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

Issue No. 19 - Evidence - April 13, 2017


OTTAWA, Thursday, April 13, 2017

The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:31 a.m. to study the present state of the domestic and international financial system.

Senator David Tkachuk (Chair) in the chair.

[English]

The Chair: Good morning and welcome to the Standing Senate Committee on Banking, Trade and Commerce. My name is David Tkachuk and I am the chair of the committee.

I am pleased to welcome back Governor Poloz and Senior Deputy Governor Carolyn Wilkins. Our last meeting with them occurred in October regarding their fall Monetary Policy Report.

Thank you for being here today to brief us on your Monetary Policy Report, April 2017, which was released yesterday.

Senators, a link to the report was sent to your offices and we have copies today, so signal the clerk if you need anything.

Governor, welcome and the floor is yours.

Stephen S. Poloz, Governor, Bank of Canada: Good morning everyone. Senior Deputy Governor Wilkins and I are pleased to be back before you today to discuss the bank's Monetary Policy Report which was published yesterday.

At the time of our last appearance in October, I spoke about the factors that caused us to downgrade our outlook for the Canadian economy. Six months later, I am pleased to say that today I can discuss the factors that have led to us to upgrade our forecast.

For some time we have been talking about how the oil price shock that began in 2014 set in motion a complex series of adjustments throughout the economy, including a significant restructuring in the oil and gas sector. What we are seeing now is that energy-related activity has stopped declining and is transitioning to a new level that is commensurate with the current level of oil prices.

Because that large negative force is now essentially past, it is no longer masking the sources of strength that have been at work elsewhere in the economy for some time, particularly the growth in output and employment that is being driven by our growing service sector. The expansion over the past six months has exceeded our earlier forecast, and we have revised up our outlook for average annual growth in 2017 to a bit over 2.5 per cent. That is one half percentage point greater than we projected in January. We project growth of just under 2 per cent in 2018 and 2019.

A crucial question for the bank now is whether the stronger economic data that we have been seeing in the last few years is signalling increasing momentum. Some of the strength is coming from factors that seem unlikely to continue at the same pace. For example, the very strong growth in consumption spending in the first quarter was supported by a temporary boost from the Canada Child Benefit.

Housing activity has also been stronger than expected. Here we have incorporated some of this strength in a higher profile for residential investment throughout our projection horizon, but we still anticipate a slowing longer term in the projection horizon.

The current pace of activity in the Greater Toronto Area and in parts of the Golden Horseshoe region is unlikely to be sustainable given fundamentals. House price growth in the GTA has accelerated sharply in recent months, suggesting to us that speculative forces are at work.

In terms of the labour market, recent data have been mixed. Job growth has certainly been firm, but both wages and unit labour costs have been growing only slowly. The data suggests to us that material slack remains in the Canadian labour market, in contrast with the U.S. labour market, which is close to full employment.

At the same time, Canadian exports and business spending are still weaker than you would expect to see at this stage of the business cycle. The companies are telling us that while they plan to raise spending, the planned increases are modest or tied to maintenance rather than expansion. In short, the economy is not yet firing on all cylinders.

In addition, Canadian companies are dealing with heightened levels of uncertainty related to U.S. tax and trade policies. We still don't know what tax changes may be coming or when. The range of potential trade measures under discussion is even wider now than it was in January. It includes such things as a boarder adjustment tax, increased tariffs aimed at specific industries or countries, non-tariff barriers, and even broader multilateral measures.

[Translation]

We do not know which of these will be enacted, and their timing is uncertain. Each would affect the global and Canadian economies through a different, complex set of channels. With all of this uncertainty, we cannot reliably model the impact of changes to U.S. trade policy. Instead, we have built in an extra degree of caution in our forecast for exports and investment relative to our January projection. Total inflation has been close to 2 per cent and is expected to dip to about 1.7 per cent in the middle of the year before returning to near its target.

However, our core inflation measures are all in the lower half of the target band and have been trending downward. This supports the view that the economy continues to have significant excess capacity. Our current base-case forecast calls for the Canadian economy to absorb its excess capacity sometime in the first half of 2018, which is a bit sooner than we projected three months ago.

[English]

We are certainly happy to see the recent strength in the economic data and we want to see more of it in order to be confident that growth is on a solid footing. We judge that the economy still has material room to grow, and we remain mindful that significant uncertainty continues to weigh on the outlook. Given all of this, we judged that the current stance of monetary policy remains appropriate and maintained the target for the overnight rate at one half per cent.

With that, Senior Deputy Wilkins and I would be happy to answer the questions.

The Chair: Thank you very much.

Colleagues, we have larger committees now. There are 13 of us here today, including myself, so I will try to keep my comments to a minimum and let you go at the governor. Keep your preambles short, your questions crisp and we will be able to get to everyone. I will do the best to govern that because we will try to be out of here by 12:15.

Senator Black: Governor and deputy governor, welcome. It's nice to see you today. Thank you for the continued work you are doing on our behalf.

Being from Alberta, I am concerned about what I am seeing in the housing market in Toronto, as you are as well. I am concerned about the consequences if it is a bubble and if the bubble bursts. We have seen what happens when bubbles have burst in the past.

Yesterday I was reading an interesting point of view expressed in an editorial in The Financial Post which perhaps you saw. I want to quote the end of it to you, governor, and I am interested in your comment. They are talking about the housing bubble and what needs to be done. They have a point of view that I want to raise for your contemplation. The paper is saying:

At the root of the interest-rate/housing-bubble conflict are fundamental disagreements over how central banks operate. The almost exclusive dependence on interest rates to control policy, in Canada and around the world, could once again be fostering conditions that create bubbles and subsequent financial crises.

Could you comment?

Mr. Poloz: Yes. I am aware of this argument. In fact, I appreciate the argument.

If we go back to the global financial crisis of 2007-08, arguably monetary policy was perfectly on track in the lead- up to that episode. Inflation was under control. According to the textbook, everything should have been fine, but financial system or financial stability risks were growing in the background.

That, of course, had at its root not just a period of calm. The way the story goes is that an extended period of calm with steady growth and no recessions, nothing to make you nervous, makes investors less risk-averse, so more risk taking, and not just investors, but their financial intermediaries. That combined with innovations in financial engineering, the rest of the story has been made into a movie.

Senator Black: But are we going to see that movie again?

