THE STANDING SENATE COMMITTEE ON BANKING, TRADE AND COMMERCE
EVIDENCE
OTTAWA, Wednesday, April 27, 2022
The Standing Senate Committee on Banking, Trade and Commerce met with videoconference this day at 6:30 p.m. [ET] to study matters relating to banking, trade and commerce generally, as described in rule 12-7(8).
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Good evening, everyone. Welcome to this meeting of the Standing Senate Committee on Banking, Trade and Commerce. My name is Pamela Wallin. I’m a senator from Saskatchewan, and I am chair of this committee.
Before we begin tonight, just a few housekeeping details. I would like to remind senators, and, of course, our witnesses tonight, to keep their microphones muted unless recognized by the chair. We’re still having all our technical issues here.
I would like to remind senators and witnesses to keep their interventions as clear and as brief and concise as we can to ensure we get around the room more than once and get as many questions and answers as possible.
Also just a little business note. We will adjourn at 8:15 this evening for an in camera session, so please do not leave before that. We have many issues coming before the committee, and everyone needs an update on where we are and what our calendar looks like.
We will carry on now, and I’d like to introduce the members of the committee participating this evening, beginning with the deputy chair, Senator Deacon, Nova Scotia. We have Senator Bellemare, Senator Gignac, Senator Loffreda, Senator Marshall, Senator Massicotte, Senator Ringuette, Senator Smith, Senator Woo and Senator Yussuff.
Today we have the pleasure of welcoming back Tiff Macklem, Governor of the Bank of Canada, along with the Senior Deputy Governor, Carolyn Rogers. We’re so pleased to have you both with us this evening to update us on the Monetary Policy Report just released for April 2022, and also all of the questions that are swirling out there in the world writ large that people have to deal with. We will begin, Governor Macklem, with your opening remarks. Thank you.
Tiff Macklem, Governor, Bank of Canada: Thank you, chair, and let me begin by saying how pleased we are to be here with you. We’re really looking forward to the opportunity to do this in person, but we’re at least here virtually, the Senior Deputy Governor Carolyn Rogers and I, and we will be pleased to discuss our recent Monetary Policy Report and our policy announcement of two weeks ago.
We published that Monetary Policy Report as Russia’s unprovoked invasion of Ukraine entered its eighth week, and the war is, without doubt, causing tremendous human suffering of the Ukrainian people and our hearts go out to the Ukrainian people. The war has also injected new uncertainty into the global economic outlook.
It is boosting already-high inflation in many countries, including Canada, and it is disrupting the global recovery. Against this backdrop, we have three main messages.
First, the Canadian economy is strong. Overall, the economy has fully recovered from the pandemic and is now moving into excess demand.
Second, inflation is too high. It is higher than we expected, and it’s going to be elevated for longer than we previously thought.
Third, we need higher interest rates. Our policy interest rate is our primary tool to keep the economy in balance and bring inflation back to the 2% target. Two weeks ago, we raised our policy rate by 50 basis points to 1%, and we indicated Canadians should expect further increases.
Let me expand on each of these three themes.
[Translation]
Canadians have been through a lot in the past two years. Everyone has been touched by the pandemic, through illness or the loss of loved ones, fear and uncertainty, job loss or business closure. We experienced the sharpest and deepest recession on record, and repeated waves of the virus have made the recovery bumpy. Thanks to exceptional monetary and fiscal stimulus, effective vaccines and a willingness to adapt and innovate, the economy has bounced back remarkably quickly. It has been the fastest and sharpest recovery ever, and now demand is beginning to run ahead of the economy’s productive capacity.
[English]
The labour market shows this clearly. Before the pandemic, Canada’s unemployment rate was 5.7%. When the pandemic hit, it quickly soared to 13.4%, and now, two years later, it is at a record low 5.3%. Job vacancies are elevated, and wage growth has reached pre-pandemic levels. Businesses can’t find enough workers to meet demand, and they are telling us they’ll need to raise wages to attract and retain workers.
We expect strong growth to continue in the months ahead. As public health restrictions ease, Canadians are spending more on services: travel and recreation, lodging and restaurants. And they’re still buying a lot of goods. Housing activity is strong, and while we expect it to moderate, it will remain elevated. Business investment and exports are both picking up, and higher prices for many of the commodities Canada exports — wheat, potash and oil — are bringing more income into the country.
Robust investment, improved labour productivity and higher immigration should help boost the economy’s productive capacity, and higher interest rates will slow spending. When you put this all together, the bank forecasts the Canadian economy will grow 4.25% this year before moderating to 3.25% in 2023 and 2.25% in 2024.
That brings me to my second point. The bank’s primary focus is inflation. Consumer Price Index, or CPI, inflation in Canada hit a three-decade high of 6.7% in March, well above what we projected in the January Monetary Policy Report. The war has driven up the prices of energy and other commodities, and it is further disrupting global supply chains. While most of the factors pushing up inflation come from beyond our borders, with the economy in excess demand, we are facing domestic price pressures too. About two thirds of the CPI components are growing above 3%. That means that Canadians are feeling inflation across their household budgets, from gas to groceries to rent.
Our latest outlook is for inflation to average almost 6% in the first half of 2022 and remain above our 1 to 3% control range throughout this year. We then expect it to ease to about 2.5% in the second half of 2023 before returning to the 2% target in 2024.
High inflation affects everyone. Inflation at 5% per year — or three percentage points above our target — costs the average Canadian an additional $2,000 a year. And it is affecting more vulnerable members of society the most, both because they spend all their income and because prices of essential items like food and energy have risen sharply.
[Translation]
This broadening in price pressures is a big concern. It makes it more difficult for Canadians to avoid inflation, no matter how patient or prudent they are as shoppers.
This brings me to my third point — interest rates are increasing. The economy needs higher rates and can handle them. With demand starting to run ahead of the economy’s capacity, we need higher rates to bring the economy into balance and cool domestic inflation. We also need higher interest rates to keep Canadians’ expectations of inflation anchored on the target. We cannot control or even influence the prices of most internationally traded goods. But if Canadians’ expectations of inflation stay anchored on the 2% target, inflation in Canada will come back down when global inflationary pressures from higher oil prices and clogged supply chains abate.
[English]
We are committed to using our policy interest rate to return inflation to target, and will do so forcefully if needed. Increases in the bank’s policy rate raise the interest rates on business loans, consumer loans and mortgage loans, and they also increase the return on savings.
We have been clear that Canadians should expect a rising path for interest rates, but seeing their mortgage rates and other borrowing costs increase can be worrying. We will be assessing the impacts of higher interest rates on the economy carefully.
We recognize that everyone wants to know where rates might end up — how high they will need to go. It is important to remember that we have an inflation target, not an interest rate target. This means we do not have a pre-set destination for the policy interest rate.
