THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Tuesday, September 27, 2022
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 6:30 p.m. [ET], in camera, to consider a draft agenda (future business); and to study matters relating to banking, trade and commerce generally, as described in rule 12-7(8).
Senator Pamela Wallin (Chair) in the chair.
(The committee continued in camera.)
(The committee resumed in public.)
The Chair: Welcome, everyone joining us online to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy.
My name is Pamela Wallin. I am the chair of this committee, and I’d like to introduce the members of the committee. We have Senator Bellemare, Senator Gignac, Senator Loffreda, Senator Ringuette, Senator Smith, Senator Woo, Senator Yussuff, and we have Senator Moncion in tonight for Senator Deacon, who, we are told, is on his way, so we will see.
We are pleased to welcome Yves Giroux today to our discussion of the Canadian economy and inflation. He is the Parliamentary Budget Officer. He is accompanied by Diarra Sourang, Director, Economic Analysis at the Office of the Parliamentary Budget Officer, or PBO. Thank you both for being here tonight and for all your work, which we’ve been plowing through and reading.
We will just invite you to begin, Mr. Giroux, with some opening comments.
Yves Giroux, Parliamentary Budget Officer, Office of the Parliamentary Budget Officer:
Honourable senators, thank you for the invitation to appear before you today. We are pleased to be here to discuss the state of the Canadian economy and inflation. With me today I have Diarra Sourang, Director of Economic Analysis.
As you are no doubt aware, inflation remains high both in Canada and globally. Earlier this year we published our Inflation Monitor report, which provided an analysis of consumer price inflation data through April. In our view, the resurgence of high inflation can be traced back to the COVID-19 pandemic. More recently, the Russian invasion of Ukraine has compounded inflationary pressures.
Based on our earlier analysis, supply or sector-specific issues were also a key driver of high inflation. That said, the rise in core inflation at the time suggested that strong demand was also putting upward pressure on inflation.
In accordance with the PBO’s legislative mandate to provide impartial, independent analysis to help parliamentarians fulfill their constitutional role, which consists of holding government accountable, my office will continue to prepare reports and analysis on the state of the nation’s finances and the economy.
[Translation]
Next month, my office plans to release our Economic and Fiscal Outlook. This report provides a baseline projection to help parliamentarians gauge potential economic and fiscal outcomes under current policy settings. Our last outlook was published in March and was based on data and assumptions made prior to the Russian invasion of Ukraine. Our upcoming report will present updated projections, taking into account increases in interest rates and other recent developments.
Additionally, my office will release an updated assessment later this week of house prices in Canada. This report examines house prices relative to a household’s capacity to borrow and pay for the purchase of a house in selected Canadian cities. The report will also present scenarios that examine the potential decline in house prices by the end of the year.
Diarra and I will be pleased to respond to any questions you may have regarding our analysis or other work of the Office of the Parliamentary Budget Officer.
Thank you.
[English]
The Chair: Thank you very much.
Can I take you back to the Fiscal Sustainability Report, just to set the stage here for us:
. . . fiscal policy at the federal level is sustainable over the long term. We estimate that the federal government could permanently increase spending or reduce taxes by 1.8 per cent of GDP . . . .
And that would not change the outlook dramatically. Does that also apply with the new spending more recently announced, the GST, the dental program, et cetera?
Mr. Giroux: The Fiscal Sustainability Report that we released in July includes information that was available until the end of June, so it includes budget spending, but it does not include spending that was announced after that.
That being said, the amounts that were announced recently are not material in the sense of — they are material, of course, but when we compare them to a long-term scenario of fiscal sustainability, they don’t affect materially the fiscal sustainability of the federal government because they’re supposed to be temporary for the large majority of these initiatives.
The Chair: Our witness last week, David Dodge, former governor of the Bank of Canada, said that basically we’re going to see zero growth for the next couple of years. Is that an assessment that is contextually right for you? Is that what you’re seeing as well?
Mr. Giroux: I would say it’s probably pessimistic. I don’t anticipate zero growth for a number of years. What we will be releasing next month will be our updated forecast or our projections, Economic and Fiscal Outlook, or EFO, and I don’t think we will be that pessimistic. We will, of course, revise down our estimate compared to March, when we released the last EFO, but I don’t anticipate zero growth for a number of years.
The Chair: Thank you for those remarks.
Senator Loffreda: Thank you, Mr. Giroux, for being here with us. I always enjoy your reports. They’re very insightful.
