THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, October 20, 2022
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:30 a.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: Hello, honourable senators and everyone. My name is Pamela Wallin, and I am the chair of this committee.
I will introduce members of the committee today beginning with the deputy chair, Senator Deacon, Nova Scotia; Senator Bellemare; Senator Gignac; Senator Loffreda; Senator Marshall; Senator Massicotte; Senator Smith; Senator Woo; Senator Yussuff. Joining us today, also, is Senator Mockler. Welcome.
We will continue our discussions on the state of the Canadian economy and inflation. We have the pleasure of welcoming Mr. Mark Carney, Vice Chair of Brookfield Asset Management Inc. and Head of Transition Investing. Most everyone in the country knows him as the former governor of the Bank of Canada and then former governor of the Bank of England.
Welcome and thank you for joining us today, Mr. Carney.
[Translation]
Mark Carney, Vice Chair of Brookfield Asset Management Inc. and Head of Transition Investing, as an individual: Thank you, Madam Chair and senators.
I have been testifying in the Senate for a decade. It is a great honour for me to be here. Now I am not a governor. I’m a private citizen.
[English]
I hope I can provide some perspective to your deliberations. In the brief period provided to me, I thought I would provide — in part because they’re topical but also they’re relevant — a few observations and some lessons from the situation in the United Kingdom and how it might relate to our situation.
We all know that the reaction to the U.K. budget was sharp. It occurred in an environment of high and volatile inflation and sharp repricing of risk globally. I think one of the lessons is that sound money and credible fiscal policies will be rewarded but mistakes will be punished, and no one is really going to be exempt.
The second point is that the U.K. experience underscores that it’s counterproductive for fiscal and monetary policies to work at cross purposes. Colloquially, if one foot is on the brake with monetary policy, it’s foolish for the other to stomp on the gas. While governments may provide targeted aid to the Canadian households that are most affected by inflation, this is a time to reduce deficits, in my opinion, not increase them.
Third, one of the lessons in the U.K. is the importance of institutions. The government initially refused to use its independent parliamentary watchdog to produce a forecast. There were clear intentions with the civil service and the central bank. In Canada we have very strong institutions. The Parliamentary Budget Officer can regularly assess the sustainability of our finances — that’s critical — and we have a highly competent and strong central bank that, of course, must be held to account, including by this committee, but also have the independence to conduct monetary policy in difficult times as well as good.
My fourth point is that the experience in the U.K. underscores that in an environment of tightening monetary policy, there will be rising tensions between various macroeconomic objectives. In the U.K., it wasn’t just fiscal policy and monetary policy that were at cross purposes but tensions between financial stability and price stability, which saw the Bank of England both selling government bonds and buying then. We’ll see some tensions between price stability and currency integrity in Europe, tensions in emerging markets between price stability and growth, and between internal and external balance in Japan.
Finally, I would suggest that the U.K. budget failed, in part, because it missed the imperative of inclusive growth. Most of the tax cuts proposed would benefit the wealthiest, and inequality was set to increase with expected future cuts in benefits. Canadians know that our focus must be a better Canada for all. With trade agreements with the G7 and much of Asia, we’re well positioned to bring global manufacturing and high-paying jobs to Canada, even in this difficult environment. But for that, we need co-operative economic policy, including between the federal and provincial governments to build a clean electricity grid. We need tax reforms to encourage skills development and business investment and bold new approaches to mid-career skills development and training.
The British experience, in closing, shows that institutions matter, partial solutions fail and solidarity is essential. So by working together and by building, Canadians can turn the current anxiety into prosperity for all. With that, Madam Chair, I hand it back to you.
The Chair: Thank you very much. I want to follow up on that quickly because you’re saying no country needs fiscal and monetary policies working at cross purposes. Where do you think we are at this point? How do you interpret the most recent comments from the Finance Minister?
Mr. Carney: I’m not sure I’ve tracked — and I should say as well that while I can provide general perspectives on these issues, I’m not following every word, every data point. I hope you forgive me for that, but it reflects my current role.
We had quite a considerable fiscal support package that was necessary during the depths of COVID. With the 20/20 hindsight, and hindsight is always 20/20, that support package went on a little longer than was strictly required. Of course, during a time of uncertainty, that added to inflationary pressures. There was a period of time where fiscal policy was reinforcing some of the challenges that the Bank of Canada began to see.
What has happened since, as you’re aware, is the bank has been moving smartly and aggressively to tighten interest rates, and fiscal policy has been consolidated. In other words, the deficit has been coming in.
I may not have seen the specific comments you referenced, but I think that the general posture of the Deputy Prime Minister and the Finance Minister and the government is to focus on temporary and targeted relief to those Canadians most affected by the higher prices and the energy crisis. As a balance that is the appropriate stance to policy, given the inflationary pressures and the need, as I said, in a more challenging environment globally. In an environment where we have left the world of low-for-long interest rates, low volatility, an environment where borrowing costs will be higher — in my judgment, not higher just in the short term but in the medium term — fiscal discipline is an imperative.
The Chair: Thank you very much.
Senator C. Deacon: Thank you, Mr. Carney, for being here. What a delight to have you with us today. The clarity of your comments is always greatly appreciated. I want to ask two questions related to business investment in this environment.
With increasing interest rates, how do you see them affecting new projects, green and otherwise, essential projects that are challenged because of the increased cost of capital and increasing market uncertainty? How do you see it as it relates to those larger projects?
Second, what effect do you see increasing rates having on investments, not just the green transition but more broadly across the private sector as it relates to highly productive intangible sectors of the economy?
Mr. Carney: Great question. Let me start with the second part of your question, Senator Deacon, which is around the intangible sector. It’s not unique to Canada, but one of the challenges we have is that financing of intangibles tends to be more through equity investments as opposed to debt investments. Partly, that’s a product of history and bankers being prudent and liking to have not just the prospect of future cash flows but actual property or real assets on which they can fall back in the event of a default.
But that economy is not totally in the past. In fact, we’re going to see a lot of tangible investment in the new green economy, and I’ll turn to that, but huge engines of growth in our economy relate to intangibles in a broad variety of sectors. That, really, to my way of thinking, goes less to issues of where we are in the macroeconomic cycle as opposed to the structure of financing markets and our financial system in Canada.
I hope you’ll forgive me for drawing on some of my experience in the U.K. because it’s more recent, but one of the things we began to emphasize there was what is necessary in order to have enhanced financing of intangibles? How do you use data that companies accumulate? Not just traditional financial data, but through the sociograph, through commerce platforms, et cetera. And how do we have an open-as-possible and competitive financial system in order to use those data?
Let me be a little more specific, if you’ll grant me the time. There are platform companies like Shopify, Amazon and others — great successes — that collect data effectively. The question is whether they use them, and they have different policies in and around this. Shopify is very careful about it.
That information can be used to more effectively finance companies that are early stage and heavy on intangibles. One of the key things for the system to work is to ensure that that borrower or that company, if you have the system in place, can port their own data, including not just financial but all data, over to an alternate provider. I would suggest that this is something that is under development in various economies not yet there, and it might be a priority for consideration. I think it should be a priority for Canada.
I’ll try to be quicker on the green economy, although I would be happy to drill down on it.
I’d say that the most important thing to drive green investment is clarity of purpose and high credibility about the direction of climate policy, if I can put it that way. Canada has legislated a net-zero objective, has an increasing track record of a series of climate policies, including — and I would salute the ministers — the Minister of Finance and the Minister of Environment, who share various responsibilities, so I’ll say the government — for initiatives such as the Carbon Contract for Differences initiative, which provides a higher degree of certainty for investors today to make the types of investments necessary for Canada to be competitive and get emissions down.
Those types of measures, again, are going to dominate shorter-term cyclical issues around the cost of capital that is obviously rising during this period of rising interest rates and slowing growth.
Last point, if I may, which is a general macroeconomic point. We are moving from one regime to another regime, not just in Canada but the world. We’re moving from a low-for-long, low interest rate, low volatility, widely available capital regime, relatively generous pricing of risk — if I can put it that way — to one where we have higher interest rates, higher inflation, higher volatility and much more acute pricing of risk. It doesn’t mean risk isn’t priced and capital is not available, but this period is a period of moving, as I say, from one regime — to speak like an economist, one equilibrium to another. During this time, it is going to be difficult in certain periods for businesses to access capital, so it puts a primacy on these underlying structural changes, both in terms of policy, whether it’s for climate and a green transition, or for financing for intangibles.