What I can say is that Canadians should expect interest rates to continue to rise toward more normal settings. By “more normal,” we mean within a range we consider for a neutral rate of interest that neither stimulates nor weighs on the economy. We estimate this rate to be between 2% and 3%. Two weeks ago, we raised the policy rate to 1%, which is still well below neutral. This is also below the pre-pandemic policy rate of 1.75%.
[Translation]
How high rates go will depend on how the economy responds and how the outlook for inflation evolves. The economy has entered excess demand with considerable momentum and high inflation, and we are committed to getting inflation back to target.
If demand responds quickly to higher rates and inflationary pressures moderate, it may be appropriate to pause our tightening once we get closer to the neutral rate and then take stock. On the other hand, we may need to take rates modestly above neutral for a period to bring demand and supply back into balance and inflation back to target.
[English]
Finally, let me say a say a word about our balance sheet. As of this week, we are no longer replacing maturing Government of Canada bonds with new ones, so our balance sheet will shrink. This brings our exceptional monetary policy response full circle. When the economy needed exceptional support in the depth of the recession, we lowered our policy rate to its lower bound and complemented this with quantitative easing, or QE. Last November, we ended QE and began reinvestment. We have now moved to quantitative tightening, or QT. With the economy fully recovered, it is time to normalize our balance sheet. QT will complement increases in our policy rate by putting upward pressure on longer-term interest rates.
Let me stop here. Senior Deputy Governor Rogers and I will be happy to take your questions.
The Chair: Thank you, there are many questions. Hands are raised. We appreciate your opening remarks. We will begin with the Deputy Chair, Senator Deacon.
Senator C. Deacon: Thank you, Governor Macklem and Senior Deputy Governor Rogers. Wonderful to have you here.
I want to dig into why you think inflation is going to moderate so consistently over the next number of years given that we don’t just have excess demand on our horizon, we have constricting supply from supply chain problems. Certainly in food, I think Russia’s invasion of Ukraine is thought to be having significant effects over the next period of time because of reduced production in the bread basket of Europe and the number of agricultural inputs that originate in that part of the world that will be essential to production in the rest of the world.
The other thing I would add is that expectations of inflation can be inflationary. I want to get a handle on why you think inflation will moderate so consistently over the next two to three years.
Mr. Macklem: Senator, you’ve highlighted the two main reasons why we have considerable upward pressure on inflation. The biggest reason, as you outlined, are things that are beyond our control. They are global supply chains that are gummed up. We’ve seen very strong global demand for goods, given some of the unique circumstances of the pandemic. People can’t get services. They’re substituting into goods. That’s running up against a global supply chain that is being impaired by the pandemic itself.
The war, as you indicated, is further disrupting supply chains — disrupting shipping in particular, for example. Then, of course, the war has substantially increased the prices of many commodities like oil and food — wheat being a prominent example.
Yes, there is considerable uncertainty about how long the war will last, where oil prices will go and how long it’s going to take to sort out these supply disruptions. But I think there are good reasons to believe that, at a minimum, these things aren’t going to continue to get worse, and they should start to abate. Remember, inflation is rising prices. So even if these things just stabilize — they don’t add further inflationary pressures — you should see some natural reduction in inflation, providing we keep inflation expectations well anchored. I need to really underline that. If we don’t keep inflation expectations well anchored, inflation will get stuck. It won’t just come down, it will get stuck at a higher level and then it will be much more difficult to get it down.
The other thing we’re seeing is that our economy has had a remarkable recovery. Our economy is now moving into excess demand, and we’re starting to see more domestic supply pressures. So we do need to moderate the growth in spending and bring spending down in line with the economy supply capacity. For both those reasons — to keep inflation expectations well anchored and to moderate spending growth and bring it in line with supply — we are raising interest rates, and it will take some time to get inflation back down to target. We do think that as you get into the second half of the year, you’re going to start to see particularly quarter over quarter inflation rates coming down, and by 2024, we expect to be back to the 2% target.
Are there risks around that? Yes, there are. Our commitment is that we’re going to be adjusting to those risks to bring inflation back to target.
[Translation]
Senator Bellemare: Governor, you are scaring me as I listen to you. You want to fight inflation, but as you yourself said, there are supply chain issues.
I wanted to hear you talk about the effects on income distribution. You say that inflation hurts the most vulnerable, but if we raise interest rates, the most vulnerable will also be affected. Don’t you think a balance should be struck in all of this, especially if raising interest rates has no effect on the global economy? How far will you go in terms of raising interest rates and how far will you let the unemployment rate go up? I’d like to hear what you have to say about that.
Mr. Macklem: I’d like to point out three things. First, high inflation affects all Canadians. What we’re seeing right now is prices for essential goods are impacting the cost of living for Canadians. As you mentioned, it’s hitting Canadians with low incomes hardest. It’s critically important that we reduce our inflation rate to meet the target and avoid these costs for all Canadians.
Second, in our forecast, we see positive, even solid growth, and at the same time inflation is coming down. In the private sector forecasts, we see some variation and some certainty and that is not surprising, but whether variation or certainty, all show positive growth with inflation coming down. How do we get inflation down without having a recession? That’s the question everyone is asking.
I’d like to point out two things. First, inflation has a lot to do with internationally traded goods. When the disruptions in the supply chains start to subside, the pressures will ease, and if expectations of inflation are well anchored, inflation will come down naturally.
I know you’re an expert in labour markets, and as you know, there are a lot of vacancies right now. Businesses are telling us that they can’t find enough workers. So by moderating economic spending and growth, we can help fill those vacancies and reduce the overheated economy while maintaining a strong employment rate and reducing inflation.
Does this represent a risk? Are we facing a delicate situation? Will it be difficult? Yes, it will be difficult.
I want to stress that we make our decisions one at a time. We’ll update our forecast, and if interest rates have a stronger effect on the economy, we can take a break, but we don’t want the economy to overheat. We now have a booming economy, so it’s possible that we will have to raise interest rates to higher levels for a certain period of time in order to bring inflation back towards our target. We will monitor the situation closely and make decisions prudently.
[English]
The Chair: Governor, with all of the stimulus spending that we saw on both sides of the border, but certainly in this country, do you wish you had hit the monetary brakes a little sooner? We do seem so vulnerable to all of these international factors that come into play, and it’s not over yet. We’re watching what’s going on in China with the lockdown and that has had another impact on supply chains. Did you wait too long?
Mr. Macklem: [Technical difficulties] out of the deepest recession we’ve ever had, but I will say we got a lot of things right and we got some things wrong, and we are adjusting.
The Canadian economy has been through a lot in the last couple of years. Two years ago, we were at the bottom of the deepest recession we’ve ever had. Output was about 15% below pre-pandemic levels, and the unemployment rate was over 13%. Thanks to very effective monetary policy, fiscal policy, highly effective vaccines and to a large extent the resilience and adaptability of Canadians, we’ve had the fastest, strongest recovery we’ve ever experienced. Now we have an economy that’s moving into excess demand and, as you highlighted, there are some new challenges. The supply chain disruptions have surprised us. They have been more persistent and more pervasive than we thought. As you highlighted, we’re not out of the woods yet. Parts of China are in lockdown, the Port of Shanghai is seriously backed up and there are reports of new outbreaks in China.
