result, it requires us to purchase costumes and candies, or it could mean something completely different.
[Translation]
Senator Massicotte: Thank you for participating in our committee. Ms. Wilkins, my congratulations for your well-deserved appointment.
I would like to talk about forward guidance. You refer to it in your presentation today and I have read some comments explaining why the Bank of Canada will be ending this kind of targeted advice. The main reason why you refer to it is that you are not doing the work of people who want to speculate on the Canadian dollar for them. In addition, you say that it is very difficult to forecast economic models and that mistakes have been made in recent years. It is too risky to use for its indicative value.
I would like to ask two questions. In other words, your testimony is that economic models are very difficult to forecast and that economic results are not operating according to the same simple trajectory. At the same time, when we listen to the arguments from the two previous governors of the Bank of Canada who argued in favour of this indicator, it let the market predict where it wanted to go and the market did your work for you by getting to the forecast results without the tools in the Bank of Canada's possession. Why is that argument no longer valid? My second question deals with the same issue. When you say that economic models are less reliable, we as Canadians have to wonder who can predict the country's economic future if the Bank of Canada cannot. Our impression is that we have been plunged into darkness and that concerns us.
Mr. Poloz: I can start the answer and then perhaps Ms. Wilkins can add some specifics.
I would first like to mention that economic models are essential for our survival. It is not that they are unreliable; they are reliable to a certain point. There are always significant margins of error. Before, during and after a period of crisis, structural changes occur in the economy that make them less reliable than usual. But they are still vital for us in doing our work.
Forecasts play a major role in terms of the economic future and monetary policy. That has not changed. What has changed is the risks we take, the uncertainties we put on the table, that essential ingredient for our analysis. That is not something that we can just set aside. We do not say, ''that is uncertain, but here are our precise forecasts.'' We do not say that. We say: ''here are our forecasts, but this or that may happen.'' Monetary policy has to be able to deal with any eventuality. That is something else entirely. At that point, it is risk management. Do you want to add a comment on the specific models, Ms. Wilkins?
Ms. Wilkins: As the governor said, since the last crisis, the economy has clearly changed structurally. That is likely why there is greater uncertainty around the results.
I believe that this kind of opinion on future interest rates, which is a very specific measure, has perhaps fewer advantages than we were previously inclined to believe. There are elements of transparency in the models we use that really help the markets, such as how we evaluate the data and what types of indicators we examine. For example, we look at the output gap or the labour market gap. So if we show more transparency in that area, the markets will be able to draw their own conclusions according to the information at their disposal. The markets will therefore come to their own conclusions rather than ''looking at themselves in the mirror.'' So we are able to highlight the information that helps markets a lot.
In some cases, forward guidance could be useful. For example, when the Bank of Canada announced, just after the crisis, that interest rates would remain unchanged for a good length of time. That was a unique situation because the market was faced with a number of uncertainties and the bank therefore wanted to introduce a little more stability. Our feeling is that such is no longer the case. People would like more transparency in the models and to better understand our perception of how the economy is evolving.
Senator Massicotte: I understand everything you are saying. In other words, you are saying that economic models are important. But there are, in your own words, significant margins of error. I feel that, indeed, such is the case. Perhaps the risks are higher depending on economic trends.
Does that give the impression that the two previous governors were mistaken with their forward guidance, or is it a judgment call? Why are you changing the argument? The arguments are the same. You make it clear that it is not up to us to take the risk; it is up to the markets.
Mr. Poloz: That is always the case when we prepare our final forecasts. We provide a number. As always, there is a margin of error that is shown in quotation marks, or sometimes even between the lines. There is always a margin of error. I feel that it is preferable to be specific about the uncertainties with the markets and to be more open about the analyses that will actually resolve the issues.
Let me give you an example. Last year, it was very difficult to understand how our exports were behaving. Am I right? Our model predicted more exports than we actually had. Why? There are probably several reasons for that, but they are only hypotheses. After several months of feverish work, we realized that about $30 billion had disappeared. It is important to understand that situation clearly. We can adapt the model and tell ourselves that the money has disappeared for ever.
In terms of advice to the markets, I think that forward guidance has become a crutch in some ways. It is a tool that we need to update and adapt very frequently. Markets spend time analyzing and changing the terminology.
You are seeing the same thing with the Federal Reserve in the United States. That is an example where it would be preferable to use the tool in the sense that the market is one-sided, zero lower bound. I feel that it would be preferable to keep that tool for the future when the impact will be much greater in a context of demand.