Senator C. Deacon: Thank you very much for that clear answer.
Senator Loffreda: Thank you, Mr. Carney, for being with us this morning.
You mentioned in your comments that fiscal discipline is imperative in this environment going forward. Mentioning targeted support, we did obtain Royal Assent on Bill C-30 this week, and I would like to thank all of my colleagues for their support. I want to put it on the record, so thank you.
We will soon be looking at Bill C-31, which has a cost of $2 billion. Do you feel this will have an impact on inflation in our economy? You do know it’s over $2 trillion, our economy, our GDP.
What do you feel are the main causes of inflation? Could you elaborate on any additional recommendations going forward?
Mr. Carney: If I may, the first point in the scheme of things, senator, I think your preamble suggests the order of magnitude of that specific legislation. Again, I’m not familiar with the specific purpose of Bill C-31, I apologize, but those orders of magnitude are not decisive in terms of impacting inflation of $2 billion, as you say, relative to the size of the economy. Of course, it’s a question of accumulation of $2 billion. It starts to add up, and that’s where the discipline has to come in.
To your general question, which is a critical one about the broader causes of inflation — I will keep it general for the moment, and then senators may want to drill down. Yes, there are global factors, and there have been global factors for inflation, whether it’s commodity prices and goods prices or the supply chain problems, which started to ignite this period of inflation.
But really, now inflation is principally a domestic story. We have seen the contributors to inflation broaden across categories of the Consumer Price Index. I think it’s on the order of magnitude of almost 80% of the CPI components have inflation rates themselves above 3% and probably something like 60% above 5% inflation rate. It’s quite broad, so it’s not all imported inflation. In fact, most of it is now domestically generated inflation.
We see it in the service sector, particularly pent-up demand that I think we’ve all experienced. I’m glad to see you all in the room. I was told that this was virtual. I would have happily come down and attended in person because I’m not that far away, but literally being pent up in this room and the pent-up demand that comes from that, we’re seeing that through services. We’re seeing it in housing as well, and I think it’s a clear case now.
I would commend the Bank of Canada and the governor — they’re very clear about this — that the primary concern now is excess demand in the Canadian economy, domestically generated inflation, and therefore, the focus on tightening policy in order to address that.
Senator Loffreda: Thank you.
[Translation]
Senator Bellemare: Welcome back, Mr. Carney, and congratulations on your book. I have enjoyed reading it.
My question is about the chapter on adopting rules of discipline for government, particularly when you set out your 10‑point plan, including point number 2, where you talk about adopting rules. You encourage the Parliamentary Budget Officer to do this.
I would like to know how you see the accommodation of the necessary investments for human capital, for social capital and for natural capital. If we want to be responsible and move towards a contraction without affecting, in particular, investment in human capital, how do you see these rules?
Mr. Carney: First of all, I’m impressed to hear that you’ve read my book, including chapter 16.2 on the 10 points. Thank you.
[English]
I’ll answer it this way, if I may. For those who didn’t get that far, this distinction in a golden rule, if you will, between current spending and capital spending. Senator Bellemare is focused rightly on what capital is. Is it only physical capital? What about human capital and social capital?
I would suggest a few points. One is, for human capital, elsewhere I emphasize — and I referenced this briefly in my opening remarks — the importance of ensuring that investments in human capital, specifically investments in training and skills development, that this is treated as an expense, as a tax deduction consistent with physical capital investment.
We have accelerated capital cost allowances for various things, and we actually end up in a position where we, in relative terms, are disadvantaging human capital investments by companies. I would suggest that if we step back from the current situation, the one thing we know with digital and sustainable revolutions that are happening is that there are a lot of Canadians who are going to want and deserve to get new skills, and we need to have our system oriented to give them those skills. That helps address this issue of building human capital and social capital with it.
On the physical capital side, the spending of the government that is consistent with rebuilding our infrastructure, components of the energy transition, building resilience in our economy, those are separately accounted for and tracked. This is my third point — and I think I reference this in the book — this is where we need independent institutions like the Parliamentary Budget Office because, having worked in the Department of Finance over the years for multiple parties, I know that if there’s a rule like that, the temptation is always to define everything as capital and move it out from one area, which has quite a strict balanced budget approach into the other. I think it’s certainly doable and given where we are with these broader changes, it is highly desirable.
[Translation]
Senator Gignac: Good morning, Mark.
[English]
Thank you for being with us today.
I’ve read your book as well. My question would be around this climate change challenge that we have. In the last budget, Ms. Freeland mentioned we need to invest $120 billion to $150 billion a year if we want to reach a net-zero economy. Currently we invest only $15 billion to $20 billion a year.
I want to have your opinion about the potential role of the Canadian pension fund in Canada, because they have to scale down the exposure big time over the last few decades, some completely phasing out of high — exposure. The interview that you give at the World Economic Forum, you mentioned that the easiest thing to do is to sell and walk away, make it somebody else’s problem. I will refrain myself to mention which pension fund has done that, but the point is the biggest challenge is to support them and invest to reduce their carbon footprint.
My question is simple. Does the Canadian government have to be more active, proactive, and ask the pension fund to have more oversight on pension funds, because I have a son who is concerned Canada will be unable to make the transition successfully without more active participation in the pension fund. Any thoughts on that?
Mr. Carney: Yes, and good to see you Senator Gignac, and as usual, straight to the heart of the matter.
First off, this is a huge issue, and it’s a fundamental issue, whether it’s pension funds or banks or others. We will not get to climate sustainability. We will not get on the pathway to net zero if all we do is divest. For the individual institution, there’s the comfort of portfolio decarbonization, but there’s not decarbonization in the real economy. I firmly believe what we need to do is to get capital to those companies and projects that have a plan to reduce emissions, and not just reduce emission, but reduce emissions in line with the trajectory the Canadian government has set ourselves on.
So what are we doing about that? I would say there’s a diversity of strategies at this point among Canadian pension funds. There are some, such as the Canada Pension Plan — I will name them — and Ontario Teachers’ Pension Plan and PSP, actually, a third example, who have identified — and they use slightly different terminology around this — but they have both green and transition assets. So the green assets are clear, renewable power — wind power, hydropower, storage, these types of things — but transition assets are assets where there are emissions, but the investment is getting the emissions down. So think about what Dofasco and ArcelorMittal are doing in the steel sector. Investments in the auto sector happening moving toward electric vehicles, and targeting investments that get those emissions down.
That will be critical, including in the energy sector, obviously, if the oil sands pathway, for example, comes to be and has the potential to take out high single digits of Canada’s emissions over the course of the next decade. That will require capital. And it’s the type of investment that is potentially very suitable for pension funds.
If you permit me, I’ll take one step up and I’ll refer to the work of the Glasgow Financial Alliance for Net Zero. Some pension funds are part of it, Canadian banks are part of it. What we are doing is bringing together an approach for transition, which includes these types of investments, and the discipline around these types of investments. A common theme, if you will, of our discussions thus far is that we need direction but also discipline around the direction. We need guardrails around it so that it really does what it says so that we get capital to investments for the transition.
Last point, what could the Canadian government do, or what could our regulatory authorities do? One of the questions of finance institutions is do you have a transition plan for your investments for your loan book? After all, the country has a legislated investment for net zero. You’re investing in Canada. What is your plan? Who are you backing? How are you moving from where you are today to where you want to get to tomorrow?
And in those transition plans, if we have a definition of transition assets — not just green. Green is incredibly important, but we also need to get emissions down from the parts of our economy that exist today, and if the ambition is sufficiently high in those projects for investment, then it should be appropriate — it should be counted as transition — and we would see our pensions and other forms of capital really put to work on behalf of Canada and its objectives.
The Chair: Mr. Carney, before we move on, can I get you to react to a recent story about Canadian banks having some qualms over their commitment to the Glasgow Alliance? I think all of the banks — there were sources cited — have concerns about governments and liability issues, and they seem to be exacerbated by what is going on as fallout from the Ukrainian situation?
Mr. Carney: I think the first thing to say is to commend the Canadian banks for their commitment to manage their portfolios toward net zero and their commitment is that they would help achieve their fair share of the emissions reductions consistent with Canada’s objectives and consistent with a pathway to one and a half degrees. That’s the first point.