The other thing that has surprised us, obviously, is the war. The war has further clogged supply chains, it has dramatically boosted the prices of many commodities and that’s showing up very directly in inflation here in Canada.
We have been surprised by some things. That is reflected in our revised outlook. If you go back to January, we were saying that inflation would peak at about 5% and by now you would start to see some signs it’s coming down. It’s now 6.7% and it’s going to take longer to come down. We are responding to that. We’ve indicated that we will respond as forcefully as needed.
The Chair: All right. We’ll follow up on that as we continue.
[Translation]
Senator Gignac: Welcome, Mr. Macklem and Ms. Rogers. A lot has happened since your last visit here on February 2. I would be remiss if I did not mention to my colleagues and those listening to us your appointment as chair of the Group of Governors and Heads of Supervision on April 1. Congratulations. So it is an honour for Canada as well.
That said, I won’t insist on the fact that many economists and senators think that you are a little late because you, yourself, admitted a few minutes ago that the Bank of Canada can also do worse. So it’s a credit to you that you are transparent and humble.
Now that the Canadian economy has really entered a period of excess demand, what is your reaction when economists suggest that you go 75 basis points to get back to a neutral rate as quickly as possible, given that your policy rate is still 100 to 200 basis points below neutral, and you just started quantitative tightening earlier this week? Thank you.
Mr. Macklem: I think this question will interest the markets, so I’ll choose my words carefully. I hope you understand.
At our meeting two weeks ago, we raised interest rates by 50 basis points. It’s an unusual step, because normally we do it in steps of 25 basis points. In addition, as you just mentioned, we started quantitative tightening. This is the first time in our history that we have done quantitative tightening.
I want to stress that our most important monetary tool is interest rates. However, quantitative tightening will put upward pressure on interest rates over the longer term, and that will go hand-in-hand with the increase in the policy rate.
Also, we’ve told Canadians that the interest rate path is up, and I’ve said several times that we’re going to normalize the policy. We think we should normalize monetary policy fairly quickly. At our next meeting, there will be other options. We can raise interest rates by 25 basis points. I expect the board will also discuss a 50 basis point increase. There are other options, as you suggest, and they are always possible. However, an increase of more than 50 basis points in one meeting would be very unusual.
Senator Gignac: Thank you. I’ll have a question for the second round of questions.
Senator Massicotte: Thank you for being here today, governor and Ms. Rogers. We certainly appreciate it.
We had a similar meeting with you just over two months ago, and it’s clear that the inflation rate was higher than you expected or hoped on at least two or three occasions.
Your message to us today is that, regardless of the circumstances, regardless of needs, if the situation calls for it, you are going to raise interest rates significantly to manage our expectations. For those watching this evening’s proceedings, does that mean that interest rates could go as high as 5% or 7%? Obviously, it’s not 1980 or 1981, but could we see as considerable of an increase as we did back then?
Mr. Macklem: It’s important to point out that this is not the 1970s or even the 1980s. Since 1991, we have had an inflation target, and we now have some 30 years under our belt managing that inflation target. As a result, we have inflation forecasts that are well anchored.
Of course, the increase in inflation has resulted in higher expectations in the shorter term. Our short-term inflation forecast has even risen. Our longer-term forecasts are still well anchored on the target. As I said in my opening remarks, we believe there is a neutral interest rate, a rate at which monetary policy doesn’t rise or decline in the face of monetary stimulus.
That neutral rate can’t be observed directly. We estimate that it sits between 2% and 3%, and we have made it clear that we need to normalize monetary policy quite quickly in order to achieve a neutral rate. It may be necessary to go a bit above the neutral rate for a certain period of time to bring the inflation rate back to the target rate, but it would be slightly above the 2%‑to‑3% range. We aren’t talking about 7% or 8%.
This reflects the fact that inflation forecasts are well anchored on the target. Maintaining that credibility is very important, because if inflation forecasts are not well anchored on the target, it will be much harder to bring inflation back to the target rate.
Senator Massicotte: Thank you.
[English]
Senator Marshall: Welcome, Governor and Senior Deputy Governor Rogers.
Governor Macklem, you said a couple of times “the primary tool” — I don’t think you used the term “tool kit,” but I think you’ve mentioned it before, though — is interest rates. Later, you said in response to somebody else’s inquiry that it’s the most important tool that you have at your disposal.
What other tools are there in your tool kit that you could use to address the inflation problem?
Mr. Macklem: When we were in the depths of the recession, we used a collection of tools. If we could have used our interest rate more we would have, but we couldn’t because the interest rate was at its effective lower bound of one quarter of 1%. We couldn’t put it any lower. Because we couldn’t lower the policy interest rate anymore, we supplemented that with other tools. The two most important ones we used were exceptional forward guidance, indicating that the rates would stay low for a considerable period and then reinforcing that with quantitative easing. Now that the economy is more than fully recovered, we’re raising interest rates and it’s time to normalize our balance sheet as well. The other side of quantitative easing is quantitative tightening. We will no longer be buying any Government of Canada bonds.
To back up for a second, last October, we stopped quantitative easing and we went to what’s called reinvestment. We were replacing the bonds that were maturing, but we were not growing our holdings. Then two weeks ago, we decided to begin quantitative tightening. We will no longer be buying any Government of Canada bonds in either the primary or the secondary markets. That means our balance sheet will shrink. To give you an idea of the pace of that, roughly 40% of the bonds on our balance sheet will mature over the next two years, so you will see a fairly substantial reduction in our balance sheet over that period.
Senator Marshall: There’s still over $400 billion of government bonds on your balance sheet. You’re saying 40% will mature within the near future. How long before your balance sheet is cleaned up if you just let them mature? Where I’m going with this is: What are the implications of selling those government bonds?
Mr. Macklem: Our balance sheet peaked about a year ago at roughly $475 billion. It’s roughly $480 billion today, so over the last little more than a year it’s down about 16% or a little over $90 billion. We hold about $385 billion of Government of Canada bonds at the moment. With a 40% reduction over the next couple of years, you’d see a further decline of $150 to $160 billion.
Compared to a lot of countries, with our holdings of government bonds, the maturity is not that long. It’s fairly short. You will see a fairly marked reduction in our balance sheet over that period.
I would also highlight that we have decided to go for a full roll-off. We won’t be buying any government bonds in either the primary or the secondary markets. That maximizes the speed of the roll-off. There’s no offset by any purchases.
Senator Marshall: Is there any consideration of selling off those bonds? What are the implications? I noticed in the Public Accounts of Canada there was a $19 billion loss relating to the purchase of government bonds. What about the sale of government bonds? I’m quite interested in your balance sheet.
Mr. Macklem: One of the advantages of allowing roll-off is that it is totally transparent and predictable. Our balance sheet is published on our website. Everybody — every Canadian and everybody in the market — can see exactly what’s going to mature. Because we’ve got a relatively large amount maturing, we can get the balance sheet down in a way that will be quite easy for the market to digest because it’s completely transparent and predictable.