My initial question was on the affordability plan that was announced that our chair touched on. We will look at this piece of legislation in the Senate, and there will be, arguably, comments saying it’s going to spike inflation and what have you, but you’re saying it’s not material.
Maybe if you could expand on that: Will it increase inflation in Canada? Have you looked at the plan? Is it targeting the right areas that need help? There are many Canadians that do need help.
You have also made a point of saying inflation, you believe, is because of the pandemic and the war. I want you to expand on that, because governments and central banks blame supply chain bottlenecks for the current inflation problem, not fiscal or monetary stimulus. The central banks are saying it’s supply and demand. Demand has spiked. To what extent do you feel global stimulus measures increased energy, food prices and what have you?
And not to blame anybody. I’m not looking to pinpoint and say, “Here is the blame.” It’s a non-partisan comment. I’m just looking forward. If we know where the problem comes from, it will be easier to solve going forward.
Mr. Giroux: Thank you, senator. I’ll answer the first question with respect to the measures to fight inflation that were recently announced by the government. They amount in total to, I think, $3 billion to $5 billion, depending on which measures you look at and the time horizon you take.
Senator Loffreda: Well, the total affordability plan we’re looking at is $12.1 billion for new support in 2022. It goes into dental care for Canadians, doubling the goods and services tax credit for six months and Old Age Security increases, so it’s $12.1 billion. I’m wondering, because there will be arguments in the Senate that it’s going to spike inflation, and there’s going to be some push back on that, what do you feel about all that?
Mr. Giroux: Well, in a $2.5-trillion economy, it’s not a significant amount of money. It will, of course, have an impact on inflation the moment the government injects money into the economy, be it through tax cuts or increases in spending, such as these measures. It will have an impact on inflation, but I don’t think it will be a measurable or significant impact on the economy, given that it’s a relatively small amount in the overall picture of a $2.5-trillion economy.
Senator Loffreda: And it’s well needed. We all know that, yes.
Mr. Giroux: The second part of your question relates to inflation and my comments stating that these were related or had been induced by COVID. By that I meant the closing of the economy in a good part of 2020, which disrupted production lines as well as service provision and also forced governments around the world to increase the amounts they were spending to support households and businesses.
We saw an impact of closing down good segments of the economy, a big disruption, then gradually reopening the economy and lifting restrictions on the movement of individuals as well as some goods. That left severe disruptions in the economy, with constrained demand for services, and it displaced in good part some spending that was going on services — travel, for example — and that was displaced towards goods. At the same time, there were disruptions in the supply of these goods, notably with the closing down of some factories in China due to lockdowns. That’s what I meant by that.
It’s a combination of supply disruptions but also demand that was supported by government measures. Some would say “fuelled.” It’s not inaccurate, depending on the country where you are looking at, so it’s a combination of supply disruptions but also demand. Which impact or which effect is the dominant effect is very difficult to determine because of the complications that surround the fact that the economy was closed in several countries — or not closed but severely disrupted.
Senator Loffreda: Thank you.
[Translation]
Senator Moncion: Could you talk about the effect of what’s been called inflation from crooks who have taken advantage of it to raise their prices? Is this a concept that makes sense or is it a concept that is simply out of line?
Mr. Giroux: It certainly can feel that way, usually when, as a consumer, you’re faced with prices that seem to increase without reason in some cases. For example, when you fill up your car and see the price of gas approaching $2 a litre or more, and at the same time you learn that refining margins have increased significantly, you can feel like you’re getting gouged.
That said, as an economist by training, I see a supply and demand phenomenon. It’s hard to accuse everyone who is raising their prices of taking advantage of the situation, even though it may look like that. It’s hard to make those accusations, generally, without looking at a particular industry or a particular business. Price hikes like that often result in markup for profit that is generally in lockstep.
Senator Moncion: In fact, we just heard that $10 billion was returned to the oil company’s shareholders in dividends.
My second question is about the tariff barriers that exist between provinces and the impact they have had on inflation.
Mr. Giroux: That’s a good question, but it’s not one that was specifically addressed in the inflation report. However, interprovincial barriers to trade and employment are factors that contribute to a certain level of inefficiency, and that has the surreptitious effect of raising prices or increasing the scarcity of certain goods or certain trades, for example. If a nurse cannot easily work on either side of a provincial border, that creates friction in the labour market. The same is true in a number of sectors, including construction. This is nothing new. So it probably hasn’t contributed to recent inflation, but it does contribute to inefficiencies within Canada.