Second is where some tension has arisen, not just with the Canadian banks, but with some other institutions, and I understand that, and agree with it, if I can put it that way. There was a body that attempted to dictate the strategies as opposed to having objectives, financial institutions determine their own strategies and are held to account for those strategies. We’ll see in the coming years whether the loans and investments are performing in a way that’s consistent with the overall objective. That issue, the overreach, if you will, by something called Race to Zero has been dealt with. The Canadian banks, and their members are in a position where it’s absolutely clear, their commitment is to move their assets in line with one and a half degrees. That takes some time, but they set their own strategies to do so.
But what they also will do is disclose their progress on that, and that disclosure will be globally available. We’re setting up a global database, open source, all the major data providers, underpinned by the OECD, IMF, and the UN, that will be up and running by this time next year, which will have emissions by financing books for the institutions, their targets, and then progress against targets so others can judge. And this is how we get the most out of our financial system, because they determine the strategy. Sorry, I’ll stop there.
Senator Massicotte: Nice to see you, Mr. Carney. I haven’t seen you for a while, but always my pleasure.
Let me talk to you about the discussion about the whole environmental issue.
You seem to be a little bit more — maybe a lot more — optimistic than I am. If you look at the last 5 or 10 years, we’ve missed every target we’ve set. We’re even getting reports currently from the department and, again, they’re offside. We got a promise two days ago by the Prime Minister that we will meet our targets this time.
Why should we be more optimistic that we will meet them when we’ve failed miserably so far?
Mr. Carney: As you know, Senator Massicotte, in the end, you get credibility by performance and you get performance by outperforming targets as opposed to underperforming them. So I understand the motivation of your question.
First, the building blocks that make progress much more likely now include the mainstreaming of transition finance, as we just discussed with Senator Gignac and the chair. The second is further progress and building a track report on what I’ll call climate policy. It is not just a price on carbon; it includes measures to support transitions from hydrogen storage to electric vehicles, and it includes carbon contracts for differences and other measures. The track record is building.
There is an important role to be played by the Net-Zero Advisory Body to be very clear about what the gap is between the commitment and the path that the Government of Canada is trying to follow and where the policies that are currently in place are likely to bring us. There will be a gap; it is being clear about the gap. Then, in the political arena, if you will, with the Senate and others, the debate is how we close that gap and which policies are necessary to close it. That process can help build credibility.
The other thing I would say, senator, is that there are many things that are necessary in order for us to hit our targets and be on the right path, and there are also a few big things. There is the Oil Sands pathway. There is building a clean grid by 2035. There is the auto strategy that’s necessary. There is the transformation of our steel and building-product sectors. Comprehensive federal-provincial approaches there — concerted efforts and tracking of those — will be necessary to fully bridge the gap and not just build the credibility, although that’s important because momentum feeds momentum, but also to deliver the results that we all expect.
Senator Marshall: Welcome, Mr. Carney. My question is more general.
I’m on the Standing Senate Committee on National Finance also, and we have Minister Freeland speaking to us fairly regularly. We were talking about a recession back in June. When she responds, it’s almost like a “be happy; everything is under control” speech. She appeared in the Senate a couple of weeks ago, and we received the same kind of response to our questions: “The government is in great financial shape, we have a triple-A rating and our debt-to-GDP ratio is really good,” et cetera.
The last couple of days, she’s been in the media and it’s almost like she’s pivoted 180 degrees. It’s not only what she’s saying — she’s warning now of a very severe recession — it’s how she’s saying it. I had to play the video over several times. I’ve always expected a recession, but to listen to her now, it’s almost like it would rattle a person to hear what she’s saying.
So it seems like something has happened in the last two weeks. She was telling us two weeks ago — exactly two weeks ago — “don’t worry, be happy; we’re in great shape.” And now, over the last two days, she’s out there saying, “Batten down the hatches. There is a big recession coming.”
You’re watching what’s going on in the world. What do you think has happened that would make the finance minister pivot around so much, almost 180 degrees? We know there are problems in the U.K., and we know the International Monetary Fund is warning of a recession. Is there something that I missed, though? What would make a finance minister — and you don’t even have to respond specifically to Minister Freeland — what would make a Minister of Finance pivot around like that? Is it that we’re going to lose our credit rating and be downgraded? Is it the bond-rating agencies?
I would really appreciate your insight. Can you reconcile that? I’m trying to square that round hole.
Mr. Carney: I’ve been asked some difficult questions over the years, and that’s one of the toughest I’ve been asked. I would have to go into the mind of a finance minister and the track record of what she’s said.
First off, just for the record, I would see no reason that there would be any issue for our bond rating, credit rating or any sort of near-term-type issue. The fundamentals of the country are strong, and that’s a testament to Canadians, and many governments and actions that have been taken over time. That’s clear.
That is something we fall back on in difficult economic times. Unfortunately, we are in difficult economic times. And I would have said that if you had asked me two months ago. We tried to have this two months ago, and I would have said the same thing then.
Yes, I think a recession is both likely, globally and most probably in Canada. I’m afraid it’s a bit like air travel these days: We know where we’re headed; we just don’t know when we’re going to get there.
There are some uncertainties about the exact timing, but we’re in a situation today where China is effectively in a recession. There is mildly positive growth but well below trend. Europe is entering a recession. The U.K. is in a recession. The United States has momentum, which is helping to support us. But what is necessary to rebalance that economy in order to have inflation more firmly under control, given the starting point, will be a recession at some point next year in the U.S.
It will be hard for us, just given those cumulative factors, for Canada to be a full exception from that. Add to that the fact that we have the domestic inflationary pressures, as you know, which are now more domestically generated than they are externally generated. That has required the bank to tighten policy. I’m not predicting. I have no information. I’m not there and have nothing to do with the decisions. The governor has been clear that more will be required, and they’ll take those decisions.
The combination of all of that is likely to lead to a recession or at least a few quarters of negative growth in Canada.
It’s important that we do the right combination of drawing on the strengths that we have and not weakening our position further. We have to use our fiscal resources appropriately and have them targeted.
As per Senator Deacon’s question at the start, those types of measures that will put us in a better position as we come out of this slower period, whether it’s financial reform, climate policy, energy policy or other policies, we really do have to continue to pursue that.
We can come out of this much stronger than others without question, but we should be clear about what we’re headed into.
Senator Marshall: It is not one event but a perfect storm.
Mr. Carney: Yes, it is a series of things. It is a storm, not a hurricane, is how I would put it.
Senator Yussuff: Thank you, Mr. Carney, for being here.
The earlier stage during the pandemic — and subsequently — supply chains have been a big issue that we’ve been dealing with. In terms of the earlier part of inflation rising, it has been acknowledged that supply chain is part of the problem.
The Secretary of the Treasury of the United States, Janet Yellen, has proposed the idea of friend-shoring as a means to insulate global supply chains from external disruptions or economy cohesion so as to mitigate the destruction of the U.S. economy and its allies. At her talk in Washington, D.C., Minister Freeland expressed her agreement with the idea, saying it could help us defend liberal democracy.
Can you comment on Minister Freeland’s position on the concept of friend-shoring more generally?
Mr. Carney: Sure. Thank you. It’s an important question, senator. As Senator Bellemare will know, this is something I spoke about a few years ago in that book in terms of the future of globalization and a values-based globalization, which is analogous to what Secretary Yellen has been speaking about. I have spoken to the secretary about this over the years.
The way I would term it is as follows: We’ve had a series of experiences, unfortunately, over the course of the last decade and a half where there have been shocks to the system. There was a financial shock, a health shock, an energy shock and now a geopolitical shock. In all of those cases, we found ourselves wanting in terms of the degree of resilience that we have. Canada less so in terms of finance, but yes on health and yes on geopolitics and defence. And companies, very importantly, thinking about their supply chains, their value chains, so up and down the curve, and their exposure to extreme weather, to disruptions like COVID and to shifting geopolitics, whether trade restrictions, technology restrictions, restrictions on data or restrictions on financing — all of which companies have seen in different geographies over the course of the last few years.
In that environment, it makes sense to build resilience and it is desirable to build resilience, particularly with the most important parts of your supply chain, and literally have them on the shores of friends, whether it’s your suppliers, key technology, key people, financing sources, et cetera.
It’s in that environment — and I think the Deputy Prime Minister drew this out well — where Canada, which has trade agreements with everybody in the G7, plus most of Asia through the CPTPP, has a strong workforce and a competitive tax system and corporate tax system.
Another reason we should have a clean grid is that we have the potential to have a no-brainer decision from what’s called a scope to emission or energy source perspective. In other words, we would have a clean grid across Canada and, as a source for manufacturing and services, a very clear place to friend-shore, onshore, activities as part of seamless trading across those trade routes that have been established by various governments over the course of the last two years.
