THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Tuesday, November 1, 2022
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 6:30 p.m. [ET] to study matters relating to banking and commerce generally.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello everyone, and welfcome to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin, and I am chair of the committee. I would now like to introduce the members of the committee beginning with the deputy chair, Senator C. Deacon, Senator Bellemare, Senator Gignac, Senator Loffreda, Senator Marshall, Senator Massicotte, Senator Ringuette, Senator Smith, Senator Woo and Senator Yussuff.
Today, of course, we have the pleasure of welcoming back Tiff Macklem, Governor of the Bank of Canada, along with Senior Deputy Governor Carolyn Rogers.
We are very pleased to have you here live and in person and with a full house here at committee. It’s wonderful. We look forward to you updating us on the Monetary Policy Report for October 2022. We will give the floor to you, Governor Macklem, and you will have the next 10 minutes. Thank you so much.
Tiff Macklem, Governor, Bank of Canada: Let me say how pleased we are to be here back in person. We’re very much looking forward to the discussion and your questions.
We are here to discuss our policy announcement of last week together with our outlook in our Monetary Policy Report. Last week, we raised the policy interest rate by 50 basis points to 3.75%. This is the sixth consecutive increase since March. Quantitative tightening continues and is complementing increases in the policy rate. We also expect our policy rate will need to rise further. How much further will depend on how monetary policy is working to slow demand, how supply challenges are resolved and how inflation and inflation expectations are responding to this tightening cycle.
[Translation]
Our decision last week reflected several considerations.
First, inflation in Canada remains high and broad-based, reflecting large increases in both goods and services prices. Inflation has come down in recent months, but we have yet to see a generalized decline in price pressures. About two-thirds of the components of the consumer price index, or CPI, have risen by more than 5% over the last year. And rising prices for essentials like groceries and rent are hitting lower-income Canadians particularly hard.
Second, the economy is still in excess demand — it’s overheated. Job vacancies have declined from their peak but remain high, and businesses continue to report widespread labour shortages. With the economy now fully reopened, households want to enjoy many of the close-contact services they have missed, but businesses can’t keep up, and we have seen prices for services rise rapidly.
Third, higher interest rates are beginning to weigh on growth. This is increasingly evident in interest rate-sensitive parts of the economy, like housing and spending on big-ticket items. But the effects of higher rates will take time to spread through the economy.
Fourth, there are no easy outs to restoring price stability. We need the economy to slow down to rebalance demand and supply, and relieve price pressures. We expect growth will be close to zero in the next few quarters. But once we get through this slowdown, growth will pick up, our economy will grow solidly, and the benefits of low and predictable inflation will be restored.
To put this in numbers, growth in gross domestic product, GDP, is projected to decline from about 3.25% this year to just under 1% next year and, then, rise to about 2% in 2024. Inflation is expected to hover around 7% in the final quarter of this year, fall to around 3% by the end of next year and return to the 2% target by the end of 2024.
Finally, we are trying to balance the risks of under- and over-tightening.
[English]
If we don’t do enough, Canadians will continue to endure the hardship of high inflation, and they will come to expect persistently high inflation, which will require much higher interest rates and potentially a severe recession to control inflation. Nobody wants that. If we do too much, we could slow the economy more than needed, and we know that has harmful consequences for people’s ability to service their debts, for their jobs and for their businesses.
This tightening phase will draw to a close. We are getting closer, but we are not there yet.
The Bank of Canada’s job is to ensure inflation is low, stable and predictable. We are still far from that goal. We view the risks around our forecast for inflation to be reasonably balanced, but with inflation so far above our target, we are particularly concerned about the upside risks. We are mindful that adjusting to higher interest rates is difficult for many Canadians. Many households have significant debt loads, and higher interest rates add to their burden. We don’t want this transition to be more difficult than it has to be, but higher interest rates in the short term will bring inflation down in the long term.
Canadians are looking for ways to protect themselves from rising prices, and we are working to protect them from entrenched inflation. It will take time to get back to solid growth with low inflation, but we will get there. By working through this difficult phase, we will get back to price stability with sustained economic growth, which benefits everyone. With that summary, Senior Deputy Governor Rogers and I are pleased to take your questions.
The Chair: Thank you very much, governor. I just want to start with — I’m going to read you a quote here in a moment because you’re talking about demand still being high in the economy and the money supply is still flowing.