Mr. Poloz: Since that time there has been tremendous investment in the resilience of the financial system, a complete new architecture of regulation, much higher capital requirements and a much more resilient global system. Some of this would be seen to be a modest Canadianization of certain aspects, because we had a very resilient system before, but indeed there have been changes to our own system. Most of us are more confident now that if faced with similar financial shocks, the financial system would be resilient to it.

That doesn't mean that there aren't dangers of the sorts that you are mentioning. What has happened in this decade is that financial stability risk has become a key part of the policy formulation process.

Back in those days, we didn't have a Financial Stability Department at the Central Bank. We didn't have the Financial System Review, which has become a twice-annual publication where we analyze in depth the sorts of risks that you are outlining. The next one will be due in June.

There is a whole new world, if you like, built around those risks, so we go into each policy decision with those risks also on the table. They are taken into account, but we have to bear in mind that, as the article is trying to say, most central bankers only have one tool and therefore one objective. Our best contribution to this whole thing is to continue to provide a low, predictable inflation rate so that good decisions can be made and the regulation of the system is done by others in our collaboration. In Canada we have a highly collaborative model on that. That assessment of risk is something that we share around a committee table that advises the Minister of Finance when we think there are financial risks that should be addressed.

Senator Tannas: Could you explain for the folks who are listening, and myself, the difference between inflation and core inflation? What is stripped out of core inflation and why is that number so important?

Mr. Poloz: I will give you a high-level answer and then perhaps Ms. Wilkins can offer more details.

Essentially, inflation is a pretty noisy data series. Typically, almost every country uses some version of the Consumer Price Index and they use it in a year-over-year, like a 12-month context. Even with that amount of smoothing, it is a highly variable series.

What happens is that to understand the underlying trend in inflation, which is what we would want to respond to, we strip out some of the noisier things. After stripping things out, we call it "core,'' and we have more than one definition of "core'' to help us do the best job on this.

Carolyn A. Wilkins, Senior Deputy Governor, Bank of Canada: We have three measures of core. Each has a different methodology to strip out the noisiness. The noisiness is quite important; 75 per cent of the variation in total headline inflation is coming from energy prices, which fluctuate a lot. If you fill up your tank, you know that.

It is really important to do that. We have selected these three measures so that they will give us an unbiased view of what might be happening to headline inflation, the underlying inflation. We want to have something that is also highly correlated with the fundamentals that drive inflation over the longer run, like the output gap.

What you are seeing now with core inflation measures that are below headline inflation, and where they have been drifting down, is just a reflection of the excess capacity we have had over the last year. Without getting into the detail, one of the measures is very consistent with the slack that we still think exists today in the labour market and that shows up in very modest gains in wages and unit labour costs.

Senator Tannas: It would be fair to say that because our gas prices go up, it's clear, that's not something you can worry about or cure with the tools you have. Therefore, you take things like that out. If a consumer is saying that their costs are going up by 4 per cent because of carbon taxes, gas prices, and so on, you have to ignore that as you do your work around trying to set an interest rate. Is that fair?

Mr. Poloz: That is right.

Fundamentally, it takes arguably six quarters, or so, for us to have a meaningful impact on inflation. We couldn't possibly be targeting every bump and wiggle. We have to have a smoothing version and understand where it is likely to be 18 months from now so we can respond to that trend. That requires stripping out some of these things.

Of course, every individual has a different personalized inflation rate, and it is often enhanced by media attention. You remember last year it was all about the $9 cauliflower, but this year there were no articles about the 69-cent cauliflower. That is the way it is. Now the articles are about expensive gas, but two months ago there were no articles about the inexpensive gas. That is just life. We try to see through those things and these measures help us do that.

They are different in the sense that they have different strengths or weaknesses. That is why we chose to have three of them, because there is no single measure which is perfect for all seasons.

Senator Wallin: In doing some reading for this, two things jumped out at me that were a red flag. The surge in foreign cash in Canadian banks' currency deposits have increased from 2.5 per cent of total financial holdings to 7 per cent. The next fact was that foreign holdings of Canadian financial assets stood at more than 200 per cent of GDP at the end of last year, up 140 per cent. I am assuming that this accounts for some of the investment in the housing market on the front page of The Globe and Mail. Where else is it going?

Mr. Poloz: For the most part, it goes into Government of Canada debt. It also goes into our equity market or direct investment into the oil sector. Actually, we have had a couple of reversals there in recent months, but the balance is decidedly positive.

In the last few months, we have detected a heightened interest in investing in Canadian paper. Geopolitical events have made Canada look like a bit of a haven. It is traditionally a haven of some kind, but a special haven in these times.

There have been growing positions in Canadian dollars in foreign central banks and in other wealth funds, et cetera. That, no doubt, has been at least partially responsible for a little extra firmness in the Canadian dollar not just across the U.S. dollar but across a wider range of currency.

Senator Wallin: So you think it's positive?

Mr. Poloz: Well, I'm agnostic on it. In the sense of a response to positive underlying fundamentals, that's a positive signal. It just is what it is. It can ebb and flow.

Senator Wallin: On page 13 of the MPR you say that despite the fact there are strong job gains, there is a new weakness since 2016 on actual total hours worked. Initially you would think that's because there are more part-time jobs, but you say this is across both part time and full time. What accounts for that?

Ms. Wilkins: We have a special study you can look at outside the MPR. There is a staff analytical note that works through it.

You are absolutely right: The first places you would look, well, there is just an increase in part-time jobs, or you would see it's because of a shift to service-sector jobs where a lot of the jobs have been created that would account for that as well because there tend to be fewer hours worked. In fact, it's just really broad based. There is no answer that you can be definitive about, but what we think is happening is this is an indication of the continued slack in the economy. In fact, we would expect that as the economy continues to grow and the labour market improves, those hours will go back up. It's not a structural change in hours worked per week. However, that's something we will have to monitor and follow closely because hours are very much related to income.

Senator Wallin: Yes, absolutely.

[Translation]

Senator Massicotte: Thank you for being here and for your interest in our committee work. I would first like to talk about our relations with the U.S., which could represent a threat for the Canadian economy. We are talking about NAFTA and the Buy America Act, and all sorts of free trade obstacles. However, your report does not attach a lot of importance to that. We hear that there could be a threat. Could you tell us what impact that would have on our economy? Is the 2 per cent growth actually 1.5 or 1.7 per cent? Canadians could then assess the risks.