I think this is a very important development. It is a development that Canada is well positioned for. By definition, the drivers of this are consistent with Canadian values.
Senator Woo: Welcome, Mr. Carney. I think we, too, would be very happy to have had you here in person. I hope I’m not speaking out of turn in saying that we would look forward to having you in person.
The Chair: I think we did offer that invitation.
Mr. Carney: It was my confusion. I apologize, chair.
Senator Woo: Not at all.
I’m glad you started your presentation with a recollection of the recent events in the U.K., which must serve as a terrifying case study for politicians but also perhaps a conundrum for serious policy thinkers who are looking for policy space to achieve the same objectives that the U.K. Prime Minister Truss was trying to achieve — supply-side response through the tax code, if I can put it very crudely.
My question to you is where you see the policy space for supply-side responses that can lift the trend rate of growth, particularly in industrialized countries, including Canada, that have seen stagnating wage growth and flatlining productivity growth for many years now, whether through the tax code or fiscal policy, and whether that space is shrinking. If the space is shrinking because of the perfect storm of different problematic economic events, could that loosen up in the near term so that we can have more space to do things that actually change the structure of the economy rather than simply managing a potential downturn?
Mr. Carney: Senator, again it’s a fantastic question. Part of the tragedy here is that the objective, which was to double the trend rate of growth to 2.5%, we would recognize that objective. This is something we would like to do as well — in fact, we should do. We have a little higher trend growth in the U.K., but not much.
It does bear looking at why the effort failed. I’ll make a couple of points there and then go to what else we can do.
I think one of the big reasons why it failed is that it was half the story. They majored on tax cuts as the solution, as opposed to all the other hard work that’s necessary to build productivity over time. In fairness to them, I don’t think they were blind to those issues. There are some glancing references to them in the budget. But for whatever political reason — and I think that, in retrospect, they recognize that it was a miscalculation — they wanted to come out with the tax cuts and the big bang of that and the energy package. Then they were to do another budget at the end of November that would have filled in other aspects of it.
Two things: One, it looked like it reduced the growth strategy to a trickle-down tax-cut-only strategy, which is not a credible strategy for a 21st century economy, in my view.
Secondly, the scale of the spend — and most of the spend was for supporting households, as you know, as the energy package — but the scale of it, and it being uncosted, and actually the institutional structures, like their equivalent of the Office of the Parliamentary Budget Officer, being dismissed, effectively, or ignored, that totally undercut the credibility. They moved to a 7% of GDP deficit overnight. They already had a 7% current account deficit. The numbers didn’t add up and then they acted like it didn’t matter.
I’m grossly simplifying, but all of those things conspired to put the pressure on them, and I think that is clear in retrospect. It seemed clear at the time as well, but it is definitely clear in retrospect.
The objective was right. There is a role for tax competitiveness in achieving these objectives. But if you’re losing revenue on the tax side you have to think about which elements are funded. In addition, you have to use policy space, for example, in encouraging — as per the exchange with Senator Bellemare — human capital investment. I’m a strong believer that given the scale of the digital transformation particularly, we need to institutionalize, have a series of measures that support mass mid-career retraining and re-skilling for Canadians to give them the full opportunities of the new economy that’s developing. We have to be careful not to spend all our time on the short term but think about the medium and long term. That’s one element of it.
I do think, as well, that the exchanges on climate policy are critical because that can drive — as the chair, Senator Wallin, rightly referenced — the scale of investment that’s potentially there. The only way we’re going to unlock that is by, as per Senator Gignac’s point, getting our big pension funds and others investing in this, but with clear and actually relatively costless policy.
We have a policy, for example, on internal combustion engine vehicles after 2035, not having sales of them. If you work backwards from that, you see the investments necessary today. Yes, there is some support that is provided for them, but we will get a return on that support many times over in terms of the competitiveness of our auto sector, not just on the emissions side.
We need the human and physical capital alongside with tax competitiveness. We can’t give up on tax competitiveness.
The last point, if I may: One of the things we used to spend a great deal of time on is the marginal effect of tax breaks for investment. Now that we have the corporate rate at a pretty competitive rate, I think that more time on that would be well spent.
Senator Smith: Welcome, sir. It’s great to see you again.
You noted in your opening remarks that the federal and provincial governments work co-operatively to produce better economic outcomes. Specifically, you noted the need to build out clean electricity capacity. We’ve had the problems of interprovincial trade barriers and different regulations across provincial lines. How do you assess the current state of inter-provincial relations, and how can the federal government work toward reducing these barriers in creating better economic outcomes?
Mr. Carney: Senator Smith, thank you for the question. I feel the last time we saw each other, which was 10 years ago, you could have asked me the same question and I would have been still working for a better answer to that.
I think there are a few areas where we have to prioritize in these issues. We’re not going to have a grand new economic union agreement struck, so we have to prioritize a few areas. We’ve talked a bit about the grid. I think we have to move from the objective to, quite frankly, a Gantt chart, if you will, of what projects can be put in place, what’s necessary, how much is sharing of capacity versus build of new capacity and what’s realistic in terms of future demand? I know there’s some skepticism about future demand, but I think you can hair cut — at least on my numbers — our overall progress in reducing emissions through transportation and manufacturing sector and still have a considerable increase in demand. We need to get on with it and focus on what needs to be done, who needs to do what, and make this a top story.
This is going to sound slightly frivolous, but I’ll make a point I made to someone the other day. When I was abroad in the U.K., I used to read the front page of the newspapers online and we went through about 18 months when virtually every day on the front of a business page was something about cannabis and the cannabis industry. Fascinating. Where is that industry now? We should have on the front page of the business section every day or every other day what’s happening with our clean grid, what the issues are, who is doing what, who should do what, where the opportunities are, et cetera, in order to unlock that.
I view one around that and the second is, more broadly, on the energy transition and coming to terms. I think many of the building blocks are there, but not all of them in terms of getting emissions down in the oil sands. There is a pathway to do that. We need to finish the job on that. It’s partly a federal-provincial issue, but it’s also an issue, if I can simplify it, where have tremendous cash flows, profits, from that industry at the moment. Some go to government, some go to companies. How do we reinvest those as quickly as possible in getting those emissions down for the benefit of the industry, for the country as a whole and energy security more broadly in North America?
It’s not a comprehensive answer to your question, but I think as you start to build up these wins we can — and they’re pretty big wins if we can — create an environment where we knit the economy together more clearly.
Senator C. Deacon: Thank you, Mr. Carney. You led the Bank of England during their transition to open banking. I want to ask you about the effect of competition reform on helping to control inflation. I’ll note the Canadian bank profits increased sixfold the rate of inflation within the pandemic. Second, on spurring business investment and innovation in highly productive and intangible sectors. Thank you.
Mr. Carney: I think open banking or forms of open banking are critical particularly for the second. They can help with the first, but the big return is on the structural change, the financing of intangibles and the economy that comes with it.
Senator Loffreda: Quick question on the general economy. Back in June 2022 in a Globe and Mail article — and you were one of the first along with some banks to say that the risk of a global recession was uncomfortably high and Canada would fare better than most countries. Why do you think Canada will fare better than most countries? Do you still feel that is the case today? Do you have any recommendations to government to fare better? There is concern. I’m speaking to entrepreneurs and inventories are increasing, showrooms are full and warehouses are getting fuller. So there is concern on that side.
Mr. Carney: The short answer to why we should fair relatively better is a couple fold. One is, externally, the ties with the U.S. I do think the U.S. will head to a recession, but still in relative terms, better. Second, our labour market has come out of this initial COVID period in better shape than others in part because of the design of the mechanisms that kept people tied to their jobs. We lost fewer people in the labour force. Third, the improvement in our terms of trade. It has come off a bit, but it gives us more flexibility in terms of revenue. Fourth, strength in the financial sector is there.
I think, in terms of government, it’s a common theme. But these big issues that we’ve been talking about — the sustainable, the digital transformation, these big projects on [Technical difficulties] and knitting together the economy — staying the course on those and making them more tangible is one of the ways we can actually dampen the recession because of the investment that would come with that, but really accelerate out of it when the world gets to the other side.