This was Larry Summers when asked about why he had anticipated inflation would be a problem:
The secret sauce of economics is arithmetic. After I did the arithmetic, it looked to me like the amount of water we were putting in the bathtub was far bigger than the capacity of the bathtub. But I didn’t know exactly what the capacity of the bathtub would be. I thought there might be various kinds of bottlenecks.
Where are we in that analogy? Is it finding a level?
Mr. Macklem: Thank you for the question. I think one thing that is hard to understand is, on the one hand, we’re saying the economy is slowing, on the other, hand we’re saying it’s in excess demand. How do those two things fit together? I’m going to wave my hands here because I find it helpful. The economy is here. That’s demand in the economy. Supply is here. So demand is above supply. That’s excess demand. The economy is overheated and that distance between my two hands is what is putting upward pressure on prices. Now, the economy is slowing so demand is coming down. The gap is starting to narrow but it’s still pretty high and basically all our indicators suggest the economy is still in excess demand. We started raising rates in March, and so we are starting to see the effects of higher interest rates. You’re seeing it particularly in the housing sector and purchase of big-ticket items, but it is going to take time for the effects of higher interest rates to spread through the economy and bring these two into line to relieve those inflationary pressures. I hope my hands helped.
The Chair: It does mean higher inflation. We’ll begin our questioning with Senator Deacon.
Senator C. Deacon: Thank you for being here. We’ve heard a lot of different perspectives over the last weeks as to the cause of this period of high inflation. There is agreement, generally speaking, that the COVID response — the response to that massive uncertainty and the slow response from it — has had an effect on inflation, but it’s a fraction of a per cent, generally felt to be very small for the most part. Hindsight is always 20/20.
We also had a perspective at the other end of the spectrum which suggested the increase in money supply was deemed to be the issue in causing inflation. We get your stated reason. You’ve been clear and discussed it in your recent report. Could you just help us — or help me, anyway, as a non-economist who hasn’t been as good at doing the math as Larry Summers has been — understand your thoughts on the different perspectives that are being offered and help us weave our way through those?
Mr. Macklem: I’ll start by saying it is a complicated situation. You don’t get to 7% because one thing surprised you. It’s a combination of things.
One of the reasons you’re hearing different perspectives is it also depends on the point in time you get that perspective.
If you go back over the last year, when inflation began to rise in Canada, it was largely reflecting higher international inflation. We saw a big increase in the global price of oil. We saw the prices of many global commodities rise, and because households around the world — this pandemic hit everybody at the same time — couldn’t consume any of the services they wanted, they substituted them with goods. You can’t go to the gym, so you buy home exercise equipment. You’re sitting at home, so you buy a new TV, maybe a new computer.
The thing about goods is they all have to be produced, and they have to be shipped. The global supply chain was gummed up by COVID and supply-chain problems. So at the same time demand is strong, supply is impaired, and you saw all these global prices go up. That’s what initially pushed inflation up in Canada.
I hesitate to even use this word, but you will remember at the time there was discussion about this being “transitory.” So why did we think it might be transitory? Well, the reason for that is, historically, when you’ve had supply problems, they’ve tended to work themselves out. Global oil prices, for example, go up and down. If you raise interest rates as soon as global oil prices go up, by the time the interest rates are feeding through the economy, they’ve already come down, and you’ve overdone it.
We did what we normally do, and we looked through those. Unfortunately, those supply problems turned out to be much more persistent than we thought. It wasn’t so much that each one was more persistent, but there was a whole series, and, of course, there was a war in Ukraine. With the benefit of hindsight, if we had seen all that, we probably would have taken action earlier.
But where I’m going now is that we’re actually starting to see those global inflationary pressures starting to come down. If you look at various measures of shipping costs and delivery times, they are improving. It’s going to take some time to feed through to the Canadian economy, but they are improving. Oil prices have come down a bit. The prices we’re all paying at the pump are down.
But the other thing that happened, once we got through the Omicron variant, is the economy reopened, and households came back to the economy. They wanted to consume. They wanted to avail themselves of all those services they missed out on, and businesses have been unable to keep up with the demand. They have been unable to hire enough people quickly enough to keep up, and you saw a big increase in services’ prices. Services’ prices in Canada are now rising about 5.5%. That reflects domestic inflationary pressures. That is not simply imported inflation from global factors. It reflects that demand in our economy is running ahead of supply, and that is what we are particularly focused on. We can’t control global events, but we can control the balance. We can influence the balance between demand and supply in our economy.
It was a long answer, but it was a very good question.
The Chair: Thank you.