Mr. Poloz: That's a great question, but the answer is more complicated than that.

Ms. Wilkins: Clearly, we have seen the uncertainty of the trade policy south of the border. It is impossible to provide numbers right now, but we can look at the various aspects where changes could have an impact on Canada and the global economy. There are a number of options, including tariffs, non-tariff barriers, the possibility of subsidies, but also a border adjustment tax. We still don't know which options will be chosen, to what extent, or when. However, we know that it will be harmful to the Canadian economy, because it involves a number of aspects. We can suppose that there will be a drop in activity in the sectors directly affected, particularly for the workforce. For instance, if I lose my job in the forestry sector, I will have to find a job elsewhere.

Senator Massicotte: If we assume a 10 per cent tax on all imports from the United States, would there be a major impact or would it be easy to adapt to the transition?

Ms. Wilkins: It depends on the circumstances.

Senator Massicotte: Let's say 10 per cent on all imports.

Ms. Wilkins: I cannot give you any numbers, but that's not good news either for us or the U.S. Let me point out that, clearly, there will be an impact on the demand, but also on the supply. Canada's potential growth is also fairly significant. We have included a simulation in our update. You can actually look at our researchers' note. If there are changes that break the global or Canadian value chains that have been built over the years to increase productivity, we can expect to see new value chains that will be less productive. That will hurt our productivity rate, which is not very high.

Senator Massicotte: A severe, major blow to Canada?

Ms. Wilkins: This will be a major blow if value chains are bungled by change. It is impossible to make forecasts because we don't know the change in behaviour that this could cause in the manufacturing sector or in Canada, given that they could find other markets, other value chains elsewhere in the world that do not involve the United States. It isn't all doom and gloom. There are ways in the future to restore our productivity rate, but we need to look at the situation in real time. Predicting impacts isn't easy. Some scenarios are relatively negative for Canada, but they have not yet been seen. Nor will these scenarios necessarily happen.

Senator Carignan: There is much discussion about short-term prognosis. Short-term forecasts are sometimes more difficult to establish than long-term ones, given the presence of certain structural elements. What two or three major threats to the Canadian economy are on your radar for the medium term, say five years? Is it the aging of the population, household debt, real estate bubbles? Steps are being taken in Vancouver to reduce the housing bubble, and it is moving to Toronto. There has been a rise in prices in Montreal in recent months. What are the two or three biggest threats in the medium term?

Mr. Poloz: Protectionism in the United States would be the first major threat to Canada. As Ms. Wilkins explained, it is very difficult to make forecasts because it could take a variety of forms. This will certainly have a negative impact. This threat could be a severe blow to Canada. We have put this issue on hold for now, given that it is not yet concrete.

As for the threats, this isn't the same as the negative risks. Investment in Canada is relatively low compared to fundamentals right now. This is a matter of concern to us.

We would like to put forward other explanations that would not be entirely negative, including the growth of the services sector, which requires less investment for the same level of potential growth. It's a possibility. But I think this uncertainty comes from investment, and it's a long-term problem, because in fact our capital is constantly diminishing and depreciating.

The other thing is the household financial imbalance related to housing prices. It is possible that there will be a prolonged housing boom that, if coupled with debt, would create a vulnerability that may present financial risks. If a financial blow occurs at the same time, it can exacerbate the effects on the economy. For the moment, it is characterized as a vulnerability, but each prolonged period accentuates this vulnerability. These are really the two things that, apart from protectionism, are the biggest threat.

[English]

Senator Wetston: Thank you for being here today. I would just like to compliment both the governor and senior deputy governor on the important international work they do. We often don't see that. Frankly, it's extensive and it's very well-received, and they clearly have an important impact on the international financial markets, banking in both Switzerland and at the Financial Stability Board. I really want to compliment both of you on that important work. It goes below the radar screen.

In that regard, I realize we're speaking of the Monetary Policy Report, but can you provide the committee some comments on how you see the international markets today from the point of view of how it impacts Canada? I think a little bit about Larry Summers,who continues to talk about secular stagnation for example. I think about rate increases being very much tied to what the fed might do, a rate increase or two, how that might affect the Canadian currency.

You commented today, governor, on the issue of investment and the impact on productivity. I am wondering whether you could give us a sense of how you're seeing the global environment and how that affects Canada and some of these matters I just asked you about.

Mr. Poloz: Thank you for your kind words. As others perhaps know, senator, we have a past, so we have worked together on various files.

You mentioned secular stagnation. It was a hotter topic 18 months ago, even 12 perhaps. But like many hot topics, they cool off when the economic data show up, and so very few people are looking at the U.S. economy today and characterizing it as a case of secular stagnation.

There are still elements of the secular stagnation story which are fundamentally true; that is, that population growth in the world is slowing. That means that the labour available for work is slowing, and potential output for the world is slowing down. So the slow-down that we observe is in most respects very fundamental. One needs to have a 50- to 60- year window to understand that. Basically the baby boom, post-war, boosted economic growth in the opposite way to what I just described, for about 50 years. That 50-year period, we are just coming down that slope now. That also brings with it slower investment rates to maintain a slower growth in the potential economy. So those things are identifiable. They are long term and there is absolutely no doubt about them.

Now, layered on top of that is a productivity slowdown which seems at odds with all the technology we're seeing.

So there still remains a puzzle which may end up being associated with that secular stagnation view.

But at the same time, we know there are a number of things which slowed economies down which have been decidedly temporary, but temporary in a longer sense than normal. Those are basically headwinds created by the financial crisis, stocks of indebtedness, and so on, which slow things down. Every time we have had a recession after a financial crisis, it has taken much longer to recover than from a typical business cycle.

All of that is to say that the U.S. and the UK are out in front of this. The rest of the world continues to be some distance behind. Europe is showing recovery and actually responding to negative interest rates, and so that's positive. Japan is still in a very long period of slower growth; in fact it kind of led us in this direction.

But in the U.S. and Canada, we think things are moving along pretty conventionally, yet with these legacy effects I described before. What has really made us different from the U.S. has been the oil shock. If the oil shock had not occurred, we would be more or less in a similar situation.