Senator Gignac: Our next guest will talk a lot probably on the money supply and quantitative easing. You have been the former governor of the Bank of Canada and the Bank of England. Do you believe that this time central banks have gone way too far with the quantitative easing, or QE? This time we even go with corporate bond purchases, which was not the case when you were at the Bank of Canada 12 years ago. Some mentioned that contributes to an inequality because poor people have no stock equities and no bonds that help the rich, and that creates the winning conditions for inflation takeoff. Do you believe they went too far and slept too much on the switch before we were so [Technical difficulties].
Mr. Carney: There are two questions here. The first is corporate bond purchases and the general approach. I think what was less desirable during the 2020 experience were the purchases of corporate bonds and the backstopping of the corporate bond market, as opposed to liquidity into the sector so the market found its price. In other words, the price was helped to be determined by the central banks, as opposed to a market clearing price. We had a similar issue these past few weeks, at least initially, with the gilt market in the U.K. where there were purchases not liquidity against gilt, and it was a liquidity issue not a solvency issue, and it is a distinction with a difference. It is important to have markets functioning and price discovery, even if you don’t like the price. I would make that point.
The second point, which is a bigger discussion, is the overall stance of policy and the contribution to the speed with which inflation has picked up. There have been some special factors in a confluence of events. If I were to put my finger on one issue, it would be less about the instruments of policy, but more about not identifying as quickly that this was a supply shock, more than a demand shock, once we reopened the economies, and we had a series of supply shocks on top of that. That combination meant moving later than desired, whatever instruments were used.
I’m grossly simplifying, and I apologize to former colleagues at the Bank of Canada for being a bit too pithy in my response, but I’m under the chair’s orders.
Senator Massicotte: Investments in our country for over the last 10 years have been insignificant relative to the increase of our debt. In other words, the money has been spent more for the consumer side than the investment side. How do we change that to get a better result?
Mr. Carney: That’s a fantastic question. I’ll give you another statistic. In the early 1970s, 75% of the U.S. budget was spent on capital and 25% on current spending, and now it’s the reverse. Those scales. Part of what we do — and it goes back to again the exchange with Senator Bellemare — is we’re much clearer about what is for capital and what is for current. We move deliberately and recognize that the spending on capital, provided it’s truly on capital and well spent, is a gift that keeps on giving. It is giving Canadians fish as opposed to teaching them how to fish.
The Chair: Thank you, Mr. Carney. We have a lot of information in here. We really appreciate you being with us.
Mr. Carney: Thank you, Madam Chair.
The Chair: For our second panel today, we have the pleasure of welcoming Mr. Steve Hanke, Professor of Applied Economics at Johns Hopkins University. He has been called “the inflation whisperer,” and he has many other talents.
Mr. Hanke, thank you for joining us today from the United States. We appreciate it. I’m wondering if you have some brief opening remarks for us.
Steve H. Hanke, Professor of Applied Economics, Johns Hopkins University, as an individual: Madam Chair, it is great to be with you. Let me begin by simply saying that I think everyone is looking for the causes of inflation in the wrong places. We’ve talked about, as Mr. Carney just said, supply chain shocks. That was a big deal. COVID was a big deal. Oil prices going up, that was a big deal. Putin caused it, that was a big deal. In fact, inflation is, always and everywhere, only caused by one thing: an excessive growth in the money supply.
I just finished a study in which I looked at 157 countries, and I related the growth rate in the money supply in those countries with the inflation rates that existed in those countries from 1990 to 2021, and, bingo, what do you get? Almost a perfect one-to-one relationship between growth in the money supply and growth in inflation.
I’ve also looked at all the country’s post-World War II to see about these relationships, and what you find is that if there’s a sustained inflation — I define “a sustained inflation” as an inflation lasting at least two years and an inflation rate that is over 4% — you find that no country with that kind of sustained inflation has experienced it unless it’s been preceded by a sustained increase in the money supply. So it’s all about the money supply.
If you look at Canada, what we had 10 years prior to COVID is things were pretty well behaved, and the money supply was pretty much in the zone and relatively stable. Then we had COVID hit, and the money supply started surging up, and surged up considerably early in 2020. As a result, that’s why we have inflation now in Canada, because there’s about a 12- to 24-month lag between the surge in the money supply and the actual inflation hitting us in the face.
That is a summary of where I’m coming from. It’s all about the money supply. If the Bank of Canada wanted to hit its inflation target of 2%, the money supply in Canada should be growing at about 7% per year. If you look at the three-month annualized rates of increase in the money supply, it peaked out in June 2020 at almost 20%. So it was growing almost three times faster than would have been required if you had wanted to hit your 2% inflation target.
I know one controversial thing in Canada is the idea of running the printing press. Well, they have been running the printing press pretty hot and heavy until the past few months when the money supply growth rates have slowed down in Canada.
The Chair: I’m sorry, I can see the senators wanting to ask further questions of you. Thank you for those opening remarks. Our last guest, as well, said that inflation is a domestic issue, so I think we’re on the same page here.
I’m going to turn over my duties to my deputy chair, Senator Deacon. I know you’re going to start with a question, and then if you can take over the chair duties for us. Thank you.
Senator Colin Deacon (Deputy Chair) in the chair.
The Deputy Chair: Thank you.
Thank you very much, Professor Hanke, for being here. Your perspectives stand out. I’m not an economist. We’re fortunate to have economists on our committee, but I’m not an economist.
Mr. Hanke: Senator, you have a decided advantage over the economists, your colleagues.
The Deputy Chair: I’m an entrepreneur, and so I need things explained to me in pretty plain language.
I want to understand that this is causal, not correlational. Could you help take me through how you see expansion of the money supply as being a causal of inflation and not correlational?
Mr. Hanke: If you look at the German hyperinflation of 1923, many in Germany argued that this hyperinflation was causing the money supply to surge. By the way, out of the 62 cases of hyperinflation in world history, the one in Germany was relatively mild. It’s the thirteenth highest hyperinflation in world history, but it’s obviously the most famous.
There was a lot of confusion in Germany at the time, because they thought that the inflation was causing the money supply to grow. That’s not the case, and the reason we know that is because of what I mentioned in my opening remarks. There is a lag between increases in the money supply and inflation, and that lag is long and variable, but it falls within a 12- to 24-month period. That’s why we know the money supply is causing it, because inflation comes after you goose the money supply. You goose the money supply, and 12 to 24 months later, bingo, you get more inflation showing up in the picture.
That would be my response, senator.
The Deputy Chair: Thank you very much, Professor Hanke.
Senator Loffreda: Thank you, Professor Hanke, for being here this morning. I, too, am not an economist, but I’m a former banker, so I’ll focus my questions on the banking world.
There was a consensus that inflation would be transitory, and that, as we know, was fundamentally wrong. In your opinion, why did all central banks fail to foresee the current inflation problem? Are they on the right track at this point in time? With increasing interest rates and tightening the money supply, how far should the Bank of Canada go in increasing interest rates? Any further recommendations or elaboration would be welcome.
Mr. Hanke: The central banks — the United States, the Bank of Canada, the Bank of England, the European Central Bank — they’re all doing the same thing: They’re ignoring the money supply. They cancelled the money supply.
Let me just indicate that if you look at the Governor of the Bank of Canada in recent press conferences and so on, he never mentions the word money. They don’t look at the word money, and they don’t even report it on a regular basis. The last money supply number I was able to get from the Bank of Canada was from July. That’s old data. They’re not even looking at fresh data.
If you look at, for example, Chair Powell in the United States — let me read something, because all these central bankers play off the same playbook. Most of them are saying and echoing exactly the same thing. Mr. Powell said this on September 8:
Monetary aggregates don’t play an important role in our formulation of monetary policy, and we don’t think they are generally a good way to think about policy or inflation.
He has repeatedly said this in the United States, and I’m getting more or less the same picture when I look at the Governor of the Bank of Canada. They are not looking at the money supply. It is not included in their macroeconomic models, and as a result, they missed the boat.
John Greenwood is a colleague of mine at Johns Hopkins and a former chief economist at Invesco in London. He and I wrote an article. It was about the United States, but we could have written the same thing about Canada. In fact, about two months ago, he and Herb Grubel did write in Financial Post about the Canadian situation, so it’s essentially the same as the United States. John Greenwood and I wrote about a year and a half ago that inflation would end up at 6% and maybe as high as 9% in the United States. As far as I know, we were the only ones to see that, and the reason we were the only ones to see it is we were using the quantity theory of money. We were looking at the change in the money supply and how that would work through the system with this 12- to 24-month lag to give us inflation between 6% and 9% in the United States.