[English]
Senator Tkachuk: Good afternoon, governor, and congratulations, Ms. Wilkins. I believe you're the first female deputy governor, if I'm not mistaken. Congratulations on breaking that barrier.
Mr. Poloz: We do have two other female deputy governors on our governing council.
Senator Tkachuk: Thanks for that, governor.
I want to ask you about the Monetary Policy Reports which are usually carefully couched. You mentioned a weaker outlook for global momentum than just a few months ago and that it varies across regions. I understand that the economy in Europe — at least the stuff that I'm reading in the financial papers — is flat, and the United States economy is still struggling.
Could you give us some perspective on where you see growth in the world economy so that we may benefit from it, or is it kind of a bleak outlook everywhere?
Mr. Poloz: It's important to maintain our perspective here. We are in a much better place than we were two or three years ago, so we are still, if you like, healing at a global level. As you know, healing can be a slow process and it often does not go on a straight line, so you have setbacks.
The nature of the global recession that we've been in since the global financial crisis of 2008 is highly unusual, thankfully. It has in its roots a period of excessive demand, excessive borrowing, and leverage in general, both on the part of households as well as in financial markets. Of course, that led to speculation in things in all kinds of markets, but especially in real estate, and so on.
The break-up of that leaves not just a normal business cycle to be adjusted, but one in which balance sheets need substantial repair. We put this under the rubric of deleveraging, as both the financial sector and households and eventually governments spent a lot of money to cushion this thing. We also have the governments trying to regularize their budgets in many countries around the world. We call those things head winds. The economy in the private sector is recovering in time, but it's held back by these things.
The third thing which is important in this is uncertainty. As a business has lived through this, it's hard to be convinced that everything is okay now; that we're back into the clear blue sky. There is a tendency to hold back, to wait and see if it's for sure before investing and starting up again — what we call animal spirits have been crushed.
Those things hold back growth and more in some places than others. We can see it in U.S., so globally. The U.S. has done most of the repair work and now seems to be gaining traction, but that whole process has taken far longer than anyone predicted when it was first happening. That's just the way it is. In Europe, the process is much less advanced so it's in its early days and we get into this divergence in growth.
Meanwhile, all those things are connected together so you can have a moderation in China's growth for both demand reasons and for their own internal structural reasons. You keep going around the world and the next thing you know is that it adds up to something that's still getting better but it has disappointed us time after time. We just keep being held back. We called this serial disappointment in our July report. That's the way it feels, because you keep revising your forecast down and down, later and later, and yet you still see evidence that you were right the first time, but it's not happening as fast as you expected.
For us, it's making sure we have enough realism in there to take that serial disappointment on board. We think the world is heading for around a 3.5 per cent growth track. If you'd asked me two or three years ago, I would have said it's going to end back at 4 per cent growth track. At the world level, that's a pretty big difference.
In Canada we're slowing, too, but for more demographic reasons. We're slowing to more 2 per cent trend line and five or 10 years ago it would have automatically been near 3 per cent. Those are just realities that we have to take on board. I hope that gives you enough context.
Senator Tkachuk: I want to ask a question that's a bit different.
During the recent referendum in Scotland, there was a question of whether they were going to separate or not. Was it enough of an event that you would have had concerns in Canada if the response had been positive for separation by Scotland, which would have put Great Britain in turmoil and perhaps parts of Europe? Did the Bank of Canada discuss this event as to how it may impact not only Europe, but how it may impact Canada?
Mr. Poloz: We were very aware of day-to-day developments on that front.
Senator Tkachuk: You had an insider, you might say, in the process.
Mr. Poloz: You might say. In the central bankers' meetings that we attend, of course, we would hear the updates as well. More importantly, we would not spend time formalizing our views on that. That would be something if it were to occur, then we would be in a position to think about what sorts of scenarios it might have meant for Europe or the U.K., as a sufficiently important economy that it would matter to the global outlook. We didn't formalize that analysis; that was just a matter of waiting to see if we needed to.
Senator Ringuette: My question is twofold. First, I'm looking at the reduction in the value the Canadian dollar. That should stimulate exports because our products should be more competitive. The flip side is higher prices for products for Canadian consumers. I'm reflecting on the comments that you made that you are in contact with different industries and over 2,000 product categories.