The fact that our growth rate in the last little while appears stronger than the U.S. is not at odds with this underlying story, which is that the U.S. is basically back to full employment and Canada some way behind that, if you like.

So that means the two economies are in different situations. We call that a divergence. That divergence is a natural outcome of an oil shock which is bad for Canada and positive for the U.S. economy. The exchange rate moves to help the adjustment take place. All those things have happened. So we're confident that over the next year or so, we're seeing all those pieces coming together. That kind of puts us back into international context in a quick fashion.

The Chair: Governor, when you talk about the long-term economy, interest rates have been extremely low because of the 2008 recession. Is it possible that the reason that business is not investing is because they are uncertain about what is going to happen to interest rates? The longer you keep a lower than normal level, people will be reluctant to invest because they always think the future will be worse, i.e. interest rates will go up. How high? They have no idea. Stability is the thing. Unless you tell them they are going to be like this all the time, people will always say, "Well what happens to a 40-year investment, when interest rates could be 9 per cent or 10 per cent or 8 per cent?''

Mr. Poloz: We do try to provide more information than that on the long term. The next implication of having a global moderation in trend growth, because of the demographic reasons I mentioned, the next consequence of that is that the equilibrium rate of interest also goes down. For instance, for Canada and the U.S., we believe that the equilibrium interest rate in these conditions is on the order of 3 per cent, like a range of 2.5 per cent to 3.5 per cent, so much lower than what we used to think of as a normal, steady, straight interest rate. We have explained that to people.

That means that in the U.S., which is big on the process of normalizing interest rates, the destination, if all goes in a subdued and regular way, will be a much lower destination than what we saw before. That doesn't mean that interest rates won't fluctuate in the future because of cycles in the economy but that the average will be a lower average than we're used to.

So I think there are elements I agree with in your assessment. Companies are uncertain. Part of that is because of what they have been through. If you're talking to a company today, they are just happy to be here. They survived. Lots of their neighbours did not. We lost 8,000 to 10,000 Canadian companies during the strong dollar and then the recession period. It was mostly manufacturing, exporting companies. If you survived that, then you did a good thing. But are you ready to bet that this expansion we're seeing is long-lasting and to increase the capacity of your business? That's where the reluctance comes. We call that crushed animal spirit. It's from what you've been through and it takes quite a while. It takes a lot of convincing for people to say yes, and it's even convincing your board. The CEO may be ready but the board is not, so you get this reluctance.

We talk to companies today, and they talk about that. They talk mainly about what might be coming from the United States. What is the future of NAFTA? If you rely on NAFTA to do your business, well, you want to know what it will be like.

There is a lot of indication that animal spirits are stirring in the United States. That's often contagious cross-border. As certainty grows about what the future of NAFTA looks like, I think we'll see that general lift. In our forecast, we're being quite conservative with investment, precisely for these reasons. That just means that there is some upside risk if everything gets clarified.

Senator Enverga: Thank you, governor, for being here today.

You mentioned that in the last six months you upgraded our forecast, which is great. Is this because of the recent budgetary spending? Is it any part of that, like increasing the infrastructure spending?

Mr. Poloz: We incorporated that fiscal plan in our forecast a whole year ago when it was first announced. That's been part of our forecast since then. To put that into perspective, we see material excess capacity in the economy today, and then it closes over the course of the next few quarters. It closes sometime in the first half of 2018.

The contribution from the fiscal plan is sufficient to make that happen. If it weren't for the fiscal plan, it would take much longer to close that excess capacity gap. That's part of our baseline forecast, so yes, it's certainly important.

The main reason for the upgrade at this time has been the behaviour of the housing market. Back in last winter, the beginning of the year, we had the new measures put in place by the government around mortgage rules, and we assessed that there would be some moderation in the housing market. No doubt there has been, but you never know how high it would have been without the changes. It has obviously surprised us on the upside.

Most of the revision for this year, which is from 2.1 per cent to 2.6 per cent growth, four-tenths of that 0.5 per cent increase comes from faster growth in the housing market. That means that it's higher and the slowdown is later than we predicted but still is in there for the following years. That's the main shock to the forecast at this time.

Senator Enverga: When you mentioned the service sector, is it the public or private service sector?

Mr. Poloz: It's both. Health care and education, there is obviously a blend, but IT service exports are growing tremendously. It's a sector that is a very bright light. Tourism, as well, is an important growth sector; that's mostly private. It's a blend of both, but it's very promising, actually.

In the IT space, these are very high-paying, software-type jobs. Any app that you use, there are people in behind that maintaining it, putting new ideas into it, making your interaction with that company better and stronger and more profitable. Those kinds of jobs are growing strongly.

Senator Marshall: My question relates to the Toronto housing market, because it is so big. There has been a lot of discussion on it and a lot of articles in the media regarding the risk and whether it's a housing bubble and when it will burst. Minister Morneau was in the Senate a couple of days ago, and he discussed the issue and gave us his opinion. He indicated that he was discussing the issue with his provincial counterparts, particularly in Ontario.

Is the Toronto housing market the issue there? Is there a risk there, or do you think that the risk is just a vulnerability? Is there an actual risk there?

Also, the CMHC is a Crown corporation, and a lot of federal money is tied up in it. If something negative happens in the housing market, it will affect the CMHC and will flow through to the federal government.

How big a risk is the Toronto housing market? Is there a role there for the bank, or is it just a matter that you're sitting and watching and maybe advising the finance minister?

Ms. Wilkins: There are two parts to your question.

Clearly when you see prices rising in the 30 per cent range, it's difficult even when you look at underlying fundamentals to see how those could justify such strong house price increases, which is the reason why we were saying that it looks like there are speculative forces at play. That's not to say that the underlying fundamentals of the Toronto housing market don't justify price increases. There are supply issues that are well-known; the economy is doing very well there. We have immigration, and a lot of that ends up in Toronto at some point. There are lots of reasons that are supporting the market. But at the rates that we're seeing, in that context, you can wonder about the sustainability of that pace. That's why the governor yesterday reminded people that house prices can go down as well as up.

When it comes to thinking about what could be done, it's important to remember that monetary policy isn't the only game in town. In fact, many policies are perhaps better suited to deal with specific issues in specific locations, and we know them well. Some of them were used last year in Vancouver. That's a pretty important part of when you think about what comes next.