By the way, one good thing in this lag is that if you look at the situation in Canada, it looks to me like — given the fact that the money supply was peaking out in May, June and July 2020 in Canada at almost 20% on a three month annualized basis — you are probably hitting the peak of inflation in Canada right now. We’re probably pretty much at the peak right now, and it should start slowly coming down.
I think it will run and be a problem through 2023 and probably into 2024.
Senator Bellemare: I will ask you my question in English so that you can understand me better.
Mr. Hanke: Let me just interject one thing for your information. Mrs. Hanke is a Parisian. But I don’t speak French. In English, please.
Senator Bellemare: Okay. The quantity theory of money that you refer to is very old, as you know. Actually, a lot of international organizations and research people all agree that inflation today is a supply shock and that inflation is indeed more a real phenomenon than a money phenomenon.
My question is the following: How do you reconcile the money supply with the virtual way of paying today? I’m talking about the crypto-currencies and all those things where, as you know now, the money supply is something very fluid — it’s more indigenous. So how do you reconcile the new mode of payment with the money supply and the quantity theory of money?
Mr. Hanke: That’s an excellent question. By the way, the great Frenchman, Jean Bodin, in the 16th century was the originator of the quantity theory of money. It’s been refined, but it is French.
Let me talk for a minute about your first remark. You asserted that everyone or most people think that inflation is related to supply chain problems. I do not accept that conclusion, and let me give you some examples that I think will help you understand where I’m coming from.
If you look at Japan, for example, it faces the same supply chain problems as everybody else — maybe even more, by the way, than some other countries. Their inflation rate is 3% at present. Switzerland also faces the same supply chain problems as everybody else in Europe, the United Kingdom and the United States have. The Swiss inflation rate is 3.5%.
Now let’s go to China. China adheres to the quantity theory of money, and their inflation rate is 2.5%. It’s one of the lowest inflation rates in the world. All those countries — Japan, Switzerland and China — control their money supply, and as a result of that control, they don’t experience the kind of inflation we’re seeing in Canada, the United States, the United Kingdom and on the continent.
The second part of your question was about what digital currency — so-called crypto-currencies and so forth — has to do with inflation. Not very much because those are speculative assets. Things like bitcoin are not currencies. They’re not reliable units of account. They’re not used in many transactions at all, and, in fact, over half of the transactions are for illegal purposes — laundering money.
So they’re essentially a footnote. They make a lot of noise, but they’re basically irrelevant. People don’t go into the store with crypto-currencies and use them in very many places. Even places where they’re “highly” used, where they have very high rates of inflation like in Argentina and Venezuela, the use is very tiny.
The Deputy Chair: Thank you very much.
Senator Yussuff: Thank you professor for joining us today. It is true that we’ve probably seen one of the biggest crises in human history in this pandemic. In the United States but also with most governments around the world, the economy was pretty well shut down and governments were trying to figure out, of course, how to support the population. The money supply was there to serve a purpose.
Are you suggesting that we shouldn’t have done anything in the context of the biggest human crisis we’ve seen in history?
Mr. Hanke: No, I’m not suggesting that. Let’s put it this way. The government locked us down and outlawed work. They put chains around the factory gates. So the government is liable, in my view, for compensating people for the damages associated with the mandates they put on people when they locked them down.
Now the question is how to finance that. If you want to avoid inflation, you increase government spending. Okay, that’s probably going to increase the deficit, so how do you finance that? You issue more bonds, but you sell the bonds to the general public, and if you do that, you don’t get inflation. If you sell the bonds to the central bank, which happened in the United States and in Canada, that deficit is monetized. Money is created, and it’s money that creates inflation. It gets back to my original introductory remarks. You can’t have inflation unless you have the excess production of money. And we had the excess production of money because as this COVID spending occurred and deficits occurred, the central bank stepped in and bought the bonds. They monetized the deficits and created this surge in the money supply. If the bonds had been sold to the general public — to you, senator, and me — we would not have had inflation because the money supply would not have changed.
The Deputy Chair: Thank you very much. It’s wonderful to think of you supporting the Canadian economy in that way, Professor Hanke.
Senator Marshall: Thank you very much for your comments on the Bank of Canada buying all those government bonds. That leads into my question. There’s still $370 billion on the books of the Bank of Canada, and what the bank is doing is letting the bonds roll off as they mature. But I think the last bond issue to mature is going to be in 2064.
Is there any benefit to the bank selling those bonds or are there any disadvantages, because some people are calling for the Bank of Canada to sell those bonds while others say, no, they should let them mature? What are the advantages? I keep bringing the topic up, and I haven’t really gotten a good response. Are there any benefits? Is that something that would benefit the economy, or it doesn’t make any difference?
Mr. Hanke: Madam, that’s a good question, because the key is whether they let these roll off, that gives a certain speed to the shrinkage of the balance sheet of the Bank of Canada. If they sold them, of course, they would accelerate the shrinkage.
The question is: How fast is the money supply growing, M2++ in Canada, that broad measure of money? They should be trying to hit a target of around 6 or 7% growth. That’s the answer to your question. They look at the money supply and they gauge how fast they’re either letting these bonds run off, or if the money supply is growing too fast, maybe they would want to sell a few of the bonds. The key to hitting the inflation target of 2% requires growth in the money supply measured in Canada by M2++ at around 6 or 7%. That’s the answer.
Another thing that you’ve reminded me of, since the Bank of Canada has missed their inflation target by a mile — I mean, the inflation up there is almost 7%, 6.9%, the headline inflation — that’s a good bit higher than the 2% target. I’m telling you, if the Bank of Canada was an army and it missed the target by that much, there would be what they call an after-action report — the military has these — to figure out what went wrong and there probably would be a court martial.
Senator Marshall: Could I ask one follow-up question? You’re looking at all these financial records and financial statements. Do you think that the bank has a plan with regard to getting those bonds off their balance sheet, or do you think they’re just sitting back and saying, oh, we’ll just let them roll off, whenever they roll off, they roll off?
Can you tell whether they have a plan? I mean I can’t tell.
Mr. Hanke: No, they don’t have a plan. The only way you could have a plan that made any sense is to be looking at the growth rate of the money supply and gauging what you should do with the balance sheet, the quantitative tightening. By the way, what they should be doing is looking at that and gauging it and feeling your way along so that you hit the money supply target.
The problem is the governor is not looking at the money supply. He doesn’t even mention it. When he has a press conference, does he ever mention money? No.
Senator Marshall: Thank you.
The Deputy Chair: Thank you very much, Professor Hanke, you’re certainly very clear in your responses, and it’s really helping us.
Senator Gignac: Welcome to our guests. Thank you for sharing your thoughts. As an economist, from an intellectual point of view, I found your comments very interesting.
This is the second time the central banks go all in with quantitative easing. The first time was, as you know, during the financial crisis of 2008, and in the interview you gave to The Wall Street Journal, you point out that in 2008, 2010-11, they have not been followed by money supply acceleration, because the banking system was in trouble. Correct me if I’m wrong. But this time the banking was very well capitalized and no problem, they can lend money.
Is it a lesson to be learned that, one, you have a recession, the central bank should act differently with the QE, depending on the shape — not the shape, but the health of the situation of the banking system? Because the banks are the transmission mechanism concentrating on consumers and businesses. Has the central bank made a mistake this time, because what worked very well in 2008 to 2011 did not create a recession or inflation. This time, however, they have gone with the same recipe, but they have created inflation.
Is the difference the fact that the central banks have not considered the situation of the banking system, which was completely different at that time compared to now? I am trying to have a lesson learned for the next crisis, if you want.
Mr. Hanke: Senator, you’ve explained and understood exactly what the problem was in 2008 versus 2020. What you had in 2008 was precisely that the banking system was viewed as being a problem. Especially in the United States where remember Lehman collapsed, and the politicians in Washington put the blame on banks and bankers and they tightened up the regulations on the banks and squeezed the banks.
The contribution of the banks in the United States to the money supply actually went down; it was going negative. The central bank, the fed, came in with quantitative easing in one, two and three that mitigated the problem of the collapsing banking system.
That wasn’t the case in COVID, because the banks were healthy, lending a lot of money and contributing to the money supply. Then the central banks came in on top of it, and that’s why you had this huge monetary excess created. It was central banks that made the problem.