Senator Moncion: Thank you very much.
Senator Bellemare: Thank you for being with us, Mr. Giroux and Ms. Sourang.
Here’s my question. In your studies, you confirm, according to your writings, that the measures that have been adopted — personal rates — have a significant effect on supply. Do you think that the inflation we are experiencing is temporary, as was said at the beginning? Do you think that it is not reflected in the system because of wage increases, which would start a spiral? How do you see that?
Do you think the measures adopted can cause permanent damage in the context of temporary inflation? I’m wondering, as a matter of public policy, do you think it would have been better to reduce the GST? That would have had the effect of reducing the inflation rate. So by reducing the measured inflation rate, there would be less pressure later on in everything that is indexed. This would be a smarter approach.
Mr. Giroux: I’ll answer the first part of the question, senator.
Is inflation temporary? It depends on how you define “temporary.” Many people before me have said that inflation is likely to be temporary. I am not in the minds of those people, but for many the word “temporary” meant a month or two, so a shorter period. I think inflation is probably going to be temporary, at least that’s the expectation at this point, in that inflation expectations don’t seem to have completely disengaged from the Bank of Canada’s 2% or 3% target.
When you look at inflation expectations, in the short term they are higher than the target. However, when we look at a three- or five-year period, people generally seem to believe or understand that inflation will return much closer to the Bank of Canada’s target. Since inflation expectations are important for achieving inflation targets, there is every reason to believe that inflation could be temporary in nature. From there to say that “temporary” means “a few months,” it could take a year, a year and a half, or perhaps even two years to return to inflation closer to 3%, which is the peak of the target.
The second part of your question was whether the measures the government has taken cause permanent damage. Would it have been better to do something else? That is a public policy question. You mentioned a GST cut that would have had an immediate impact on lowering inflation. Yes, the cost would have been much higher as well. If we are talking about a one-point drop in the GST, it’s easily in the neighbourhood of $6 billion or $7 billion, perhaps more. The 1% of the GST would probably not have lowered inflation by 1%, because some goods are exempt. So it comes down to benefits and trade-offs, which is probably a matter for the Minister of Finance and the government as a whole. There are pros and cons to every measure the government takes.
Senator Bellemare: In terms of wage inflation, so far your data doesn’t support that trend. It’s fairly contained.
Diarra Sourang, Director, Economic Analysis, Office of the Parliamentary Budget Officer: At the moment, when we look at wage growth, we don’t really have a spiral. It is true that wages have increased, but given the level of inflation and the time it takes for wages to catch up with inflation to maintain the standard of living, we do not really have a spiral.
Senator Bellemare: Thank you.
Senator Gignac: Good evening, Mr. Giroux.
I’ll continue along the same lines as my colleague Senator Bellemare.
In the fight against inflation, does the current government seem to be choosing the path of helping the most disadvantaged? As I understand it, in the upcoming bills, the measures could be more targeted.
Other countries — provinces, states — choose something else instead. It’s not just the GST idea. It could be the gas tax or tax cuts, for example. We see this in Europe, for instance. Some European countries have much lower inflation rates than Canada.
Have you considered or do you intend to consider the best way to proceed this fall? In one case, it’s done in a regulatory way, and that may have an impact on public finances, but the impact isn’t quite the same. We know that inflation is very regressive. The poorest members of society are the most affected by inflation. Not every approach has the same impact as another.
Mr. Giroux: Indeed, you raise some good points.
I don’t think we specifically considered these aspects in our report.
Certainly, broader enforcement measures would cost more but would reduce some of the inflationary pressures, prices. However, the disadvantage would be that it would benefit the wealthy. That can be an advantage or a disadvantage, depending on your point of view. However, there is no doubt that these measures would have higher costs. The government has clearly decided to help the most disadvantaged with temporary help, rather than resorting to broader enforcement measures that would lower the inflation rate, but would represent higher costs to the public purse.
Senator Gignac: I have another question on another topic. Maybe I could ask it immediately or in the second round of questions?
[English]
The Chair: We will complete round one first.
On the question about the carbon tax and slowing down the rate of increase, that’s not targeted either to the rich or to the poor. Everybody pays it one way or another. Would that have been a reasonable step?
Mr. Giroux: That could well have been an approach. However, with the carbon tax or the carbon levy, depending on what you call it, a significant portion is returned to households irrespective of their greenhouse gas emissions or consumption of fossil fuels. Therefore, a reduction in the carbon tax under the current framework would also have been accompanied by a reduction of the rebate that’s returned to households.