With respect to the second part of your question, when we think about vulnerability, if you take the combination of really high house prices and then people who are in that market who have taken on very large mortgages relative to their incomes, whether that translates into a risk that crystalizes, that matters, really depends on if prices start growing more slowly as opposed to fall outright. If they did fall, by how much did they fall? So it's impossible to know in advance or speculate on that kind of scenario.

What we have done in our Financial System Review is pretty clear. Obviously, the bigger the price adjustment, the more important that will be not only for Toronto but the potential for spillovers to other markets. If it's combined with another kind of event that creates unemployment that is steep and lasts for a long time, then those effects are amplified even further.

Whether that risk materializes and is important for the macro economy and for the financial system really depends on how big that event is. It's impossible to say. Many people try to do that in advance; I'm not willing to do that today.

Senator Marshall: Is there a role for the bank? The federal finance minister obviously sees he has a role because he is meeting with his provincial counterparts. I know the provincial finance minister in Ontario feels he has a role. So everybody is talking about it, and then there is a segment of the population that are bracing themselves, thinking something will happen and will have a ripple effect through the economy. Is there a role there for the Bank of Canada? If there is, what is it? Are you just watching it like we are?

Mr. Poloz: I won't comment on the last part. We are certainly watching it.

At the root of this, of course, it's fair to comment that the Bank of Canada is playing a role in creating the situation. That's not to say we're causing the speculation.

Senator Marshall: I understand that.

Mr. Poloz: But the fact is that the economy was going through a very rough period and lost 40 per cent of our exports, those kinds of things. So low interest rates are the weapon we have to try and smooth that out in the economy.

When the oil price shock hit, one of the reasons that we adjusted so quickly to it was because we cut interest rates to cushion the blow, and the exchange rate moved enough to give us a more rapid adjustment than we would otherwise have had. Those are all good things, but the side effect of low interest rates is you're causing people to borrow more money and spend it. That's the point of it. When they are low for a long time, more and more people borrow money.

Senator Marshall: They get confident, yes.

Mr. Poloz: So you accumulate the debt.

Yes, there is an effect there. We can measure that. It is not causing 30 per cent increases in prices in real estate in Toronto.

If you ask yourself, well, if a speculator is buying a second or a third home for flipping purposes, if the mortgage rate were 4 per cent instead of 3 per cent, really would it make a difference if they are expecting a 20 per cent gain on their money? No, it's not going to make any difference.

The Bank of Canada's interest rate policy is for all of Canada; it can't be directed just at a certain market. You would be slowing the whole economy in order possibly to put a dent in a speculative move in Toronto.

This is not the tool for the job. Our job is to focus on inflation and create the kind of macro environment in which people can make good decisions. I would say that some of these decisions being made now are not sustainable or good decisions. As I said, I want to remind people that house prices can go down and not just up.

For an ordinary person buying a house who loves the neighbourhood and will stay there and it's expensive, I feel sorry for them; in that sense it's economics. But if the price of their house went down by 10 per cent, they would just keep paying their mortgage and some day it would be higher again.

But the speculator who owns three houses and is hoping to flip them has a real problem. Does that have ripple effects? That's the question. How big? Does it happen by itself or does it need a trigger?

The thing about houses is you have to buy the house, whereas in a financial market, you can speculate just by buying futures and incrementing your position. In the end, if you have to buy the house and it's reaching a point where the bank simply won't finance it for you, then you don't buy the house. That's what I think happened in Vancouver in the months before the new measures were put in place. It actually started to slow down by itself, so it kind of reaches a natural limit. There are checks and balances in the system.

That's more than you asked for, but there are no definitive answers.

Senator Marshall: Thank you.

The Chair: So how much oversight is there — I don't know whether you would know that. Maybe we should be asking OSFI or someone else. If a speculator loses money, that's too bad. If banks are extending credit limits that are too high so that a poor guy gets a 90 or 95 per cent mortgage, then all of a sudden there is a drop of 20 per cent in the market and he has to renew his mortgage, he is done like dinner. Do you feel confident that the banks are being careful in how they are — if they are getting enough down payment, it doesn't really matter.

Mr. Poloz: That's right. We have most visibility on the insured space, mortgages with less than 20 per cent down payment. That needs to be an insured mortgage, and that's where the rules apply.

In that space, we know that the new rules mean you need to be much more qualified to have that mortgage today than before the rules went into place, so there is a cushion in there where you can tolerate a higher rate of interest and so on because you have been tested against it.

If, on the other hand, you are in the uninsured space, then you have more than a 20 per cent down payment. That means you have more cushion from the point of view you're describing. That is only relevant if you need to actually sell the house anyway. You can renew your mortgage and just stay there forever, and the fact that the price has gone up or down is of little interest. It's cocktail conversation, not a life-and-death kind of situation. But lots of people do have to move, and they get caught in it.

The Chair: Exactly.

Senator Smith: I watched CNN last night, and they showed all of the promises that Trump has made during the election campaign and that he has changed his position. I'm wondering from an economic point of view, when you look at the United States and your discussions with other people in business and in government, is his bark bigger than his bite? Have you got two scenarios set up so that the U.S. can go one way or the other? Which way do you think it will go in terms of some of the implementations they want?

Mr. Poloz: I don't know the answer to that question.

The Chair: Watching CNN isn't going to help.

Mr. Poloz: No.

For me it's the uncertainty that matters. Even if they don't do anything, companies are wondering and they are holding back on their investments today, which has a long-term effect on the economy. It's slowing down employment growth in the new sectors that would be expanding. It's prolonging all of the legacy effects that we're dealing with. Investment could be significantly higher if that were just cleared up one way or another. That's point number one.

Point number two, I never judge a dog's bite by its bark because even the little ones can really bite. I think we just don't know, so we'll have to wait and see.

I think if there is a pattern, it is in dialogue, which I would say is an educational process. Talking to companies and understanding things more deeply appears to be playing a positive role. As understanding deepens, then positions get a little more nuanced and that's a positive.

I'm hoping that as we get into NAFTA, and so on, business is speaking on both sides of the border and helping everybody understand how these things work and how they would affect everybody. It's going to take some time. I don't see a reason to be pessimistic about it, but I think you need to be wary.