Since 2008, with the financial crisis, we've been told year after year after year that Canadian corporations are increasing their reserve for better times. They didn't see opportunities out there. You are indicating that they might increase productivity with more modern equipment. We've also signed an investment deal with China.
In your discussions with these Canadian corporations, is there any issue that their reserves will be used to export their production to China with this new Canada-China investment deal? If that is the case, we're looking at a loss of jobs. Your second premise regarding a continued uptake on Canadian exports increasing capacity is also gone.
I'm concerned about the whole scenario that you have put before us, given the value of the Canadian dollar and all those reserves held by major Canadian corporations since 2008 because of the financial crisis. With all of these components together, I'm having a hard time seeing the second phase you propose to us with regard to our manufacturing really happening.
Mr. Poloz: That's because it is really complex. We can't just assume the answer is simple either. Let me try to walk back through that, if I my, and offer some clarity.
Yes, the Canadian dollar has come down from its peak levels. Our analysis is that it looked like it had gone up a little more than predicted — that dog-on-a-leash thing I mentioned before — with the terms of trade and the price of oil because the U.S. economy was hit pretty hard by this crisis and the post-crisis period. The U.S. dollar went down against all currencies. While the U.S. is gaining traction, the U.S. dollar is tending to get its strength back and all currencies — ours, the Australian and the euro — have tended to come down against the U.S. dollar in that regularization period.
That can be the icing-on-the-cake effect on exports. The most important ingredient for export sales is recovery in the U.S. economy. Is there a demand from the U.S. for our goods and services? We see that traction coming. If the Canadian dollar is little lower than it was last year, it adds to the profit margin perhaps on the same U.S. dollar-based contract. However, it's not an ambiguous thing because we deal with lots of other countries where the exchange rate has gone the other way. As well, we have supply chains as we don't produce everything here, like we produce wheat, for example. Many of the things we produce contain imports, so it's not unambiguous that it has a one-off effect. Yes, it has a temporary effect on inflation, and we have to see through that for our targeting purposes.
The crux of your question is about what companies are telling us. They don't normally tell us what sort of investments they're planning. So far, they have told us that the investments they're planning would fall under the characterization of improving cost structures and improving productivity — sharpening things up, if you like — as opposed to increasing capacity. They have told us they have enough capacity to continue for a while, as the export recovery gathers pace and becomes more certain.
You're absolutely right that, when it comes to decide what to do next, they have choices. They can choose to invest here in a new capacity or somewhere else. Part of the story of that destructive nature of the cycle has been, for example, in the car business with more capacity investment in Mexico, say, than we've seen in Canada. That's what a level playing field is like; they have choice.
You mentioned the investment deal with China. The most important thing about it is that it works in both directions. You may be hoping that a Chinese company would see fit to expand their company in Canada to serve this market because, if they did that, they would create jobs here. However, for them to think about that, we need an equal access from both markets. I can tell you there is quite a lot of Chinese investment in the Canadian economy and, therefore, the associated job creation.
There is already Canadian investment in China, which not only creates jobs in China but also back here in the home company. That's a form of offering a competitive outcome to your global marketplace. It reduces your costs, and it's better to have half your jobs maintained here than to have no jobs if a competitor were to put you out of business, in effect.
That sort of globalization of production I think is something that we have to see as a reality. It certainly wouldn't improve our outlook if we were to try to stop it. Actually, it would be problematic for our competitiveness.
Senator Ringuette: How much is that increasing our trade deficit?
Mr. Poloz: It has an ambiguous effect on our trade deficit, which is why we should worry less about our trade deficit. Let's say a company based in Canada has a factory for some of its parts in China. To give a concrete example, to finish building Bombardier's new plane with certain parts of it being made in China, those parts must be imported to Canada. When it's done, you export the plane. That means you make trade gains on the export of the plane, but you may have a trade deficit with China. Those bilateral relationships don't have much meaning when production is spread around the world. In the end, what matters to us is that we are growing our businesses and jobs in Canada. If instead you forced a company to produce everything here, it would be a recipe for a very expensive airplane that perhaps no one would buy.
Senator Ringuette: We not only have a trade deficit with China but also a general trade deficit. When I look at the entire scenario, I have great concerns.
[Translation]
Senator Bellemare: I have a two-part question, divided into A and B about the idea of the neutral exchange rate, if there is one, and the neutral interest rates.
In your presentation, you said that, in your model, you estimate the rate at between 3 per cent and 4 per cent. I imagine that is the discount rate, which is currently at 1.5 per cent?