It would have been a reduction for sure in headline inflation, depending on the magnitude of the reduction in the carbon tax, but also reduction in supports to all households.
The Chair: I will return to that because then you have sectors like agriculture, where it really has a huge impact.
Senator Ringuette: Canada represents 1% of the global economy and 10% of the U.S. population in most indexes. The latest CPI for Canada, from August, was 7%, while in the U.S. it was 8.3%.
What is the difference there? What is happening to make inflation in the U.S. so much higher than what we are seeing here? Have you analyzed this situation?
Mr. Giroux: We have not looked at the difference and what would explain the difference in inflation numbers between Canada and the U.S. That’s certainly an interesting question. That being said, you mentioned the U.S., which is at 8%. It’s not that big of a gap with Canada at 7%. The U.K. is also a very interesting case, with inflation running at close to or above 10%. However, in their case, they have factors that can explain that, energy prices, for example. There’s also France with a lower inflation than Canada, and Japan, with a significantly lower inflation rate than Canada.
The structure of each of these economies, their taxation rates as well as whether energy is imported or produced domestically and whether before the pandemic they were in a situation where inflation was under control — or not, as in the case of Japan, where they suffered from deflation for a number of decades — are all factors that come into play.
In the case of the U.S., one potential explanation could be the significant stimulus that was announced by the President a couple of months ago, which had the impact of increasing economic activity at a time when the economy was already rebounding. Those are just preliminary thoughts. We need to look into that in more detail to provide you with a more fulsome answer.
Senator Ringuette: We do understand the issue of CPI and its relation to interest rates. Have you looked at the impact in regard to the interest that the government will have to pay on its debt? I’d be interested to see what the impact is.
Mr. Giroux: That will have a major impact on public finances not only at the federal level but also at the provincial level. We’ve looked at the impact of increasing interest rates as well as the increase in the stock of debt. We estimate that in the next four years interest payments will probably double compared to their level in 2021-22. They will probably go from $23 billion, if memory serves me well, to $46 billion. We’ll be providing an updated number when we release our Economic and Fiscal Outlook, probably in mid-October.
Senator Smith: Thank you for being with us, Mr. Giroux. It seems that Canada is taking a very aggressive approach to combatting inflation. I’d like to have you give us some feedback on the relationship between interest rates and investments. Do higher interest rates deter investment that could help with supply bottlenecks, since we know supply bottlenecks are a major contributor to inflation?
Mr. Giroux: Generally, yes. That’s one of the reasons why interest rates rise, namely, to cool demand not only from households but also from businesses. Rising interest rates act as a deterrent for investment or can act as a deterrent. That being said, if inflation is higher than nominal interest rates, it is still beneficial because the net interest cost — that is, the real interest rate — is negative. Other things being equal, rising interest rates will act as a brake on investment by businesses.
Senator Smith: Can you comment on the quantitative easing that the government went through during the pandemic and what impact that has had moving forward? That would be helpful.
Mr. Giroux: I’ll speak briefly on that because that’s the bailiwick of the Governor of the Bank of Canada and the Bank of Canada.
Quantitative easing had the impact of keeping interest rates low. That was the purpose of quantitative easing, namely, to ensure there was sufficient liquidity and that interest rates remained low.
Since late April, the bank has entered the phase of quantitative tightening, so the impact is probably reversed. However, that depends on the speed at which the bank is tightening or reversing quantitative easing. The governor or somebody from the bank would be in a better position to explain to you the speed at which they are tightening.
Senator Smith: Any comments on how far the government will go with increasing the interest rate? Do you have a crystal ball?
Mr. Giroux: It will probably go above what is neutral in terms of interest rate, which is probably in the vicinity of 2.5% to 3%. They are already above neutral rate. But we haven’t yet finalized our Economic and Fiscal Outlook. There will be more to come on that.
The Chair: The governor is coming, so we will be putting those questions to him as well.
Senator Woo: Thank you to our witnesses.
Can you comment on the impact of the ultra-hawkish policy of the Federal Reserve on the Canadian inflation outlook and the economic outlook? I’m thinking of a few different transmission mechanisms, which you’ll know about. First, of course, is the need for the Bank of Canada to match or even to anticipate Federal Reserve increases so that our exchange rate doesn’t fall further than it has fallen already and lead to greater imported inflation.