From 2010 until 2020, the Bank of Canada was only contributing about 3% to the broad money supply in Canada. Most people don’t realize it, but commercial banks produce most of the money in Canada, not the Bank of Canada. And then COVID came, and since 2020 the Bank of Canada has contributed 46% of the total broad money being produced in Canada. So they’ve flipped the thing around. You can see it’s obvious. They’ve gone way overboard and produced way too much money, the Bank of Canada. They’re contributing almost 50% of the growth in the Canadian money supply, broadly measured, since 2020.
So you understand the thing perfectly.
Senator Gignac: It’s not the tool, the instrument tool, quantitative easing problem; it’s a mistake in judgment that this time it was not necessary to go as far as they have gone because the banking system was in good shape and the transmission mechanism is not broken. This is what I think I have understood from your testimony, the problem is not the quantitative easing per se, the problem is the amplitude and size they have done that was not necessary to do. This is what I learned, because this is the second time they use quantitative easing. I don’t know when they can use it again, but this is the nuance I understand about the relationship between quantitative easing, money supply and inflation. That depends on the transmission mechanism and the situation of the banking system. This is what I understood.
Mr. Hanke: That’s exactly correct.
The Deputy Chair: Mr. Hanke, if I could, I’m going to interject for a second before Senator Loffreda. Your clarity is greatly received, especially by someone like me. Plain language as best as we can here.
We’re in the situation we’re in with inflation. We’re seeing inflation peaking, as you noted. I also noted that much earlier in your career you were an adviser to former president Ronald Reagan, one of his economic advisers at a time that I very much remember, and I think a lot of us in this room remember had exceedingly high interest rates and significant instability to fight inflation. We’re seeing the question right now about where interest rates are going in this country and I think in your country as well to continue to fight inflation.
Now that we are where we are, how are you seeing that as a strategy in the fight for inflation or the fact that because we are seeing a better management of money — well, I guess that’s an assumption I shouldn’t make, but you have indicated there may be an improvement in how the bank is managing the money supply. How do you see that as a strategy moving forward?
Mr. Hanke: Well, let me quote the dean of monetarism and my old mentor the late Milton Friedman. Friedman said monetary policy is not about interest rates. It’s about the growth in the quantity of money.
Now, let me give you some examples from the United States. The problem is there is a very tenuous, uncertain, fuzzy relationship between changes in interest rates and changes in the money supply, and it’s the money supply that really counts.
In the United States, in 1964, the federal funds rate — that’s the rate of interest that the central bank controls — increased from 3.4% to 5.8% and the money supply never slowed down. It’s back to the prior discussion that I had with the senator. The commercial banks were healthy; they were loaning money. Interest rates went up. The money supply really never slowed down. The interest rate on federal funds went from 3.4% up to 5.8%. Unemployment actually went down from 5.1% to 3.6%. The economy was booming because the money supply never slowed down.
In 1984, the federal funds rate went from 9.6% in the U.S. to 11.6%, but the money supply never slowed down. The economy boomed. Unemployment went down from 7.8% to 7.5%.
The same thing happened in 1993-95. The federal funds rate doubled from 3% to 6%, and the economy kept booming. The money supply was growing. Unemployment went down from 6.5% to 5.8%.
Again, back to Friedman’s point, monetary policy is not about interest rates. Everybody is obsessed with interest rates. Everybody should be obsessed with watching the money supply, but the data aren’t even produced by the Bank of Canada. If you look at the website, it’s out of date. They’re not even reporting current monetary data.
By the way, the quality of the website of the Bank of Canada is terrible. I look at these central bank websites all the time, and to find stuff on the Bank of Canada’s website, it takes a magician almost to figure out what’s going on. Mr. Chairman, they need a good entrepreneur in there to fix the website.
The Deputy Chair: I always look for the gold standard. Who do you see as having the gold standard for a central bank’s website? Who has the gold standard?
Mr. Hanke: The U.S. isn’t too bad. Singapore is always gold.
The Deputy Chair: Thank you very much.
Senator Loffreda: Professor Hanke, you’ve made a strong point on the main cause of inflation being the money supply, and you did state if bonds were sold to the general public instead of the Bank of Canada, we would have no inflation because there would be no change in the money supply.
My question is: Do we have enough resources, capacity, and most of all engagement by the general public to do so? Market interest rates were before COVID — during COVID, when COVID peaked, market interest rates were so low, and the average return on the equity markets has been 10% forever. Who would have bought these bonds? Obviously, you can issue bonds at whatever rate you feel is necessary, but again you’re disturbing the market and creating a secondary market. We can go back — hindsight is 20/20. I’ve said it forever — we have to be more agile and more targeted. We are doing so right now. I would like to have your insight on that.
Mr. Hanke: Well, you can sell anything if the price is right.
Senator Loffreda: The price being right is the issue. When we were in COVID and COVID had started, the interest rates were so low, and now, yes, we’ve had some hikes, but who would have bought these bonds?
Mr. Hanke: You would have because you and I would have demanded higher interest rates. We would have bought them.
Senator Loffreda: It would have caused higher interest rates. If the government is issuing billions of dollars for higher interest rates, we’re there anyway where we are right now.
Mr. Hanke: It’s clear if the government had sold the bonds to the general public rather than the Bank of Canada, the interest rates would have gone up, but so what? You wouldn’t have had inflation. Inflation, by the way, is a tax.
Senator Loffreda: Well, deflation is the enemy, right? In other words, you’re locked down; we have a pandemic. I’m not a medical expert. Like I said, I’m a former banker. I’ve always said deflation was the enemy. Nobody wants inflation, but you don’t want deflation either. So you’re locked down and you’re increasing interest rates. I think looking back, my argument would be — I’m not going to argue with you as to the main cause of inflation. I’ve said it always — excess liquidity, scarce resources, expectations. You need to manage all three accordingly.
At this point, looking back, yes the money supply, we could have managed that differently, but for it to be the main cause, I would argue this point with you.
Mr. Hanke: I think it’s not the main cause. It’s the only cause.
Senator Loffreda: Well, my argument would be even bigger at that point.
Mr. Hanke: Again, if you want to spend the money and you don’t want to monetize the deficit created by the government expenditures, you have to sell the bonds to the general public. If you do that, the general public, as you know as a former banker, they’re going to be demanding higher interest rates. But you’re not going to get inflation.
By the way, let me make this point. Inflation is a tax, and it is a very regressive tax because the people who get screwed are the little guys who are spending 100% of their money, because those are the people who have to go to the market and get hit in the face with higher prices for 100% of what they spend. Now, who benefits from the inflation? The rich guys, because there is a lag between changes in the money supply and changes in asset values, commodity prices, equities, housing. All of these things have shot up, and there is a lag of about one to nine months. Once you goosed the money supply early in 2020, the stock market, boom, it went up. Housing prices, boom, they went up. The commodity prices all went boom; they went up.
So the people with money who have invested in assets benefited from this very regressive inflation tax that has been imposed on the public due to the huge mistake of the Bank of Canada, because the Bank of Canada in COVID should have been steady as she goes. Prior to COVID, they were doing okay. They should have kept the money supply growing at about the same rate that it had been. The problem is they weren’t looking at the money supply.
Senator Loffreda: I do respect your opinion and thank you for being here. I do agree inflation is not good and it just widens the gap between the haves and the have-nots. I repeat, there are many causes for inflation. I believe that scarce supplies and the expectations at this point are driving it. But thank you for being here and thank you for your opinion, which is well noted.
Senator Massicotte: Thank you, professor, for being with us. I’m not an economist but I do quite a bit of reading on economic matters. I’m not an expert but I do know that 30 or 40 years ago we dropped the measurement of monetary growth because, obviously, better minds thought it wasn’t relevant anymore. We redefined the definition of all kinds of different forms of growth from different changes, but again today — the experts I listen to, anyway — tell me that it’s not relevant; it’s not the key factor. What is your comment to that?
Mr. Hanke: Well, this relates to my opening remarks, and that is that the profession has basically cancelled the money supply idea and the quantity theory of money. Even if you go back to my old friend, John Crow, when he was the Governor of the Bank of Canada, the models they used when John was the governor did not include the money supply, just like now. But what did John say? He always said, “Well, I always look over my shoulder to see what is going on with the money supply.” And the money supply when he was the governor was pretty well-behaved.
Why is this? This gets into a very interesting question. The central bankers don’t want to talk about the money supply, and they want to claim that everything under the sun causes inflation but the money supply. The reason for that is because they are the ones responsible for the growth in the money supply. If it gets out of control, and you have inflation, they don’t want to be blamed for it. That’s what’s going on now. They want to cancel this idea that the money supply has anything to do with inflation, because they’re the ones who produce the money and control monetary policy.