At this time, we’re not actively considering selling. The issue with selling would be that then you’re introducing something new in the market, and we don’t really think we need to do that. We can get all the tightening we need. Our balance sheet will shrink reasonably quickly. The interest rate is our primary instrument, and we can get all the tightening we need through that.
That’s how we’ve laid it out and we’re on that track. I expect that the quantitative tightening and the balance sheet is not something we’re going to manage actively one decision to the next. We’re going to let it run.
Senator Ringuette: My question will be more to the roots of the problem. You are saying that the inflation is related to Russia-Ukraine, the supply chain lockdown, labour shortages, et cetera. As a consumer, I’ve noticed a price increase in energy and food. Canada is a producer of both of these goods.
My question to you is very basic. The CPI, the basket of goods and services that is used to create the CPI — is it still adequate as a 2022 basket to use to see the CPI? Things have changed quite a lot and I don’t think that basket has been reviewed. Is it time that it be reviewed?
The Chair: If you can answer for us, governor, the basic question there on food and energy being domestically produced, that would be helpful.
Senator Ringuette: The CPI question is really the one.
The Chair: We will get to both of them.
Mr. Macklem: I can take them both quickly.
Prices of commodities like wheat and oil, they’re priced in global markets. Yes, we produce them. Our production doesn’t have much influence on the global price.
Let me rephrase that.
What we produce is priced in global markets. We export a lot of our oil. We export a lot of our wheat. Whether you’re in Canada or another country, it’s the global price. That’s what’s showing up in the CPI and you can see it clearly.
You go to the gas station, look at the price of gas. That’s the global price. You can see the effects of higher wheat prices in the latest CPI. You can see it in cereal and pasta, for example. Those prices are up quite a bit.
With respect to whether the CPI is updated, we are fortunate to have a first-class fiscal agency in this country. You’re right, the economy is always changing. Statistics Canada has been very responsive in updating the CPI. The basket weights are now updated every year in Canada. It used to be several years. It’s now every year. It’s increasingly current.
Senator Yussuff: Thank you, governor and deputy governor, for taking the time to be here.
A couple of points in regard to what you’re trying to get at, and the challenge you face.
If I look at the wage growth in the last bit since the economy has returned, yes, it’s been better, but it hasn’t been significant where wage growth has outstripped inflation rates. So people are making better wages, and the demand is there because there is a shortage. But to a large extent, wage growth hasn’t accelerated to the degree that we were expecting.
Second, in regard to the challenge you face in regard to commodity prices and some of the drivers of inflation, they’re all external on the global scene. Yet, the one tool that you have is interest rates to try to cool the economy and somehow get inflation under control.
Isn’t there a bit of a mismatch in terms of what you’re trying to accomplish? I applaud you for doing it. But at the same time, we have a major challenge on our hands when we don’t have control over most of the external forces that are driving inflation.
Mr. Macklem: I’ll take them in turn.
First of all, on wages, as you’ve indicated, we have seen wages come up. They’ve come up to roughly pre-pandemic levels. As you know very well, there are a wide range of different wage measures, but on average they would be around 3%, which is roughly where they were before the pandemic. They were very low during the pandemic, so they’ve come up quite a bit.
Looking forward, we expect to see wage growth move up further and there are a few reasons for that. One is, if you talk to companies, they tell you that they’re having a lot of trouble attracting and retaining workers, and they’re planning further increases in wages to attract and retain their workers.
This is sort of saying the same thing, I guess, but when we look at it, we’re looking at a broad range of labour market indicators and they would all suggest the labour market is moving into excess demand. The labour market is now well above where it was. Employment is now well above pre‑pandemic levels.
If you look at a broad range of indicators, whether it’s the macro indicators, employment rate, unemployment rate — which is at a serious low — or if you look at some of the more granular indicators, looking at different types of workers, different markets, they all suggest that the labour market is more than fully recovered from the pandemic and is overheating. That does suggest that we’re going to see further increases in wages.
What we look at is the relationship between wages and productivity. Higher productivity pays for higher wages. So far, higher wages are not an independent source of inflation. The sources of inflation are what I’ve already talked about.
As long as productivity goes up with wages, and we think there are good reasons why productivity will rebound — we can come back to that — wages can grow faster without contributing to inflation. But we will be watching closely that relationship between wages and productivity.
Your second point about much of the inflation being global, there are two things to underline here. First of all, we do have an economy that’s moving into excess demand. These higher global prices — which, yes, are beyond our control — when combined with an economy that’s moving into excess demand, means that it’s much easier for companies to pass through those higher costs.
When we survey companies, that’s what we’re hearing. Historically, companies have been pretty careful about passing on higher input costs to their customers because what they tell us is there’s a lot of competition. Our customers don’t like price increases; they’re going to go somewhere else. We can’t increase prices, or at least not very much.
Now what you’re hearing against the background of strong demand is that they’re less worried about their competition. They have lots of customers so they’re passing things through quickly. So this excess demand is interacting with higher prices of global goods. That’s an important reason why we do need to moderate demand in line with supply.
I will be brief on this last point.
It is critical that we keep inflation expectations well anchored. Canadians are counting on us to bring inflation back to target. We are determined to realize that confidence. We’re prepared to be forceful to make sure that we succeed in our mandate.
Senator Woo: Good evening, governor and senior deputy. Thank you for appearing at our committee.
Can I ask you to comment, please, on what you see as the relative contribution of fiscal policy to the current condition of excess demand that you’ve described, and the prospect of a contractionary fiscal policy helping us get out of that excess demand situation therefore making your job easier?
Mr. Macklem: You probably won’t be surprised. I’m going to leave discussions of appropriate fiscal policy to governments, to Parliament and to senators.
We have a very clear mandate, and that is to bring inflation back to control, back to target. The way we look at it is we take government policies as given — provincial policies, federal policies — and those are included in our outlook. We put those in our models. It’s in there with how strong the U.S. economy is, what we think the strength of consumer spending will be and what businesses’ investment plans are. We put all that together. That gives us a projection for demand.
We look at demand relative to supply. And that’s an important input into the actions that we need to take to bring inflation back to target. Fiscal policy is really for the government, for Parliament and obviously you play a role in approving and discussing fiscal plans.
Senator Woo: Could you comment if fiscal policy, as you see it in the years to come, is on a contractionary direction?
Is that the premise that you’re using in your models?
Mr. Macklem: The emergency measures that were taken have rolled off, so spending and particularly transfers have diminished dramatically as we’ve come out of this. I wouldn’t describe fiscal policy as contractionary going forward, though the level of spending has reduced a lot as the economy has recovered. But you’ve seen the fiscal track.
The Chair: We’ll pursue that one by looking at the budget and whether spending really has contracted.