The second is that this same phenomenon is being played out in other countries where perhaps they are having to tighten more than they would want to tighten for the purposes of their domestic economies in order to avoid imported inflation through a falling currency relative to the U.S. dollar.
In that situation, if the U.S. has gotten it wrong — and they got it wrong, of course, in the last decade — what probability would you assign to an overshooting risk where, essentially, the U.S., through a beggar-thy-neighbour policy, drives us all into a recession, causing a much worse situation than what you described as a transitory inflation for our economies?
Mr. Giroux: Thank you, senator. You seem to have explained transmission mechanisms quite well. The Federal Reserve, or the Fed, is in a tightening mode. As you explained, Canada usually has to follow suit, at least to a certain extent, at the risk of seeing the Canadian dollar depreciate sharply, which would further exacerbate inflationary pressures. That’s probably one of the important inputs into decision making at the Bank of Canada in their decision to increase interest rates.
One of the risks of the Federal Reserve in the U.S. increasing the rates and potentially increasing the rates too much, if that were to be the case, is the risk of pushing the U.S. economy into a technical recession, if not a full-blown recession, but I don’t think so. If that’s the case, it will be a painful recession.
So maybe a technical recession, which would obviously act as a weight on the Canadian economy, lowering economic growth in Canada because of the very close interdependencies of both economies.
Senator Woo: What scope do you think we have to decouple somewhat our approach to interest rate increases so that we don’t overshoot as well in Canada and drive the economy into more of a recession than is necessary to bring down inflation?
Mr. Giroux: I’ll give a brief answer, but the governor or somebody from the bank will probably have a more fulsome answer. I think there is little scope to decouple our monetary policy from that of the U.S. because of the impact this would have on capital flows and also on the exchange rate. Given that three quarters of our goods and services trade is done with the U.S., that decoupling would have major impacts not only on the exchange rate and financial flows but also on trade.
Senator Woo: Thank you very much.
Senator Yussuff: First, thank you, witnesses, for being here today.
This certainly is a real challenge for low-income households, dealing with inflation. They’re not like the rest of the economy. They don’t have indexation to their pension and wages. In terms of the measures that the government has announced, do you find this would be extremely helpful for those households that are struggling with day-to-day challenges in meeting budgets and buying groceries and paying rent? The measures that the government has announced could really assist these low-income households in managing in a way that recognizes that the pain we’re all struggling with is not shared proportionately across the income scale across this country.
Mr. Giroux: Thank you, senator. It’s true that food and gas prices going up affects everybody. But when there is little discretionary money remaining at the end of the month or at the end of the week for low-income households, it has a greater impact. That’s probably why the government chose to target the measures that it announced recently to those with low incomes, for example, a doubling of the GST credit, which is income-tested. So it will go to those who are probably suffering the most from inflation. It doesn’t mean that others are not suffering, but when you’re making $200,000 a year, of course, inflation has impacts, but there are usually more ways to mitigate the price increases than when you’re a $20,000- or $30,000-a-year household.
The Chair: Can I ask a question? You said you were going to do a housing report shortly, but there is something I was reading today, and it was kind of a troubling figure. A quarter of the people who live in the downtown cores of cities are suffering what they call shelter poverty. We used to call it being house poor. It’s the people who are spending more than a third of their income on housing. Is this a trend you’re seeing — that the shelter poverty, or being house poor, is increasing pretty quickly?
Mr. Giroux: We haven’t looked at those who are specifically house poor, but we’ve looked at the affordability of an average-income household and what they can afford compared to the average price of a house in big Canadian cities. We find there’s a significant decoupling between the average price and what these households can afford. It suggests that those who are very stretched financially to make their mortgage payments and other payments related to housing, that’s increasing. So there are more of these households that are struggling to make ends meet, despite the fact that prices have started to go down. Interest rates going up is not improving affordability for average households.
The Chair: This was not just as a result of the recent inflation hikes; this is just as a proportion of the family income or the individual income. We have some of the most expensive housing in the world.
Mr. Giroux: Yes, you’re right. It started before the last few months. It’s something that was —
Senator Gignac: My next question is probably more to Mr. Giroux, the economist, rather than PBO. A year ago, central banks, the Fed or Bank of Canada, mentioned that inclusive recovery is more important, and that explains why they do not increase interest rates. It’s very important to have inclusive recovery. Now the Fed or the Bank of Canada will probably mention this fall that inflation is the worst in a millennium. They have already increased by 300 basis points and they go with very fast and furious hikes.