Senator Ringuette: I'm more and more puzzled because for a number of years we have been hearing of the billions in reserve in the major Canadian industry. At first the reason for them not investing was because of the financial crisis, and afterwards it was because the markets were not there. All that time, there was no rhyme or reason in regard to the fact that because of the low interest rate, it's certainly not to invest their cash.

It has been almost 10 years now, and they are still sitting on these cash reserves. We have gone through a slate of, "Oh, well, it's because of this or that.'' Now, in the last few months, it's because of U.S. uncertainty. I think there is more to it than that. How can we find out what it is and try to unlock those reserves to create a larger economy and greater certainty in our own market?

We have a brand new trade agreement with European countries. That should give us a positive boost, yet we still have from year to year a different reason why they are not investing in better equipment, new technology, new markets and so forth. They are still sitting on that money.

Mr. Poloz: Right. Fundamentally, you think of the macro economy as a single business. For simplification, you might look out the window and ask, "What rate of return would I earn by investing in this business?'' You see year after year of 1 or 2 per cent growth. You might conclude: That is not much of a return on investment. It's kind of risky, too. It's not risk-free, that's for sure, so I'm going to wait until it is a little more certain. I'm going to sit on my cash. It's not costing me much to not invest it. I'm not getting much for keeping it, but at least it's safer to keep it than to risk it and have, for example, NAFTA change and disrupt my business — something like that.

I think of it in a simple way. When you go beneath the service, there are certain sectors investing heavily. There are other sectors that may be in a longer term slowdown, so they are not. Take the auto business, for example. Mexico has garnered the biggest share of new investments in auto assembly and the southern United States. Canada has not. Canada is closing auto plants. That's almost a tectonic kind of shift. It's a very traditional, large business in Canada. The parts business is doing great, but the assembly business has been shrinking. Traditionally that has been an important place where normal investment would go, and that is much less the case today.

You can kind of list things like that you have heard about. That would mean less investment, so you have to look to new things. The fact is we haven't reached that almost magic stage of expansion where we are creating new companies and they are creating new products, new exports and new jobs. The self-sustaining upward momentum has not been established yet.

The U.K. economy has resumed that kind of natural growth process and the U.S. has. I believe we are not far behind, but it's something we have to wait to see.

[Translation]

Senator Moncion: My question is about the existing securitization program. Mortgage interest rates are low. Financial institutions use the securitization market extensively to get the financial margins they need to offer mortgages at low interest rates. Do you have an idea of the extent of the link between securitization and speculation in the real estate market that contributes to the rising house prices and astronomical sums in securitization at present? What is the causal link between the two?

Mr. Poloz: That's a complicated question.

Ms. Wilkins: The securitization program serves to improve the liquidity sources for this market. That is why we have a program like this. It is intended for families who want to buy a house. Obviously, there have to be controls on the quality of the mortgages that go into those securities there. There are fairly stringent standards that the OSFI imposes on banks and that CMHC imposes on institutions that are not regulated by the federal government. Guidelines B-20 and B-21 ensure the quality of mortgages in order to avoid the problems we have seen in the United States. To the extent that this program gives financing to people who buy for investment purposes, it could fuel that. We must not forget that there are many investors who do not need financing and that mortgage insurance stops at $1 million. This limits the direct or indirect impact on speculation.

Senator Moncion: But we have seen in recent years that financial institutions have made a lot of CMHC-insured loans to be able to securitize them in order to get the margins that come out of CMHC and those charged to people, Which allows people to buy houses, but —

Ms. Wilkins: It is impossible to tell the difference between demand from people who want to live in their home and that other part. All I can stress is that the part that might be speculative is not always financed in that way. Often we hear that there is no mortgage, and that it is paid in cash.

[English]

Senator Wallin: You were talking a few minutes ago about the new tech jobs particularly in the service sector, but we are also seeing the flip side of that, which is lots of job loss due to technological replacement.

I know you have done thinking in the past — we've talked about it here — on bitcoin, blockchain and all that. Have you done any work on Mr. Gates' proposal that we should tax these new "peopleless'' jobs?

Mr. Poloz: Well, no.

Senator Wallin: Do you think it is worth looking at?

Mr. Poloz: It will be important for us to understand that certainly from the point of view of how the economy actually evolves. This relates to one of the questions we talked about earlier, which is how do you measure investment and is there really low investment or not?

I will give you some advertising here because Ms. Wilkins will give a speech in Toronto next week, on Tuesday I think, about technology and the displacement of jobs.

Without giving it all away, do you want to give us a little preamble of the ground that will be covered there?

Ms. Wilkins: Sure.

Clearly we are interested in productivity. We talked today about how important that is to raising the standard of living and has been in the past. These technological innovations are an opportunity to do that but an opportunity that comes with a side that needs to be carefully managed by policy-makers, by government like you, where you need to think about the transition period of the people that are working and that are displaced and how you manage that. Also there are the effects that could come from a polarization of incomes that we have seen in the past.

I think the kinds of suggestions on how to change the tax system like Mr. Gates suggests really come from that concern. Although I'm not a tax expert and it is certainly not the central banker's job to give advice on tax, what we can say is that if the gains that come from productivity are being given to the owners of capital as opposed to workers, it does raise the issue about the relative taxation of those two sources.

There are trade-offs. If you are going to make a big investment in R&D and you have something that you need to develop to bring to market, you want a rate of return on that, otherwise you are not going to do it. On the other hand, if you don't distribute those returns to workers, then you have an issue with the distribution of income. Those are the kinds of hard choices that people like you face already and will continue to face.

The Chair: Would it not be better if we let the market govern itself? I wonder how Bill Gates would have felt if we said maybe we should tax those operating systems you're selling because you will lose the telephones and all the postal workers will be replaced. This happens all the time. That, by itself, had a huge impact on our economy. No one sends a letter anymore. Those poor postal workers will all be gone.

Ms. Wilkins: That is a good question because you want the innovation. You don't want to get in the way of it.

The Chair: Of course.

Ms. Wilkins: We see it in financial technologies in fintech. That is exactly the question everyone is asking.

At the same time we know that some of these technologies and the structure of the market, there are forces there that could lead to some market or monopoly power. When that happens, governments tend to think and competition authorities tend to think that maybe something needs to be done to manage that.

Again, those kinds of issues often come up with technology because that kind of technology has a lot of barriers to entry. It's expensive to get into it and to succeed at it. Like Facebook, once you succeed, everyone flocks there. We call those network effects. Naturally you end up with huge concentrations and monopoly power, and governments need to think about whether or not they are comfortable with it. Again, that is a social decision.