Senator Loffreda: Thank you, Governor Macklem and Senior Deputy Governor Rogers, for being here this evening. I would like to address the issue of increasing interest rates, but look at it from a different angle, which is the impact that increasing interest rates will have on our economy in the long term.
Let me elaborate. Based on my experience in the banking sector, access to financing is always easier for bigger firms than small- and medium-sized companies. The low interest rates have encouraged large firms to access capital in a greater fashion. This has led to more mergers, acquisitions and further expansion of the big industry players — or the superstar firms, if we can call them that — and too often at the expense of small- and medium-sized businesses that don’t always have the same leverage to raise additional debt financing to repurchase shares or boost capital investment. When preparing for this evening, our office came across some research on this very topic in recent days when I shared the question I wanted to put forward this evening.
Do you have any insights on the matter? Do you believe an increase in interest rates will help level the playing field and could be more advantageous for smaller companies over the long term, obviously? They are the bulk of our economy, and I understand that the consumer is always the motor of every economy and the vehicle of every recovery, and the increasing interest rates won’t benefit the consumer. But in the long term, could they be beneficial to small- and medium-sized companies because of the lack of cheap capital and higher interest rates? I’d like your insight on that.
Mr. Macklem: It’s a bit of a difficult question to answer. We control the interest rate on one-day money, one-day interest rate. That does get transmitted through the financial system, through markets. There are a variety of financial channels, and certainly in having raised interest rates by 75 basis points, having signalled that we expect to be raising interest rates further, you’ve already seen a substantial move up in the term structure. Quite a bit of those interest rate increases are already built into future financing costs, and that is rippling through smaller businesses and bigger businesses.
I think having a stable economy and low stable inflation is very important for all businesses in terms of being able to make predictable investment plans and being confident that the value of a dollar today is the value of a dollar tomorrow.
As you highlighted, small business is particularly important in this country. We have a lot of small businesses. They are an important engine of growth, and certainly we’d like to see more investment, and an important part of that is coming from small business because investment will build the supply side of the economy and will be another thing that will help bring supply in line with demand.
Senator Smith: Thank you, governor and deputy governor, for being with us.
To what extent has the federal carbon tax impacted inflation numbers? Does the carbon tax account for any significant portion, if at all? There have been think tanks that have suggested that carbon pricing might have to be significantly increased. What impact could that possibly have on the economy, if at all?
Mr. Macklem: We do include the announced carbon prices in our own projections and in our Monetary Policy Report. You have to look carefully to see it, but there’s a little slice in the inflation forecast that reflects the carbon tax. It’s contributing about 0.1% of inflation per year. One of the reasons why that is small is that the carbon tax is going up gradually over time, and we measure inflation on a year-over-year basis. In any one year, the contribution is pretty small.
Senator Smith: If there was a significant increase for any reason that the government needed more funds to pay off whatever indebtedness it had, would that have any impact at all, or will it just be marginal all the time?
Mr. Macklem: The carbon price has an impact. When I was at the House Finance Committee, I think in January, I was asked what the impact would be if it were removed entirely, and I wrote back to the committee and indicated it would take 0.4% off inflation. Inflation is 6.7% now, so it would be 6.3% if you took it off. It’s certainly there, but it’s not a major factor in the grand scheme of things.
The Chair: Just a couple of quick points here, governor, before we move on to our final session. Could follow up on your answer to Senator Woo about how you see the fiscal plan, the spending plans, basically just looking at the last budget and the new programs announced? Do you see that as deflationary or contracting or something that won’t impact the decisions you have to make?
Mr. Macklem: The forecast that we put out two weeks ago doesn’t include the recent federal budget because it came out just ahead of our forecast. It already builds in previous budgets, federal budgets, provincial budgets and the previous spending plans.
With respect to the most recent budget that came out, the net of new measures — when you look at both the spending and revenue measures — is about $30 billion over five years. That is positive relative to the projection we put out. It’s a positive impulse. But $30 billion over five years is not big enough to have a material effect on our macroeconomic projections. When we get to our next projection in July, we will include the latest budget announcements in there. There might be some effects on some of the components, but I don’t think there will be much of an effect at the aggregate level or at the level that would influence decisions.
The Chair: There has been response to some comments from the Bank of England governor, and some of the experts in this field say it’s going to be indicative of the language that we’re going to hear. You have mentioned the recession word a couple of times. His phrase was:
We are now walking a very tight line between tackling inflation and the output effects of the real income shock, and the risk that that could create a recession.
What would you put that risk at?
Mr. Macklem: What I would underline is if you look at our own forecast, we have really solid growth. This year, it’s 4.25; next year, 3.25; 2.25 the year after that. It’s good growth, and we have inflation coming back to target. I have no doubt things aren’t going to play out exactly the way we forecast. They never do. But there’s quite a bit of room. With that amount of solid growth, there is quite a bit of room. Even if growth was a bit weaker, it’s a long way from negative.
I do think it will be delicate. I share Governor Bailey’s view that assessing the balance between demand and supply is particularly hard when you have these global supply issues. They’re global; they’re hard to predict. Sitting in Canada, we don’t have a particularly good line of sight on these. We certainly share information at the global table, but they are hard to predict. Where will the war go? How will COVID play out in China? These are fundamental uncertainties.
Then on the spending side, we’ve never come out of a pandemic before. So exactly how the household will react? Households have a lot of extra savings — how much of those savings will they deploy? How much will they save for a long time? Those are things we are looking at very closely.
There is a considerable uncertainty. It will be a delicate balance, but if you boil it down, the economy is overheating. That’s creating domestic inflationary pressures. We need to cool growth to cool inflation. We don’t want to overcool the economy, but we don’t want it overheating and creating inflation.
Yes, it is going to be delicate, but we do need to raise interest rates to moderate that spending growth and get inflation back to target.
The Chair: We will begin our second round here, and our time is fleeting, so short and sharp if we can. We begin with Senator Deacon.
Senator C. Deacon: I want to take advantage of the fact that we have Senior Deputy Governor Rogers with us as well. I was intrigued with the report from the Office of the Superintendent of Financial Institutions and the Bank of Canada working together examining another uncertainty that we have in our future, and that’s the economic and financial risks associated with climate change.
I wanted to zero in on that for a second, just to look at two of the findings that I understand were in that report. First, the limitations we currently have on our FIs — our financial institutions — as it relates to their credit risk methodology and their lending portfolios and the fact that it needs significant investment. The other is how the slow response to climate change will bring about greater volatility in our economy based on the modelling that you did. I’m just wondering if you could speak to that report a bit and offer some thoughts in that regard.
Carolyn Rogers, Senior Deputy Governor, Bank of Canada: Sure, I’d be pleased to. The first question that you asked around the methodologies for credit risk grading inside our financial institutions is best put to my colleagues from the Office of the Superintendent of Financial Institutions, who I know visit you regularly as well. They’re the experts in that field. I would prefer to leave that question to them.