At the end of the day, my question is this: We are approaching the crossroads where they will have to choose — particularly if geopolitical events or inflation expectations remain high — between fighting inflation and preventing a recession. If they have to choose, have you any opinion which is the right scenario? Because a year ago it seems that the labour market was very important, and now inflation is very important. At the end of the day, are we heading to another policy mistake? Because they admit now a year ago it was a policy mistake to sleep too long on the switch before increasing the interest rate, but now maybe they are heading to another policy mistake by creating a recession. If you had to choose between the two, more as an economist than PBO, what does history tell you to choose?
Mr. Giroux: Thank you, senator. This is turning out to be probably the most interesting Senate testimony I’ve had in a long time, given that you ask all the interesting — well, you always ask interesting questions —
Senator Gignac: I prefer to be a senator than a witness.
Mr. Giroux: Particularly as an economist, I enjoy these questions. I hope you enjoy the answers as well. I don’t think the bank has to choose between fighting inflation or avoiding a recession. Personally, I think it can do both. It can engineer a soft landing, but it has very few tools. Achieving a soft landing will be dependent on avoiding or the absence of further shocks on the world economy.
For example, if there were to be an aggravation of the conflict in Ukraine, it could well be very difficult to do a soft landing. But in the absence of major shocks, it’s quite possible — even likely, I hope — that the bank will be able to bring inflation under control and avoid a recession. Even if Canada were to enter into a recession, with the state of the labour market right now, I don’t think it would be a recession à la 1982, where we saw massive layoffs and unemployment spiking. I think a recession, if it were to happen, it would be relatively painless, so to speak, compared to other recessions.
Senator Gignac: Thank you. In your upcoming update of the economic forecast — maybe it would be more useful for the National Finance Committee — but even if you do not predict any recession, is it possible that in the upcoming report you have scenarios with a mild recession, a full-fledged recession and the impact on the labour market, on public finance? Because we are just concerned — so far deficit is lower, whether provincial or federal, thanks to inflation. But if we are heading for recession, it’s another ball game completely. As senators, we are curious to see what the impact would be if you have a mild or full-fledged recession. Is it possible to have such a scenario in the upcoming report?
Mr. Giroux: It’s certainly possible, but it’s not something we are working towards at this point. When we release our next EFO, Economic and Fiscal Outlook, I would be happy to testify again and have that type of discussion.
The Chair: Relative to the large banks and other people, you are really optimistic. Everybody else is talking about hard landings, and you’re saying not so much. Where are you getting that optimism from?
Mr. Giroux: Generally, I’m not an optimistic person, but thank you for telling me I’m an optimist this time. We take that from the numbers that we are seeing, the models that we have and the behaviour or the anticipated action we think the Bank of Canada will take, as well as what will happen with the world economy. The fact that Canada is an oil-producing and oil-exporting nation also helps to mitigate some of the negative impacts of increases in energy prices that we have seen for a number of months now.
Senator Loffreda: We have discussed the significant increases in interest rates and the impact on government debt. One area we don’t often look to in our committees, and I think we should more — even in the Finance Committee we discussed it this morning — is the increased revenue side. I’m going to join you and be an optimist in saying that I had heard when I was in university in the 1980s — we would have many economists tell us they’d never seen a country repay their debt without inflation.
So what will be the impact of increased revenues? Yes, we will have — maybe not — but if we do have a recession, hopefully that impact will be short-term, but the increased revenues will be long-term.
I’d like to end on this note on that question because I read your report — always insightful — and I noted on page 16, where you’re making a “Fiscal projection summary: federal government,” you report that “given projected declines in transfers to individuals and other governments,” you project that:
. . . revenues will exceed program spending over much of the projection period, resulting in sizable primary surpluses by the end of our long-term projection.
I’m looking long term here. I think that’s sound fiscal management.
You also suggest that the federal government’s net debt of 39.4% of GDP in 2021 would be eliminated in 2061, by then obviously in the absence of policy changes. “In the absence of policy changes” is a big phrase.
I’d like to maybe have you elaborate a bit on what impact of the increased revenues would be. How do you see that affecting government debt in the short term and given the recession, if there is a recession? Hopefully, there won’t be, but like our chair said, many are forecasting a difficult landing. Hopefully, there will be a soft landing, and if there are any recommendations on how we can have a soft landing, feel free to give them out this evening. You said you’re having a lot of fun. Why not increase the fun we’re having?