Mr. Poloz: It is at 1 per cent.
Senator Bellemare: When we hear that the neutral interest rate is between 3 per cent and 4 per cent, does that mean that it is going to reach that level tomorrow morning and that mortgage rates are going to go up tomorrow morning? What do we have to say to the people listening to us?
Mr. Poloz: Is that part A of your question?
Senator Bellemare: Yes. Here is part B. The exchange rate also has an effect on the daily lives of people who travel and who buy imported goods. The consumer can see that the exchange rate has gone down a lot since 2013. Is there a neutral exchange rate in your model? Must we expect the Canadian dollar to go up in value? Is a part of that exchange rate a monetary policy decision or is it the result of market forces?
Mr. Poloz: I am going to ask Ms. Wilkins to answer part A of your question.
Ms. Wilkins: That is a very good question. What is very important to understand about the neutral rate is that it is the rate for the long term, when the output gap is closed, when inflation is at the target of 2 per cent, when there are no more headwinds and shocks affecting the economy. That means that, even if the output gap is zero and inflation is at 2 per cent for a sustained period, as long as there are still headwinds, in terms of interest rates, we will need more flexible monetary policies. I think that answers your question.
I think there is a way of seeing the importance of knowing what the neutral rate is; it will give you an idea of the importance.
In the Monetary Policy Report, we did an experiment. We hypothesized that we had not dropped the interest rates in Canada after the crisis — or when it started — that the United States had not done so either and that we had kept interest rates at the neutral rate. What our models found, although it is an approximation, is that the output gap would have been 4.5 percentage points lower. That means that the unemployment rate would have been considerably higher. We would also have seen a fall in sales of automobiles and other things in the real economy. So it is very important for us to properly situate ourselves.
So, as long as headwinds and shocks are driving the economy down, we will need a more flexible money policy.
Senator Bellemare: So consumers should not be concerned about part A before Christmas?
Ms. Wilkins: We are not going to disclose that!
Mr. Poloz: That is a form of forward guidance. In terms of the exchange rate, similarly, in theory, there is a balanced exchanged rate, meaning that the same concept of neutral does not apply in this case. The problem has to do with the fact that many things are at play, both here in Canada and abroad. So it is very difficult to forecast the balanced exchange rate. In fact, whenever we guesstimate, things change. It is very difficult. That is why we do not give forecasts in this matter. I would say that, although we have a bird on our currency, it is nice to see it floating.
Senator Hervieux-Payette: Someone gave me this before the meeting because they knew I was coming to it. I have the latest price of oil with me. It is around $80, under $90. At the same time, mortgages insured through CMHC are at $547 billion. I was wondering whether you see a potentially negative impact in the long run because much of Canada's economy relies on oil. If the price of oil remains under $90, could there be a ripple effect on the value of homes?
Mr. Poloz: That is an interesting question. In theory, it is possible for the price of oil to change significantly enough to affect Canada's economic outlook quite drastically and to disrupt the balance in housing prices. That type of ripple effect can occur.
However, our analysis of the price of oil is based at around $85. That is the assumption we have used in our forecasts in the report. It will reduce our growth rate by 0.25 per cent next year. That is quite significant given that our growth rate will be between 2 per cent and 2.5 per cent. In those circumstances, 0.25 is a significant figure. At the same time, it is not very serious in the big picture; it does not change our opinion that the economy will gradually close the production gap and so on.
So I would say that, in that sense, our housing market will not be affected. However, marginally, this will certainly, or probably, reduce job growth in the energy sector, which might affect the demand for and the price of houses. It is very difficult to see from here.
Senator Hervieux-Payette: At the end of the day, Senator Ringuette and I are definitely concerned about two matters: the rate of household debt that keeps going up. I do not see when this rate will decrease. I was concerned when it was at 240 and I think it is at 260 now. Are you seeing a steady increase? Anyway, as soon as people get into financial trouble, the house of cards will come tumbling down. On a few occasions, Canada has reviewed its mortgage policy, but you can still buy a house with a 5 per cent down payment and a 25-year mortgage. Personally, I do not think that is safe; I think it is a risk.
Are you advising the Minister of Finance or the CMHC to consolidate this sector and stop the bleeding? I was reading in the paper that 127 cranes were building condos in Toronto. There might not be so many in Montreal, but there are a lot; I actually think there will not be enough Canadians to occupy those condos. The same is true for the west coast. There is a condo building frenzy and, as I told you, I am not sure who is going to live in them. I think demand is not strong enough for what is being built.