I would be happy to talk about the report. The second point you made is probably one of our most important findings in that report, and that is there is a very strong relationship between how early we start to deal with the impacts of climate change on the financial sector in Canada and the degree of volatility that change will bring and its potential impact to stability. I think that was one of the key findings in that report. We knew this intuitively, but that report put a lot of really solid analytics and data behind the intuition that a large structural change needs to occur in the Canadian economy to get to net zero, to get to the commitments that have been made. Like any major change, the longer time we have to make that change, the less likely it is to be very disruptive and create problems. I think that was the key point.
The other really important point to make about that study is that it makes a lot of assumptions that we needed to make for the purpose of analytics. It assumes a lot of perfect foresight on policy change, and we know that won’t be the case. The disruption that we’re going through now with the invasion of Ukraine shows that there can still be shocks that affect our transition away from fossil fuels. So again, I think the message is the one you picked up, which is the longer the runway we have, the less disruptive the change will likely be to the financial sector.
Senator C. Deacon: We have a challenge in that our declining business investment in innovation — and success in innovation, increasing productivity growth — has meant that we have less room in our economy without triggering inflation in terms of growth. So to what extent do you see the disruption of the move towards addressing climate change and these other factors? To what extent do you see advancing innovation and investment in innovation in our economy as being a critical factor?
Ms. Rogers: As the chair asked me to be brief, it’s very important. We’re a small, open economy, and we still have a reliance on the fossil fuel sector. We can’t just turn that off and transition overnight. We will need to continue to innovate and invest over time as we transition. So investment and innovation in that sector will be critical to our ability to transition.
Senator C. Deacon: Thank you, witnesses.
The Chair: We appreciate that a lot, Ms. Rogers. Thank you.
[Translation]
Senator Bellemare: I’m going to switch topics. Since we have the two of you, I want to use this opportunity to ask about crypto-currencies, an issue that is currently being examined. I wanted to gauge your appetite, governor, for a central crypto‑currency. Where do you stand on that, and what would the impact on monetary policy be?
Mr. Macklem: When it comes to monetary policy, what matters is that the Canadian dollar remain at the heart of Canada’s financial system, and from what I see in the future, the Canadian dollar is going to stay at the centre of the financial system. We need to have a Canadian currency and a floating exchange rate. That way, we can have a Canadian monetary policy for Canadians that reflects Canada’s needs.
That is not to say that the system can’t have episodes of unevenness. Throughout our history, we have seen waves where the system has experienced unevenness, and I anticipate we will see others. On our end, we are examining the possibility of a digital currency at the Bank of Canada.
Ultimately, it isn’t up to us. It’s up to the government and Parliament. In a more digital economy, there are good reasons why Canadians should have access to a digital currency associated with the central bank.
We are working very hard to ready ourselves for that possibility, but no decision has been made. It started with a research project, and now we are looking at a plan for possible implementation.
Senator Bellemare: It would have a neutral effect in terms of monetary policy, then. Having or not having a digital currency would not impact monetary policy. Do I have that right?
Mr. Macklem: Yes, what matters is that the Canadian dollar remains at the centre of the system. The technicalities of monetary policy operations may be affected, but not really the conduct of monetary policy.
Senator Bellemare: Thank you.
Senator Gignac: I’d like to discuss a different topic, social inequality in Canada and the role of monetary policy.
You gave a speech last year — I believe it was in May 2021 — and you said that quantitative easing could influence asset prices and investment values, and contribute to social inequality by accelerating wealth. After all, people who are less well off seldom have a lot of money in registered retirement savings plans and they tend to be renters.
Why not take a more aggressive approach in unwinding your balance sheet? I realize that you don’t want to trigger any financial market disruptions, but given that Canada’s medium- and long-term rates are below those of the U.S. — which explains the weak Canadian dollar, by the way — why not announce ahead of time a more aggressive unwinding of the bank’s balance sheet? Proportionately speaking, you provided more financing to the Canadian government than the Federal Reserve did to the U.S. government.
Mr. Macklem: The other thing I said when I spoke about the effects of quantitative easing on inequality is that the most important thing for equality is employment. For monetary policy, the effect of quantitative easing and exceptional forward guidance is to bring down the interest rate to the effective lower bound, and the impact is a remarkable turnaround in the labour market. The effects of the crisis were very uneven, and thanks to a strong recovery, those inequalities have been reduced. The employment rate among women and youth is now higher than it was pre-pandemic, and yet, they were among the most affected groups.
Yes, the effects are also felt in terms of wealth inequality, but the most important thing is the effect on employment income, and I think it has worked well.
As for the second half of your question, I would say that we are going to see a reduction in our balance sheet fairly quickly. I want to stress that our main tool is the interest rate. We have a lot more experience using interest rates to support monetary policy. We can be more nimble in our response with that tool than through the very active use of quantitative easing.
Senator Gignac: Indeed.
Mr. Macklem: Interest rates are our main tool. We used quantitative easing because we couldn’t use our primary tool, the interest rate. We can’t lower it anymore, but we can raise it further. We have a lot more experience, we are very familiar with [Technical difficulty] between interest rates and the economy, and it is a more flexible tool. For all those reasons, we use it first.
Senator Gignac: Thank you.
[English]
Senator Marshall: I want to go to the balance sheet that my colleague was just discussing.
If you were more aggressive in cleaning off your balance sheet and sold some of those Government of Canada bonds, would you incur a loss? Has there been any assessment by the bank on that option?
Mr. Macklem: Yes. In general, we probably would incur losses. If you look at our balance sheet, you can see the value of the indemnity as interest rates have gone up. We bought these bonds at much lower interest rates. Interest rates are higher now, so there would be a capital loss.
I would like to underline a few things. We don’t run monetary policy to maximize our revenue. Our monetary policies are guided by our mandate. If we sold them at today’s interest rates, most of the bonds would be at a loss.
Senator Marshall: Can you give us an idea of the magnitude? The reason I’m asking is because if you did pursue a more aggressive rolling off of those bonds, those losses roll into the government’s financial statements. I’m trying to get a handle on the relationship.
Mr. Macklem: Every time interest rates change, it changes. We report it every month on our balance sheet. It’s about $20 billion right now if you sold everything in one day. It’s a bit of a theoretical calculation in that respect.
Senator Marshall: Thank you. I appreciate that.
[Translation]
Senator Massicotte: The last time you were here, governor, we talked about the very significant rise in housing prices. According to you, one explanation was the fact that Canadians had a lot of cash and savings, and were demonstrating their confidence in the economy through their real estate purchases or renovations.
You explained, however, that when the economy goes back to normal, Canadians will move towards other consumer goods, such as vacations, food and restaurant outings.
Is that projection correct? Can you tell us where things stand with the rise in housing prices and what the impact will be on people’s liquidity?
[English]
Mr. Macklem: I’m going to ask the Senior Deputy Governor to take this question.
Ms. Rogers: I’ll ask your permission to answer your question in English, if I may.
Senator Massicotte: No problem.