Mr. Giroux: If I knew how to engineer a soft landing, I don’t think I’d be here. I’d be wealthy and enjoying something that’s taxed at a higher rate, such as a luxury boat.
Interesting question, as always. With respect to the impact of inflation on the debt, the government has issued debt over decades on a nominal basis, with interest rates that are fixed for the vast majority, except for real return bonds, which form a very small portion of the overall stock of that. Inflation running faster than anticipated has the benefit of reducing the relative size of the debt compared to the economy. A small amount of inflation like that will shrink the size of the debt a little bit in relation to the economy.
However, that risk, as we are seeing now, increases interest rates, which forces the government to pay more to finance the debt that it is refinancing.
On the revenue side, we are seeing much better than expected income tax revenues flowing into government coffers, which led the government to post a surplus for the first three months of the year. Of course, the first three months do not guarantee that this will continue over time. We still anticipate the government to be in a deficit position when the books are closed at the end of March 2023. We’ll know that in a year, of course, given the time it takes to get public accounts. This will probably have a permanent impact in lifting the revenue prospects of the Government of Canada.
That is relatively good news from a fiscal perspective, certainly in the short term. But as you mentioned, the Fiscal Sustainability Report looks at what will happen over the next 75 years in the absence of any new policy direction, and I don’t think that the governments that will be successively elected over the next 75 years will do nothing. That is to give an idea of the direction in which we are headed, not of what will happen.
The Chair: Seventy-five-year advanced planning.
Senator Loffreda: I figure if he has 75-year advanced planning, maybe we can have an estimate of what the revenue impact would be.
If I can put in a quick question. We all know that the Bank of Canada has not been predicting inflation. We had that discussion. I think Senator Gignac raised it well the other evening at our Banking Committee. The Bank of Canada recently suggested that inflation has now peaked, although they are looking at increasing interest rates because of the supply chain bottlenecks that continue. The demand continues to outpace supply. We see the consumer spending in Q2, which has been very healthy, as well as the significant labour shortages.
Do you feel that inflation has peaked at this point in time? Do you agree with the Bank of Canada?
Mr. Giroux: Based on what we are seeing right now in the overall economy, it seems that inflation has peaked. That, however, could change if there were to be further disruptions in Europe or elsewhere in the world. But so far, yes, it seems all signs are pointing to inflation having peaked and being on the decrease over the next several months.
[Translation]
Senator Bellemare: I would like to come back to the questions that were just asked. For several years now, we have relied heavily on monetary policy for economic support. However, during the COVID-19 pandemic, our economy was crushed, and we had to support it; we had no choice. Going forward, what role do you see for fiscal policy? From 1945 to 1975, fiscal policy was very active; now it is less so and we are in a passive mode. At the provincial level, fiscal policy responds to needs. At the federal level, do you see a particular role that would have a more beneficial effect on the economy than monetary policy? Monetary policy is used to stimulate the economy, but it is so general. When you want to contract the economy, it’s a lot of chemotherapy. Can fiscal policy be more useful, flexible and agile?
Mr. Giroux: That’s a very broad question that I wasn’t expecting. Monetary policy plays an important role. Budgetary fiscal policy is indeed — I don’t think we have a fiscal policy as such as it stands. Instead, governments are trying to achieve a series of interventions. For example, the provinces want to deliver effective health care and education services to the public. The federal government has its own objectives and priorities set out in political parties’ platforms and in throne speeches. However, I don’t think we have a fiscal policy other than to ensure that the debt-to-GDP ratio falls or remains stable. The goal seems to be to reduce the debt load. Beyond that, unless I’m mistaken, we have no fiscal policy other than to deliver the goods according to the government’s priorities.
Senator Bellemare: I agree with you, but perhaps we should have a more articulated fiscal strategy.
[English]
Senator Woo: First on a technical point from Senator Bellemare, because there is a lot of debate about sources that are pushing up demand-side inflation. Would you characterize the current fiscal stance as contractionary on a year-over-year basis? I know the year is not over, and you’ve said there’s a surplus for the first reporting period and that there will likely be a deficit by the end of the year, but probably a smaller deficit than in the previous year. To that extent, can we say that the current fiscal stance is contractionary?
Mr. Giroux: It depends on your point of view. If you look at 2020-21, of course, it’s significantly constraining. But if you look at pre-COVID years, it is probably neutral, slightly expansionary, maybe slightly contractionary. I would have to look at the numbers, but I don’t see a big difference. Diarra is not kicking me under the table, probably because there is a wall separating us.