Mr. Poloz: If I could add one point to this. I am like a history buff. To me, the long sweep of history has been such that we have had no end of technological improvements.

The Chair: Exactly.

Mr. Poloz: All of those technological improvements have created more jobs than they have displaced. I actually am optimistic on this. I see no reason why this technological revolution we are in will cause us all to lose jobs. In fact, it will create many jobs.

I mentioned examples earlier. An insurance company that creates apps to increase your productivity while processing your various things with the insurance company has an army of technological people back there maintaining that one little button on your iPhone. Those are great jobs that didn't exist before that technology came along. Well, that technology reduces productivity, which lowers the cost of everything. And that raises the spending power that everyone has. So that spending power goes on other things that you never thought you ever needed and creates other jobs.

They may not be the same jobs, and our kids won't work in the same jobs we had, perhaps, but that is why the transition is of such importance. You don't expect the laid off oil worker to do apps on the iPhone, but the stock of housing keeps growing and so jobs in the renovation sector continue to be a source of strength in the economy. That is not such a giant leap, is it, in terms of the training required to move?

It is possible to get a little overwhelmed by the night and day, "Robots will do this,'' or what have you, and since I am older I often look at that longer sweep.

The Chair: I am with you there, and even older.

[Translation]

Senator Massicotte: I would like to talk about demographics. We know that the Canadian population is aging, which means that health needs are increasing and that more and more costs are being imposed on society as a whole. The country will suffer from this situation within 15 to 20 years.

Statistics Canada reports that, with the exception of three Canadian cities, virtually all regions will suffer from fewer workers, as there will be fewer people available to contribute to society's many needs. This problem will become even greater in the future.

This is a rather alarming fact. Productivity is always talked about as the solution. There is also an increase in the number of workers. Statistics Canada is categorical about the rate of immigration. The result is that the number of workers, with the exception of three Canadian cities, is constantly decreasing.

For the past few years, we have heard that the solution is to encourage people to work longer. Aside from people with physical limitations or learning disabilities, much of the population can afford to work longer. Today, health is better. For 50 years, life expectancy has increased by 10 years, and the solution, I believe, is an active and productive population. However, as you know, in 2016 the federal government reduced the retirement age to 65 years. This affects not only those who receive retirement benefits, but also Canadians who perceive the age of 65 or 67 as the normal retirement age. This has a major impact on people's financial planning. How do we reconcile the two perspectives?

To be honest, I was happy when the government increased the retirement age to 67. Now, we are going to have to back down while the rest of the world is making efforts to work longer and to encourage the population to work longer. What is the financial impact of that?

Mr. Poloz: As I mentioned, there is, of course, a demographic impact on the trend of economic potential that is growing as a result of prolonged participation in the labour market. On the other hand, there is the immigration rate that is fueling the process. Currently, almost half of labour market growth is due to immigration and, within about 10 years, there will be almost zero domestic growth. All the growth in the labour market will be due to immigration.

Age is important and can influence this trend. The only thing that is important is flexibility. If people want to retire at age 60 or 65, that is their choice, but they also have the choice of working until they are 70 or 75 years old. What matters is flexibility and the ability to learn new things, or maybe to work part-time. These things improve our productivity. In my view, government programs need to focus on this concept of flexibility.

Senator Massicotte: Thank you, Mr. Poloz.

[English]

Senator Wetston: I have two quick questions.

Governor, I think some of your comments around speculation in the Toronto real estate market — of course I live there and feel it every day with agents knocking on my door. You and your esteemed deputy governor have experience over the last few years in the house financial crisis. You mentioned this in your comments with respect to central banks and monetary policy and that everything seemed to be okay in 2008 and 2009, but we missed something. What we missed is we did not look into the weeds of finance to understand what was going on. I don't need to remind either of you about credit derivatives and mortgage-backed securities, and in Canada our own situation with ABCP, et cetera.

You talked about animal spirits, which I have heard you talk about before, and I have also been supportive of that notion in the sense of capital markets because bubbles often flow from exuberance and optimism and all those characteristics. Do we need to look into the weeds of finance to get some answers regarding this issue of speculation in the real estate markets? I don't know whether we do or not because dampening behaviour with respect to what is occurring would be encouraging.

My second question is probably more toward your senior deputy. She has mentioned this before. I would like to know more about what she's doing in the fintech sector internationally, if I could ask that question. I realize it's a general question, but I'm quite interested in it.

Mr. Poloz: Just a few comments on looking into the weeds: We do look into the weeds. Our FSR, which as I mentioned is in progress right now and will be published in June, does go beyond what you call the core of the financial system in order to dig around the weeds.

There are certain aspects, especially in the real estate sector, that we understand less well just because the data are less available to us. It's more a question of visiting and asking the right questions. Of course OSFI is very interested in these things, as are our colleagues at CMHC. That is the group that gets together to discuss these issues.

You might think or wonder if everything looks like it's all under control in the insured space, and yet the biggest growth in mortgages in the last year has been in the uninsured space. So you might ask questions like: How is that occurring? That means you need at least a 20 per cent down payment and houses are even more expensive and how, exactly, is that? We do force ourselves to understand those things as best we can.

By the way, one of the elements is the family money seems to be playing a bit of a role. Intergenerational transfers or loans —

Senator Ringuette: Inheritance?

Mr. Poloz: Or inheritance. That is something that is often not discussed, yet there is a huge stock of housing that at some point will be inherited.

All those things matter and we do our utmost to bring you the full picture. I don't have the full picture for you today, but in eight weeks we will.

Fintech — my goodness, how much time do we have, chair? Okay, a couple of minutes on fintech, Ms. Wilkins.

Ms. Wilkins: Thank you for the question. I'm always happy to talk about fintech.

I am doing two things internationally. The first is probably the largest one, which is I'm chairing a group of the Financial Stability Board that is looking at fintech to see what kind of issues in the future the regulators and supervisors will face from a financial stability point of view. This is part of requests from the G20 leaders to look into the digitalization of the economy and what it means for growth for financial inclusion and, of course, for stability of the financial system. It will be published in June, so we will have a chance to share it.