They don’t want the noose around their neck. They know the public is mad as hell about inflation, and they don’t want the public coming after the central bank. They want the public to say, “Oh, it’s those supply chains; oh, it’s the war in Ukraine; it’s Putin; it’s oil prices.” So forth and so on. Anything but them.
Senator Massicotte: I hope you’re wrong, but I appreciate your advice.
Senator Marshall: I’ll make a confession. I’m not an economist either; I’m just an accountant.
I’ve been using the website of the Bank of Canada quite a bit and looking at those bonds, so I guess if they sold them off, they would have to sell them at a discount, because the rates are so low.
Just listening to you talk, I find it very ironic. I see irony in all of this, because the people who created the problem — and I look at the government and the Bank of Canada as partners in this, so they’ve created the problem, and now we’re looking to them to fix the problem? I don’t know if you want to comment on that, but I had a bit of confidence before I came to this meeting. I’m not so sure anymore.
If you have any comments on that, I would appreciate it. If you don’t, well, I can understand that also.
Mr. Hanke: I have two comments: One is that the only prerequisite for any of my courses in economics is accounting. If you can’t understand accounting, you can’t understand economics, period. That’s Point Number 1.
Point Number 2 is that if these people created the problem and are unwilling to go back and look at what caused the problem and understand it, I have very little confidence that they know what’s going on.
These governors of these central banks and the chairman of Federal Reserve, they’re flying blind. They’re flying blind, because they’re not looking at the money supply. It’s like flying an airplane with an altimeter that doesn’t have anything on it. You have to have the money supply on the altimeter; otherwise, you don’t know what’s going on.
The Deputy Chair: Thank you very much.
Senator Gignac: Thank you, professor. I have to confess that, yes, I’m an economist, but I have to be very humble. I was convinced until your testimony that no one needs to follow the money supply. When I started my career 40 years ago as a junior economist, on a weekly basis we produced charts and tables and followed the money supply and one and two, and we were as convinced at that time that it was the appropriate thing to do.
We just want to find the truth of what we have to follow. It’s your international study that I’m intrigued with. For example, you referred to some European countries, I think, that inflation has been very low and the money supply is under control. Correct me if I’m wrong, but I think all the central banks have done more or less the same thing during the pandemic with their QE.
These countries who have been able to maintain very low money supply and keep inflation under control, what have they done, that we have not done? Is it because their banking system was different? I tried to understand. I think you referred to Switzerland — I don’t know which country you referred to in Europe, but I know you referred as well to Japan.
Mr. Hanke: The one that’s really the most orthodox and follows the quantity theory of money is China, and the inflation rate is 2.28% in China. Japan has an inflation rate of 3%, and I don’t know that they follow the quantity theory of money. I wouldn’t say that they did, but de facto, they do, because the money supply doesn’t grow very fast in Japan.
Switzerland is in third place, and the inflation rate there is about 3.5%. They tend to be, as you know, paying attention to the quantity of money. Those are the three, shall we say, orthodox central banks, and as a result of that orthodoxy, they’ve been able to control inflation.
And they’re important countries, by the way. They’re not nonentities that are, kind of, anomalous. They are important countries, and they’ve been doing the right thing.
Senator Gignac: Thank you, and thank you for your contribution to this thinking, because I think we will have an interesting discussion when the Governor of the Bank of Canada comes in early November.
Senator Bellemare: Just a comment. I remember the John Crow period when he was the Governor of the Bank of Canada. I remember that time; I was teaching economics, and I was looking at the interest rates that we had at that time. Mortgage rates were at 18%. The unemployment rate was at 14%. The youth couldn’t find any jobs, and to fight inflation, they were following this monetary theory of Milton Friedman, and they were very strict about it. This had a boomerang effect on the inflation rate.
At that time, for a longer period, when you compared the economic performance of Canada to the economic performance of other countries who did not use such a theory so strongly, we did not perform well, and it affected our economic tissue all over Canada. Some counties in the Maritimes were so hard hit that it took decades to reconstruct their economic structure, because monetary policy was the way to go to fight inflation, but it had a boomerang effect on expectations.
When Canada started to abandon this view and introduce more of an approach with expectations and a more subtle way to conduct monetary policy, the economy went back to growth. If you look at Canadian history, we had the highest real interest rate in the world to fight that inflation, but it was always there, because it was feeding back into the system and creating a decrease in the supply, increasing the problem even more.
With all due respect, I don’t agree with you. Not at all. I wanted that to be put on the record, as an economist.
The Deputy Chair: Any comments, Professor Hanke?
Mr. Hanke: We had roughly the same problem in the United States that John Crow had. Remember, we had a chairman of the central bank named Paul Volcker, and Volcker was given the green light by former President Reagan — and I was on former President Reagan’s council of economic advisers at the time — to kill inflation. Well, he did kill it. Unfortunately, we had two recessions in the first term of the Reagan administration, and Reagan didn’t blink an eye. He said to kill inflation. That’s the dragon. We have to kill it, and Volcker killed it.
The Deputy Chair: Thank you very much. I’m just wondering, Professor Hanke, we’ve seen a lot of economies in the West work in lockstep. They do a lot of trade with one another, and they’re working in very similar manners in response to the COVID crisis.
When we start seeing disjointed monetary policies, what effect do you see that having on exchange rates and currency and economic balances between countries? Might that have an untoward effect from your standpoint?
Mr. Hanke: This is kind of a complicated question. This is something new that’s come up. This is actually the most cutting-edge thing. At the IMF-World Bank Group meetings last week, it kind of reared its head. Now the song sheet that everyone’s reading from is the following: They’re essentially saying the reason we have the problems we have now is that there wasn’t enough coordination, that we should have been coordinating things more. It’s kind of another excuse, you see, an exogenous thing that came from outer space — non-coordination. And if we just coordinate now, everything will be okay.
It’s like the supply chain thing. Somebody else caused it. We didn’t cause it at the Bank of Canada; it was the fact that we really weren’t coordinated with everyone else. That’s the problem.
Do you see what I mean? I think the coordination thing is a red herring, actually, and, quite frankly, a lot of nonsense. If you want to coordinate, the way to coordinate is to go back to something like the Bretton Woods System where the exchange rates are tied together. Now, that’s coordination; that’s real coordination. That answers your question about what happens to exchange rates, by the way. Just go back to Bretton Woods; they’re all locked in a grid together.
The Deputy Chair: Could you speak to, in relative terms, the extraordinary energy price increases that Western Europe is experiencing right now and the effects those are having on inflation? How do you see that fitting into the perspective that you’ve been offering to us today?
Mr. Hanke: First, the reason the energy prices are going up is the sanctions that the West, including Canada, has imposed on Russia. That has completely disrupted the international oil market. The cause of that is the fact that Europe has banned and restricted the importation of Russian oil and gas. Putin just gave a speech last week; he’s perfectly willing to sell as much gas and oil as people want to buy. The problem is Europe has outlawed it in most of Europe, if not many parts of the world with sanctions.
The other part of your question is does the oil price cause inflation? It does not cause inflation. Let me take you back to Japan in the 1970s. It was kind of a natural experiment. Remember, in 1973, we had the Arab oil embargo. Oil prices shot up in 1973. The Bank of Japan made a decision that, to ease the pain and accommodate those increased prices, they would let the money supply grow more rapidly than it had been growing. As a result of that growth in the money supply, they got inflation. A lot of people said, “Oh, the inflation was caused by the oil prices going up.” No, it wasn’t. You can see this by looking at the second oil shock in Japan in 1979. The Bank of Japan said, “No, we’re not going to increase the money supply to accommodate these oil price increases. We’re going to hold steady.” As a result, they didn’t get inflation.
This is the difference between relative price changes, oil prices moving up relative to everything else, and the overall aggregate price index moving up and down, up and down. Within the basket of the Consumer Price Index items, you have hundreds of items being measured. Those relative prices are moving all over the place. If you have an equal number going down as going up, the price level stays the same. But if you have all of them going up, more or less, you’re going to have what we have now — high inflation. Oil prices do not cause inflation. Just remember Japan.
The Deputy Chair: Professor Hanke, thank you for your very passionate and clear comments. We’ve had some very concise presentations, and yours is very concise and focused. We’re very grateful. Thank you for taking the time to meet with us.
Mr. Hanke: Thank you very much for inviting me. It has been a pleasure to be with you, Mr. Chair.
(The committee adjourned.)