Senator Woo: But it would not be correct to say that fiscal policy currently is exacerbating inflation through massive spending relative to recent periods?
Mr. Giroux: Not compared to COVID years.
Senator Woo: Correct.
My next question goes back to my previous set of questions on imported inflation. Can you tell us what estimates you use in your model for the elasticity, if I can use that word, of exchange rate changes on inflation? How big is the fall in the Canadian dollar? How does that translate to inflation? What are the orders of magnitude?
Mr. Giroux: I don’t have that information off the top of my head. Maybe Diarra, who is younger and smarter than me.
Senator Woo: When do we worry? How much has the Canadian dollar to fall relative to the U.S. dollar before we start to think that this is going to start showing up two or three months from now, 20 or 30 basis points? Or is it so trivial that let’s not worry too much about it?
Mr. Giroux: I wouldn’t say it’s trivial. It depends on how it happens: if it’s gradual or sudden. If there were to be a sudden drop in the Canadian dollar, that would probably have ripple effects throughout the economy and could have significant impacts on the inflation rate and other sectors of the economy. Conversely, if there were to be a sudden rise in the Canadian dollar, that would also have an impact on the Canadian economy in terms of decreasing inflation but also decreasing the competitiveness of exporters. I can’t answer in terms of a precise level at which we’d have to worry about that.
Senator Woo: That’s helpful. Thank you.
The Chair: You’ve talked about the impact of things you can’t predict, whether it is the pandemic or Russia’s war in Ukraine. I guess we could have seen that coming for a little bit. We’ve also got some domestic pressures here. I’m looking at Senator Deacon, who has just gotten off a plane from Halifax. A part of our country has been completely devastated and will take a lot of infrastructure spending and repair.
Is that something you’re anticipating that may have a hit or an impact in terms of government spending and, in turn, on inflation, or whichever way you think that will go?
Mr. Giroux: When we see natural disasters striking regions of the country, it is something that has an impact on the national economy. Obviously, it has a significant impact on the regional and local economies, but what we tend to see is that the impact is felt nationally in the numbers for the Canadian economy as a whole. However, it doesn’t tend to be as big as the impact we would expect, looking at the level of devastation, because of the government support and the reconstruction that takes place.
The Chair: And insurance and those things.
I think we’ve just about covered the waterfront. Does anyone have any final comments?
Senator Yussuff: There’s a slight “hyperness” about where wages are going compared to inflation. The Governor of the Bank of Canada has commented in a particular way that certainly caused some people some grief. If you look back over the last two or three decades, wages have not risen relative to inflation in this country. Canadian workers can argue that, as a matter of fact, they’ve fallen behind. Most of the data that exists suggests they’ve fallen behind.
Even in this “hyper” moment of inflation in the country, wages haven’t significantly risen to the level that we could be alarmist. Inflation has certainly gone up. The trends are showing that. But it hasn’t gone up in a significant way that makes people wake up in the morning and think we have a double problem. We have a supply chain problem, where prices are rising because we don’t have enough supply in the market, but workers have been fairly restrained in terms of how they’re approaching their collective bargaining and, equally, their recognition that they’ve got to play a role in how we get inflation back down. Would you characterize that as fair?
Mr. Giroux: Over the last couple of decades, wages have kept pace with inflation, if I’m not mistaken, and probably outpaced inflation to a certain extent. That tends to be the case when labour productivity is positive, which has been the case in Canada for most of the recent past.
It’s true, however, that in the last few months, maybe years, wage increases have taken place, but probably not at the same pace as inflation because of rigidity in wages in many sectors. In the long term, wages tend to grow with inflation and productivity, but certainly in the short term there has been a decoupling recently.
The Chair: We’re also seeing wages grow because of the worker shortage or “quiet quitting” and all of these factors coming into place. How do you assess that?
Mr. Giroux: I think it’s uneven, depending on the sector. I haven’t looked specifically at all sectors, but there have been more increases at the lower end of the spectrum, where it’s more difficult to find workers, whereas it hasn’t been as high for the higher end of the spectrum.
The Chair: You can put your economist hat back on. Where have all these people gone? It seems odd. Do you have theories on this?
Mr. Giroux: I have questions. I have very few answers, like most of us.
The Chair: It’s puzzling.
Thank you all for coming. Senators, please join me in thanking Mr. Giroux and Ms. Sourang for appearing this evening. Thank you so much for your time.
(The committee adjourned.)