I have some serious concerns about the quality of those investments and I would really like to know who is sounding the alarm at the Department of Finance.
Mr. Poloz: Yes, we agree. In fact, that is the most significant risk we have identified in our report. Carolyn, would you like to talk about it?
Ms. Wilkins: Yes. As the governor said, on a number of occasions, we have expressed our concerns about household debt and the real estate market. In terms of household debt, the debt to disposable income ratio has plateaued at somewhere around 160 per cent. We see that the growth rate of household credit has slowed down; in fact, the growth rate is quite low compared to the historical norm. Even so, the level is very high, which creates vulnerability if a negative shock were to occur; that is a concern for us.
When we look at the real estate market, we see that, at the beginning of the year and even before, it was showing signs of a slowdown — and especially because of the temperature at the beginning of the year. However, as indicated in our report, we are still seeing signs that the market is picking up a little in terms of housing starts, sales and house prices, especially in certain cities.
As a result, we think that the most likely situation will be a soft landing, because, in spite of everything, housing starts are relatively in line with the demographic demand. We are seeing other slowdown signs in other cities, with the exception of the three most active ones, Toronto, Vancouver and Calgary. But that is still a concern.
However, I can say one thing about the regulatory situation. The government, OSFI and CMHC have already taken a few steps to raise the standards. We believe that mortgage underwriting guidelines B-20 and B-21 have helped to slow things down.
Senator Hervieux-Payette: What are B-20 and B-21?
Ms. Wilkins: They are the mortgage underwriting guidelines implemented by OSFI about a year ago, precisely to provide bank regulators with some standards to follow on loans. Those guidelines seek to increase or ensure the quality of mortgages.
Therefore, there are some factors that encourage households to have a healthy financial behaviour. Mortgages are not tax deductible. They need to be renewed every five years. We are aware of the interest rate risks. Other things tell us that the quality of the banks' portfolio and the loans is quite good nonetheless.
[English]
Senator Greene: Thank you very much for coming here today. I noticed that today the United States announced it was easing off or abandoning its policy of quantitative easing. Could you tell us what that means in a wider context? Is it a sign that we've won? What impact does it have on Canadian banks that operate in the U.S.?
Mr. Poloz: Sure. This is unambiguously a good thing. Quantitative easing was always in theory in the central banker's toolkit but was never brought out until we were truly in an emergency situation. While the U.S. economy is gaining traction, as we say in our report, and has been for a while, as I said earlier, these things never seem to go in a straight line. It's easy to have a back step. The fed has done a massive amount of quantitative easing and they have gradually slowed down the rate at which they buy assets until, as of now, it's zero. They aren't reversing their quantitative easing, but it's a bit like being in your car and you have stepped on the accelerator right to the floor. You have reached a certain speed and it's not what you would like because you're going up a massive hill but at least you're moving confidently forward, so you ease off on the accelerator and things keep moving for you. They are no longer adding more liquidity to the system, but all the liquidity is still in the system. That's an important thing to remember.
According to the announcement, it will be a considerable period before that translates into some movement in market interest rates. That's a process of ensuring everything is coming together as expected.
Banks operating in that market have access to massive amounts of liquidity, so if you walked into a bank to borrow money you would have no problem with the capacity of the bank to do this; it would be a simple credit analysis. It's making sure that the economy is actually moving on its own and taking up that credit in a natural way, which is the stage we still need to happen.
Say the economy grows at 2.5 or 3 per cent. It's doing that with interest rates equal to zero, so you know it hasn't become natural. You're looking for the natural parts to take it over. Over time, the central bank can then begin to ease up on how much stimulus it's providing. It depends on those global headwinds that I talked about before which are affecting not just us but the Americans as well.
Senator Greene: You mentioned interest rates equal to zero. We have all heard about the problems in Europe with regard to Spain, Italy, Greece and so on, but this week the central bank in Sweden put its interest rate at zero. That's a rare thing, I'm sure. Could you comment on what that means? Of course, Sweden is outside the euro zone so it has an independent currency.
Mr. Poloz: It does.
Senator Greene: Could you tell us what that means for Europe in a wider field, or maybe just the northern European countries — I always thought they were on a stable and good path in contrast to southern European — and also vis-à-vis the successes that are happening over on this side of the Atlantic and the problems that Europe still faces?