Ms. Rogers: I will make a couple of points about housing. Some are the same ones you heard us give you last time we visited. The imbalances we have seen in the housing market have been with us in Canada for quite a while. They are symptomatic of a chronically low supply by a long period of sustained demand. Part of that demand has been interest rates, but it’s also partly a growing population, a good economy and Canada’s desire for housing.
In a pandemic that has been exacerbated. People were in their homes all the time and wanted larger homes. So we saw even more housing activity over the last two years and interest rates were held low.
In our view, the growth in housing prices right now is not sustainable. It is not good for the economy, and one of the reasons is the one you’re making. We need investment in other parts of the Canadian economy. There is an awful lot of spending that’s going into housing right now.
The good news is that housing is one of the parts of the economy that’s sensitive to interest rates, so we do think as interest rates go up, the demand for housing will be one of the things that goes down and will moderate demand. But certainly housing will be one of those things. It is our hope that the demand and the investment that has gone into housing will go into other parts of the economy as that demand moderates.
The Chair: As you say, so much money has been put into mortgages and into the housing sector. I also read today that the line of credit debt in this country is very high, at $168 billion. What does that signal to you?
Ms. Rogers: The proportion that’s in line of credit?
The Chair: The number and that people are increasing their indebtedness both through mortgages and lines of credit.
Ms. Rogers: Household indebtedness has been a vulnerability that the bank has talked about for a while.
One of the things that we’ve seen over the last two years is that Canadians have accumulated what we call excess savings. The fact that they haven’t been spending as much does mean that they have paid down some of their debt. They do have some excess savings. What we’ll be watching for is the degree to which that excess savings does buffer the effect of rising interest rates, particularly for those homes that are stretched on the amount of debt they’re holding.
The Chair: I guess it’s the flip side of that. There may be savings, but also their indebtedness is going up. How do you reconcile those two?
Ms. Rogers: As I said, we are very aware that households are carrying more debt. Some of that debt, as you say, is in credit lines. One of the impacts of the increased activity in housing is more housing debt. That’s something we’re aware of. Interest rates will impact that. That is something we’ll be watching for.
Senator Yussuff: Governor, obviously one of the key mandates of your responsibility is to fight inflation, but they did add, of course, this recognition about dealing with the inequality that we have seen. You have spoken a bit about this in the past. Obviously, the people who are taking the brunt of inflation are people at the lower end of the spectrum who are struggling with tight margins and with trying to manage their budget.
As you look at the projections of trying to increase interest rates, how do you balance that and not drive these people back? There have at least been some positive shifts in the job market since the recovery, which have brought people into higher wages and some better jobs. How do we ensure that we don’t undo some of the positiveness that has come out of the pandemic with the economy going forward?
Mr. Macklem: A couple of points there. First of all, what we know from history is that if we don’t control inflation — if inflation expectations get unmoored — the most vulnerable members of our society are going to suffer the most in terms of higher cost of living. The other thing we know, though, is that nothing in the economy works very well — labour markets don’t work well — when inflation is high and variable.
Getting inflation back to target and keeping inflation expectations well anchored is job one.
As I mentioned earlier, the economy is overheating. We need to cool growth in spending to cool inflation, but we don’t want to overcool the economy. What we want to do is get that soft landing because, actually, getting that soft landing is also what’s going to get inflation sustainably back to target. If we overcool the economy, inflation will be at risk of going below the target, and we won’t achieve our goal.
The other thing I’d highlight is that — and I said some of this earlier, so I’ll be briefer — we have a situation now where, in the labour market, there is an unusually high number of job vacancies. I won’t pretend this isn’t delicate. Our macro tools are very macro, but if we can slow demand spending, we can reduce those vacancies to more normal levels without actually putting people out of work. You’re right. There were a huge number of people out of work. People are back at work. They’re earning better wages.
What we want to do is take out the excess demand in the economy, and that’s what will get us the soft landing and get inflation sustainably back to target.
It is going to be delicate. There are risks on both sides, and we’ll be watching this carefully as we move forward.
Senator Loffreda: My question is on productivity growth, innovation and the link to labour. The government did acknowledge in its budget earlier this month that the Achilles heel of the Canadian economy is productivity and innovation. We all know that inflation is driven by expectations, and we discussed that we’ll eventually see inflationary pressures on the labour market. But historically, if we look at the return on capital and the return on labour, the return on labour has not kept pace.
This is where I’m going: Do you think there is a correlation between the lack of productivity, innovation and growth in Canada and the economical labour that has historically been available in Canada? In other words, do you think Canadian businesses and firms aren’t innovating or keeping pace with other nations because of the economic level of wages? Would an inflationary impact on wages help accelerate innovation and productivity? Obviously, we don’t want inflation, but do you feel that if we see some inflation on the wages, it will help our productivity and innovation?
I’m just trying to take a look at it from a positive angle and what positive effects we can come up with, with some inflationary pressure on wages.
Mr. Macklem: You raise an interesting point. As you’ve indicated, Canada has historically grown more by population growth than, in particular, growth in the labour force and less by productivity growth. For example, you can compare us to the United States, which has had systematically higher productivity growth.
I would agree with you that, going forward, we’re not getting as much growth from labour force growth. Our society is aging, fertility rates are lower and the Baby Boomers are retiring. For all those reasons, the growth of the labour force is going to be lower going forward than it was in the past. Immigration, which is coming back up, will offset some of that, but it won’t entirely offset it. So if we want to sustain the kind of growth rates we’ve historically had, we’re going to have to rely more on increasing output per worker because we’re not going to be able to increase the number of workers as much. That doesn’t mean there isn’t some potential to grow the labour force. There is. I mentioned immigration. The participation rate of women has come up a lot. I think there is some more potential for it to go up even further, if you compare us to some. On that front, we’re well ahead of the United States, but there are countries that have even higher female participation than us. There are also certain parts of the labour force for certain communities where we could see bigger participation.
There is some potential there, but the reality is that we’re going to have to rely more on productivity growth going forward. To some extent, that will rely importantly on business investment. If workers have better tools to work with — better equipment, better computers, better technology — their output per worker is stronger, and if labour markets are tighter, you would expect the relative cost of labour to be higher. That’s one of the market mechanisms that would encourage that shift towards more investment.
That is certainly something we would hope to see.
Senator Woo: I’m sure you’re following the debates about differential inflationary dynamics in different parts of the world, particularly comparing the EU with North America — the U.S. especially. Do you have a view as to whether the inflationary experience is different in different regions of the world, particularly if Canada has a different kind of experience from the U.S. and the EU? If so, does it matter?
Mr. Macklem: I have two points. Inflation in all our countries is too high. The only exception is Japan, which continues to have very low inflation.
The average in the EU is a seven handle; in the U.S., it’s higher. In Canada, it’s high six. So we’re all well above our inflation targets. I think the reason for that is pretty obvious. The main things driving inflation are global, and they’re affecting all of us.
The other side of it, though, is we are in different stages of our recovery.