One of the things about fintech is there's a lot of hype out there. There really is. It is going to change the world or it's not going to change the world. It covers every single sector of the financial system you can think of, from insurance to payments to advice, robo-advice. It permeates everything. Our goal, really, is to separate the hype from what we sensibly and logically think might be issues for supervisors.

We are really trying not to think about all the risks, all the bad things that might happen. To your point, chair, we should also be thinking about what good things can come from this and how we can harvest them. If it's helping banks having more sources of finance outside of banks, having greater efficiencies that also involve safer systems, then that's good. If you can include more small businesses and have more sources of financing for small businesses, include more people in the financial system, this is all great. We need to do it safely. There are some areas that we should think about proactively so we don't wake up one day with a system that is in place and is hard to roll back.

Another thing is that Christine Lagarde from the IMF has set up an experts group for fintech to advise them on their work program, and I'm part of that group. We are all conscious of the fact that this is evolving. We're in the early stages and we need to do some fundamental research to understand what it means for how the financial system is wired and how it will change the business models of our major financial institutions like banks and insurance companies, and how it might either make the system more stable or not. That's a big research program that we're involved in and we're contributing to from the Bank of Canada's point of view.

[Translation]

Senator Carignan: My question is on the topic of the day: marijuana legalization. Has the Bank of Canada begun to measure the economic impact of legalizing marijuana and its impact on gross domestic product over the next few years?

Mr. Poloz: I must admit that I have no analysis on this very interesting topic. I don't know if there will be an effect on productivity.

Senator Carignan: The CIBC did a study last year that mentioned $3 to $10 billion in production.

Mr. Poloz: Indeed, it's a new business that might create jobs. That's something but, I apologize, I have no information about this.

Senator Carignan: It's also an underground economy that will become —

Mr. Poloz: It's possible. It's interesting.

Senator Carignan: You haven't calculated it?

Mr. Poloz: No, I'm sorry.

[English]

We'll put it on the list and take a look at it.

Senator Smith: In its budget, the government introduced innovation increases and a focus on innovation. As you look at innovation, they've got five or six clusters they want to focus on. Who will be the players? Will it be big corporations or entrepreneurs? Going back to Senator Ringuette's question, will big corporations free up some of the money they have held in abeyance and not spent on some of these opportunities?

What will happen to entrepreneurs? We brought this question up before, this whole issue of venture capital and our resistance over time and history to really build a venture capital capacity in Canada.

What are your thoughts on that? Who is going to win and what will happen to big players and small players? What about venture capital? Where do they fall in all of this?

Mr. Poloz: That is an interesting question. I probably don't have much to say about it in terms of the territory and the budget around helping to facilitate the creation of clusters and superclusters. But existing clusters are a wide mix of both really small and large companies participating. For instance, you have new technologies spin off from BlackBerry, which end up in all automobiles, and so you get this partnership between a really large company like Ford and that emerging technology. So there is small and big in that example and that is kind of the model.

A lot of the true innovation that is going on is almost on the level of plumbing, if you like, for other business. It's a B2B model.

Even the stuff the various companies that Terry Matthews creates are all for some miniscule piece of somebody's operation that makes a major difference and that becomes a company that then can use that application. Having done it for that mother ship, it can then do it for many other mother ships, small and large, because the scale is automatic, if you can get your application to fit somewhere in the big machinery of a large firm.

To me, one of the characteristics of a successful cluster is that it's got both innovation and tiny or small, and the ability to scale, because the partners are there. Whether it means drawing actual money in, that varies from model to model.

In the middle space, where the small firms can hit a hockey stick and grow, I'm quite excited by this creation of the business growth fund, which is actually a private-sector initiative, but with certain rules that make it easier to happen. It's being led by the banks themselves. That is to create an entity that focuses on patient capital in the growth space, so it goes a step beyond venture cap. It does not walk on venture cap's grass at all.

The venture cap space appears to be quite healthy in my sense of it. It is healthy and doing better than, say, 10 years ago. If you think back 10 years, it was hard to see the evidence of returns compared to the U.S. venture cap space. We seem to be suffering from maybe a lack of financial managerial capability: great innovations but not the business acumen to bring it to the finish line.

I don't have data, but I have a sense that things are riding a steadier path now, and the venture cap space is actually pretty fluid. That's a fairly imprecise but a positive observation.

When you're talking about 5 million to 10 million, that's the next step in a growth story. That's where this business growth fund would kind of take over. What comes with it is not just money, but mentoring so that it builds a network. This is a very successful model in the U.K. It builds a network of mentors that can go on board. You get an investment, and you also get in you a board member who is a guider and a networker, which adds significantly to the success of that model.

Senator Enverga: I have a question about climate change. As our country becomes warmer, there will be more access to tourists and longer access to certain resources. Do you see any economic impact because of this? Will climate change be part of our long-term growth?

Mr. Poloz: I don't know if Carolyn has a comment to offer. I'll offer one from my level. You can comment if you want.

This gives and takes. It's a very complicated question because certain businesses in Canada may have a downside to climate change; others may have an upside, a couple of which you have mentioned.

Certainly climate-based or green technologies are a positive. We do have a strong emergent sector there. There is a water cluster and an energy recapture cluster, those kinds of things.

We do have companies that will capitalize well on the policies or the private-sector response to climate change. There are growth opportunities in it, but at the same time, there are negatives that we must bear in mind.

From our perspective, the financial sector side, in what sense does climate change pose new or different risks to the financial system, all the way from the obvious, such as the concept of stranded assets, which you've got lending all against those things? There is a collateral vulnerability, but more into climate change affecting weather and, therefore, exposure of insurance companies to more events and those kinds of things. That's the path that most central banks are kind of spending more energy on. How many more vulnerabilities emerge because of climate change?

From a business growth point of view, we have to wait and see how the economy would adapt.

Is there anything you would like to add to that?

Ms. Wilkins: I think you covered it well. The other aspect is green finance. There is a whole new market out there that, as a central banker, we want to understand.

It's a global market, and that market is very different depending on which country you are in. There is a big interest in understanding the different kinds of markets in different countries and whether or not some international principles or coordination might be useful so that the market continues to function really well.

Other than that, I think you covered it all.

The Chair: Thank you very much, Governor Poloz and Deputy Governor Wilkins. We always look forward to these visits, and your insights help us in all our other deliberations.

(The committee adjourned.)