Mr. Poloz: That's a complicated question. I certainly won't comment on a colleague's policies, but the situation as they have described it is they are concerned that the inflation rate is too low and will not get up to their target unless they provide more stimulus to the economy, hence the switch to as low as interest rates can go. That's already in effect in the euro-area, as we know it.
As we said earlier, Europe is on a different pace or track from what we saw in the United States, but the problems are not that different. We had too much leverage. Now we have the deleveraging phase, the economy is slow and companies are too uncertain to invest. You get this vicious circle and you get stuck there.
The central bank can only do so much in that, for example, making sure liquidity is available. It goes hand in hand with fiscal policies and we're watching that with interest. Sweden is a separate case from Europe, as you suggested, and their conditions have been better than the rest of Europe.
What determines your inflation rate, just as with us, is where you're performing relative to where you're capable of performing. If you're performing under your capacity, there will be continual downward pressure on your inflation rate. For ourselves, we'd say inflation is close to targets. It is around 2 per cent right now, but half a point of that is because of temporary effects due to high meat prices and the fact that telecommunications prices have gone up a lot in the past few months. There is also the exchange rate from the past depreciation. If we take those things out, inflation is running at 1.5 per cent. If the economy continues to perform below its capacity, then we predict inflation will gradually make it way back down to 1.5 per cent, which would be too low for us.
The economy is gathering strength, being driven by exports from the U.S., and that will give us a closure of that excess capacity over the next couple of years and bring inflation sustainably to 2 per cent. It's a similar analysis in Sweden, but their net analysis is such that they need to stimulate more in order to bring it about.
Senator Greene: Are you more worried about Europe now than you were a year ago?
Mr. Poloz: No. That's a hard question. I've been worried about Europe all along and it's hard to say whether it is more or less. The good news is they have made important institutional architectural changes. They have brought new regulation to their banking system. They now have a single authority in charge of the banking system that is about to kick into gear and they just completed their asset quality review, which has laid bare any problems that remain in the banking system. It was a massive exercise to analyze 130 significant banks across Europe with the same template and stress tests and to report all that. On balance, the market has found that to be reassuring. That transparency shows some problems remaining, but you might have guessed the problems were bigger without that. It takes away some of that uncertainty. To me, that's an important step forward, whether it makes me feel better or worse. I will leave it at that.
Senator Greene: Thank you.
[Translation]
Senator Maltais: I have two questions as well. You talked a great deal about the drop in the price of oil, which has a significant impact on our exports and the money coming into Canada. For some months, I have noticed that some companies have taken a great interest in natural gas. People from around the world are interested in Canada's natural gas.
In your economic outlooks, is natural gas a product that might become profitable for Canada?
Mr. Poloz: Yes, certainly. The natural gas market is different from the oil market because natural gas is less mobile; it is only partially mobile. Eventually, with a lot of investments in natural gas, in its liquefaction and mode of transportation, the situation in a global market will change. For the time being, that is more the case for the price of oil.
The technology is there to move from one to the other very easily. For instance, in some plants, it is possible to have both. Eventually, we will see a competition between the two if the product becomes more refined. The two markets will then work hand in hand. For the time being, that is not really the case. I am sure that, with time, it will be a very profitable activity for us.
Senator Maltais: Here is my second question.
Mr. Poloz: I am sure that it will be for Ms. Wilkins.
Senator Maltais: In your brief, you said — and I completely agree with you — that the falling Canadian dollar is good for exports, especially in the United States, or is going to be good for exports.
I would like to talk about metals. Canada is a large metal exporter. Despite a drop over the past two years, we are feeling a new tide of openness, especially for mines in the north. We feel that metals are becoming popular again, especially in Asia, where countries do not have that type of resource. Can the drop in the value of our dollar harm or benefit the trade in metal with Asia?
Mr. Poloz: That question is a bit complex and has many aspects. To start with the price of metal in American dollars, clearly the profit margin will be higher with a lower Canadian dollar, all things being equal. At the same time, it is often the case that the value of the Canadian dollar is lower when the price of raw materials is lower. It is a bit like the example of the dog and the master I mentioned earlier. We can make the following link: all raw materials, not just oil, affect the Canadian dollar. It all depends on the situation.
The second reservation is the fact that we have to buy a lot of equipment for mining. Moreover, we often have to import the equipment from other countries. It is possible that this may drive the cost of production up for those mines.