In North America, Canada and the U.S., our economies are more than fully recovered from the pandemic. We’ve moved into excess demand. In the United States and Canada, you are seeing interest rates moving up. You’re seeing both central banks signalling that people should expect further increases.
In Europe, I think the recovery is not as far along. So while they’re certainly facing higher global inflation — they have high inflation like we do reflecting these global forces — the underlying fundamental domestic sources of inflation are probably not as big as they are in North America.
I think the central banks are all moving in the same direction, but they’re moving at different speeds, reflecting their domestic circumstances. That’s how the international monetary system is supposed to work. You’ve got flexible exchange rates. You’ve got central banks that are reacting to the conditions in their countries. The flexibility in the system allows different countries to focus on their domestic situations.
The Chair: A point of follow-up, governor, on the question from Senator Bellemare on cryptocurrency. We’ve taken a fair amount of testimony on this topic over the last few months.
Do you think that, basically, we don’t have a regulatory structure in place, and that is something the bank should have been leading on, not following on? What do you say about the timing of that, whether the barn door has, in fact, closed and that the private sector engaged in cryptocurrency is actually setting its own regulatory framework?
Mr. Macklem: Yes. New digitalized forms of money, digital assets, what’s sometimes called — a bit of a misnomer — decentralized finance, much of this is unregulated. This does pose some risk.
A secure financial system is a cornerstone of the Canadian economy. It’s a big competitive advantage for Canada. We do need to ensure that new types of services are secure, properly regulated and that financial stability considerations are being properly reflected.
We are pleased to see in the last budget the Government of Canada indicated a legislative review on digital monies and assets, and I think it will be important for that to proceed.
The Chair: Do you see a greater role for the Bank of Canada on that issue?
Mr. Macklem: The two roles, one for the Bank of Canada that is already defined is we were given a new responsibility to oversee retail payment systems. Most of Canadians’ payments are made in some sort of electronic format.
This regime will provide, I would say, a kind of a basic level of oversight on retail payments systems, which will include electronic. When I say “basic,” it’s a registration regime. They will need to register with the Bank of Canada. We will be ensuring that the funds they have are in something safe so when Canadians need the money, it’s actually there. We will be assessing that they have appropriate operational risk management so there isn’t a breakdown.
The other issue we’ve already talked about is the potential for the Bank of Canada to introduce a central bank digital currency. As we’ve already indicated, we’re working on that.
There are other issues. For example, stablecoins are largely unregulated and they have some other features. They could be susceptible to runs, for example. If the assets that back them in a stress period may not be as stable as they aspire to be, in which case you could have a run.
Those are the sorts of things that this legislative review needs to address.
The Chair: Before we wrap this up, we have a question from Senator Deacon followed by a question from Senator Gignac.
Senator C. Deacon: Thank you, governor and senior deputy governor.
On the Retail Payment Activities Act, the consultation process that the bank is running gets very positive reviews from those who are involved. It is great to see how consultative it is and how risk is being assessed relative to sizes of organizations and other factors. A tremendous job all the way around.
I want to build on Senator Woo’s question a little bit as it relates to the international nature of the inflationary risks and effects that we’re seeing.
How do you coordinate with other central banks to assess the factors, the smoke signals they’re seeing that are causing them to act and the fact that your responses — if not coordinated, at least to some degree — could have a significant effect on exchange rates, which themselves then could be causing inflation in one economy or another, or certainly effects in one economy or another?
What is the level of coordination that you see, or at least information sharing, so there’s more informed action globally?
Mr. Macklem: Let me first thank you for your comments on the Retail Payment Activities Act. We are very deliberately doing our very best to listen to Canadians. I’m happy to see that the engagement is appreciated. Certainly, I can tell you we find it very helpful as key input into the decisions we need to take. I will definitely take that back to the team.
With respect to the international community, there are a whole series of forums. I was in Washington most of last week when we had G7, G20 and International Monetary Fund meetings.
For the central bank community, what I would particularly highlight is the Bank for International Settlements — which is the central bank for central banks — has an operational dimension. But mostly it is a meeting place. In the last two years, we’ve been meeting virtually. We’re now restarting in-person meetings. But it is a meeting place for governors to get together and actually share their perspectives and discuss the issues.
There are a few dimensions that are hugely valuable. One is, in a globalized world — particularly, for example, right now — we have supply chain disruptions. Those are happening mostly outside of Canada’s borders, although we’re not entirely immune.
Talking to the governors of other central banks, getting a better understanding on the ground of what is happening in their economies is extremely valuable to us. But it’s also helpful to put our heads together and talk through how we see the issues and risks, what we are each thinking about in terms of our responses.
I will say that parts of the international architecture are having some difficulty given that Russia, which is part of the G20, is part of these. It’s very hard to have a G20 discussion when the biggest economic event is the war and the country that is invading — unprovoked, unjustified — is at the table.
Fortunately, at the G7, we don’t have that problem. At the Bank for International Settlements, the Russians are not coming and they’re not getting any of the materials, so we are able to have these very valuable discussions.
Senator Gignac: You mentioned a couple of times this evening that the economy is overheating and that interest rates at 1% are too low. You are independent, and you have my support to do the best that you can.
Having said that, the neutral rate range between 2% and 3% is far from static. You have already revised it upward by 25 basis points. Is there a risk that two or three years from now we realize that the neutral rate range could be between 3% and 4%? What determinants would we have to follow to see that?
Mr. Macklem: We don’t observe the neutral rate directly. We have to estimate it. As you indicated, we actually revised down our estimate of the neutral rate as we went into the pandemic and you can see it in our projections. We thought the recovery would take longer. We thought there would be more scarring. We thought that would reduce the neutral rate. In the event, we’ve had a rapid recovery and we don’t think there’s been nearly as much scarring, so we put our estimate of the neutral rate back to where we had it before the pandemic.
Going forward, the neutral rate could move higher. We can get into a big debate of the various factors at play. But there are two things.
One is if it moves, I think it will move reasonably gradually. I don’t think it’s going to just jump. The second and more important point is we have an inflation target. We don’t have an interest rate target. We don’t target the neutral rate. We target the rate of inflation. If the neutral rate turns out to be higher, we will see that we need to raise rates more to get inflation back to target. We’ll be adjusting at each step going forward.
The Chair: That sounds like the topic for our next gathering.
Thank you for that. Really appreciate your time tonight, both to Tiff Macklem, the Governor of the Bank of Canada and the Senior Deputy Governor, Carolyn Rogers. We really appreciate you taking this much time. The issues are complicated, you’ve shed light and we are very appreciative. Thank you.
Mr. Macklem: Thank you. This is an important element of our accountability and our reporting to Canadians. So I appreciate all your very good questions.
The Chair: Governor Macklem, thank you again.
Ladies and gentlemen, we are going into an in camera session. For members of the committee, just let me ask this question quickly: Is it agreed that each committee member be allowed to have one staff member present during the in camera portion of the meeting?
Hon. Senators: Agreed.
The Chair: Agreed. Thank you. That is carried.
(The committee adjourned.)