Basically, the answer is ambiguous. If the only thing that changes is the Canadian dollar, the profit will go up. However, other things can change at the same time.
[English]
Senator Tannas: I was intrigued by the 2000 product categories and the disappearing $30 billion from the model. Could you provide us with any colour around the product categories or the groups of categories? Were any of them obvious to you? Were any of them surprising or counterintuitive? Can you give us a little bit of colour?
Mr. Poloz: We expected to find some destruction of capacity in the auto sector to start as we knew about it. We lived through the crisis. I was with EDC at that time, and we did the major loans to Chrysler, GM and so on. Part of that was approximately 20 per cent to 30 per cent reduction in capacity of parts suppliers, for example. We knew that would be there. We are also aware that in the category of large transport trucks there had been a closure. That's a significant piece of this number we have.
About 500 product categories had fallen by at least 75 per cent, many of them by 100 per cent. They were exporting in 2000 and by 2005 or 2006 they had lost a lot of competitiveness already, so it's not just about the crisis and that's an important thing to bear in mind. Of course, the dollar was rising throughout that period, so it was getting tougher to compete. We had some reductions in the past and throughout that period. Then, the crisis came and demand fell a lot. That was the catalyst to finish off some of those stories.
There were examples in the wood products business, like the disproportionate number of exporters attached to U.S. housing construction who felt this much more than other companies. Even though they had a recession on everything, housing was huge. There were some closures in many of the raw and finished wood products and in the kraft and high quality pulp business. You might say we have been using less paper for a long time, so things were already happening; but between 2000 and now, they disappeared.
To summarize, I don't want to point to specific companies as it's not really our place. If you thought about it or searched around in the media reports over the last 10 years, you could probably make some good guesses. There may be some in your town that you would know.
It's not all because of that one thing. There are multiple factors. Talk to a company and you'll hear a complicated story. Every story is different. It's not clear that anybody could have done anything about it. This all happened to us.
We have the best banking sector in the world, the best fundamentals and a great fiscal situation. We had all those things; but in this global complex, we're a small place. We went for this ride, and we're reliant on exports. If you run a company and lose 50 per cent of your sales, then the least you will do is downsize. If it were for only a year, you could survive. There is a big difference between this business cycle and the typical one. It has been so long and slow. The bank might let you hang in there for one or two years, but five years? No one can do that. If production capacity gets reduced, then it looks like we have less excess capacity than we thought.
When you do that, you get freed up labour, so that's why the labour market indicators are really your ultimate measure in this context, because you have a bigger amount of room to grow by that. What you're hoping for is that, over time, they invest and that it builds up more new capacity and pulls those kids out of the basement into the workforce. That's our story.
It's not going to happen that quickly, it's easily a two-year story. We have to be patient, because the world is not making it happen very fast for us.
The Chair: Governor, the Province of Ontario, for many years, was a major economic driver, if not the economic driver, of Canada's economy. In recent years, the manufacturing sector in Ontario has come under substantial pressure. To what extent do you view the high and continuing-to-increase price of hydroelectricity in the province of Ontario as having affected the manufacturing sector?
Mr. Poloz: I don't have a specific measure or numerical answer to give you, but the story we have just been talking about, about the closures and so on, would be disproportionately borne by manufacturing-type companies. We know by looking at the map that there is manufacturing everywhere, but odds are that there will be more in Ontario and, behind that, in Quebec, and then scattered. There are casualties everywhere, in every region, but the extra focus would be in Ontario and, to a slightly less extent, in Quebec.
The competitiveness equation relies on a lot of things. We often think: How much does it cost for your labour? How much do you pay in wages, and then what's your exchange rate? As economists, we talk a lot about those two ingredients of competitiveness and we measure that as a concept.
You think, ''Well, productivity is the thing that can change it.'' But there's an awful lot more that goes into it. So I think it of as the competitiveness equation, having all kinds of things in it. It could be just red tape that would be the cost of doing business. You could have exactly the same thing in one country as in another country, and, if red tape is higher in one country than the other, then the one with less red tape can get the deal at slightly less cost.
You could have a difference in the ability to attract the right workers. You could have higher property taxes or other kinds of taxes. You could have higher energy costs. All of those things go into that, and I just want to make sure we understand that the story we're telling about those 500 sectors has some of all of those things in it. I'm sure that we'd be able to say, ''If the energy cost in Ontario is higher than in North Carolina or Tennessee, then that makes a difference to the same company.'' I have had companies mention that to me. However, it's such a complicated thing that there are other things and they say, ''This is our advantage,'' and ''That's our advantage.'' It's never unambiguous, Mr. Chair.
The Chair: Thank you for that answer. That concludes round one. I have one question in round two from Senator Bellemare.
[Translation]
Senator Bellemare: Based on the Monetary Policy Report and what you said in your presentation, the unemployment rate indicator underestimates the extent of the underutilization of the labour force.
On page 15 of your presentation, the graph seems to show that your labour market indicator suggests that the unemployment rate is 0.5 per cent lower than your labour market indicator. Is that pretty much it?
Mr. Poloz: Yes.
Senator Bellemare: Have you examined the regional aspects of this indicator? Are there regions with a real lack? In the east, we know that the unemployment rate varies between 12.1 per cent in Newfoundland and 8.9 per cent in Nova Scotia — Quebec is at 7.8 per cent. Have you studied the matter at all? Do we add 0.5 or is it more in those regions?
Mr. Poloz: That is an interesting question. My colleague will give you an answer.
Ms. Wilkins: Perhaps I can start by explaining why there is a difference with the blue line, our indicator, which has more information than the unemployment rate. There are eight different things in this indicator, but I can highlight three of them.
First, there is the issue of part-time work. What we are seeing is an increase in part-time employment, and a major part of that, even more than before, is linked to an involuntary situation. A measure shows that 28 per cent of people who work part time would rather not be working part time.
The other thing is that the average unemployment period is still rather long. On average, people are unemployed for 22 weeks, which is a really long time. The participation rate, the labour market participation has also gone down.
Senator Bellemare: Do you look at the participation rate as well?
Ms. Wilkins: Yes. The interesting part is that the unemployment rate has been at 7 per cent for a while and, this year, it would have gone up if the participation rate had not gone down. Clearly, we would expect the participation rate to go down, because the demographics are changing. However, we estimate that it has probably dropped twice as much as we would expect with the demographics. So there is more to it than that.
When we put all that together, we see that the current unemployment rate or our labour market indicator shows that the capacity is greater than we can see with the unemployment rate. We have not calculated this indicator for each region, but we know, and this is probably very intuitive, that when we look at the employment growth over a year, it was higher in Alberta than anywhere else. It is very likely that, if we look at the other indicators, we can see that the gap between the two measures is wider—or we would expect it to be wider.
Senator Bellemare: You still did the exercise by measuring the various aspects, such as the decline in the participation rate; the difference between the blue line and the red line is the result of all those aspects, and you must have quantified it somewhere.
Ms. Wilkins: There is an article you can read if you are interested; it is on the bank's site, in the spring issue of the Bank of Canada magazine. That article explains the methodology.
Senator Bellemare: Perfect.
Senator Massicotte: As we know, the interest rates are really too low to encourage economic growth. In addition, as we very well know, and we talk about it quite often, having very low interest rates has all sorts of negative consequences on the economy, including on the value of homes and consumer debt. I am sure there are many reasons and motives for perhaps increasing the interest rate as soon as possible.
However, does that mean that we will increase the interest rate earlier than planned, to be able to counteract the negative consequences that are still there and that will eventually create problems for us?
Mr. Poloz: That is actually the key issue in our report. The situation is clearly very difficult. It is an unprecedented situation in our history. When strong headwinds are pushing us, we must have a much stronger stimulus than usual to overcome those winds. At the same time, that also causes all these other problems and financial risks. It is not low for long, but lower for longer.
That is why we have a policy like that to stimulate the economy. Usually, we do not do that for a very long time. We do it for a year or two, not for five years. Eventually, by stimulating the economy, we start creating risks and these risks tend to increase. The government has implemented four macro-prudential changes to mitigate those risks. However, the risks are still there and that is the price for our policy. Our policy is a target for the inflation rate, which is key. The other things are secondary and they are not welcome in the slightest. We must study them carefully. Basically, our task is to influence the production gap and keep the inflation rate stable at 2 per cent. That is why we have this policy.
[English]
The Chair: Thank you. Governor and Senior Deputy Governor, on behalf of all members of the committee, we express our great appreciation for your appearance today. It is always a pleasure. We look forward to seeing you again in the spring. Thank you.
This meeting is concluded.
(The committee adjourned.)