[Translation]
Senator Gignac: Welcome, Ms. Rogers and governor. When you were here in the spring, I asked you what would happen if your optimistic outlook on inflation didn’t come to pass, and you said things would be difficult. Rates have risen by 350 basis points since then, and you anticipate further increases. As an economist, I agree with and support your goal of bringing down inflation. I think that’s extremely important, and I especially support the fact that you are separate from the political process. How do you determine whether it’s too much or make sure you don’t end up overdoing it? In other words, employment is clearly a lagging indicator. What leading indicators do you track so you know when to sit on the sidelines for a time out?
Mr. Macklem: You’re right: we have hiked interest rates significantly thus far. The effects of that are already being felt in the housing sector and in spending on big-ticket items, and we know that the actions we have taken will bring about further effects. How do we try to determine whether it’s enough or not? There are two parts to that answer, the things we watch closely and the way we examine them.
First of all, if we look closely at the effects of the interest rate increases on the economy, they will clearly start with interest rate-sensitive sectors — as we are already seeing — but it will take longer for those increases to affect services because people don’t take out loans to buy services. How do we do it? We use models. We have extensive experience with interest rate increases. Models provide us with information, and we can tell whether each step produces the anticipated outcome. We have to monitor factors that change over time. For instance, Canadians are more indebted now than they have ever been, so the effects could be stronger than projected by our models. Conversely, households accumulated more savings during the pandemic, so they have more money in their bank accounts, in other words, a bigger cushion to protect against interest rate increases. That’s an important consideration, and we’ll see what ends up happening.
Second, the events affecting supply chain disruptions play an important role. Those are international factors. Two weeks ago, I was at the Financial Management Institute of Canada. I often meet with other governors. We try to understand what is happening globally and how it will affect inflation domestically, in Canada. Lastly, we keep a close eye on inflation and inflation expectations. When it comes to inflation, we focus more on measures of core inflation. Here’s the good news. Measures of core inflation have stopped rising, sitting at approximately 5%, but they haven’t started to decline. That’s something we are watching closely.
Near-term inflation expectations are high. In the long term, they remain reasonably well anchored to our targets, but our survey results show that households and businesses are more uncertain, so there is some risk and things could change. We use models as well as surveys when it comes to inflation. We survey businesses on a quarterly basis, and one of the questions we ask is what they plan to do with their prices for the goods and services they sell. Survey results indicate that businesses, on average, expect the rate of price increases to be lower going forward than last year. Those are the early signs. They aren’t yet reflected in the data, but we are confident we will see inflation drop.
Senator Gignac: You didn’t mention money supply as being one of the indicators you watch. The committee recently met with a professor emeritus from Johns Hopkins University, and he said there was a relationship between growth in the money supply and inflation in every country in the world. He also said... That’s not on your website. Forty years ago, when I started my career, every Thursday afternoon, we had to calculate the growth in the money supply. Why do you think money supply is no longer relevant?
Mr. Macklem: First of all, we examine a lot of things. I highlighted the main ones. We examine money supply and credit supply. If we see that people have more money, they will probably want to spend. We look at mortgage credit growth. That gives us information on what is going to happen in household markets. When I began my career, we looked at money supply every week. During that time, we learned that the relationship between money supply, inflation and the economy wasn’t consistent. There was a time when money supply was targeted. You and Senator Bellemare no doubt remember what a disaster that was.
The Bank of Canada managed to reduce growth in the money supply with all the targets, and inflation rose. That was in the 1970s, with inflation and increases in variables. In the end, this created the conditions for inflation targeting. The most important thing is targeted: inflation. We use all kinds of information to determine what’s going to happen with inflation, but we target the things that are important.
Senator Gignac: Thank you.
[English]
The Chair: We will come back to that issue throughout the evening.
Senator Ringuette: Thank you for being here.
Understanding that your mandate is inflation, and your target is 2% and the fact that you raised the overnight rate six times in the last six months, my question to you is this: Do you have a model that will indicate to you your maximum overnight interest rate that is possible before that particular overnight interest rate becomes a trigger to the famous R-word, a recession? If so, what is your model telling you right now with regard to what should your maximum interest rate should be not to trigger a national recession?
Mr. Macklem: We have models; we use models. To get back to Senator Gignac’s question, we need to be forward-looking. What we do now is going to take time to affect the economy and inflation. So we need models.
Models are models; they’re not reality. You’ve got to use them with a lot of care. You supplement them with other types of information that I just talked about.
We published our forecast last week, and in our forecast, we have a significant slowing of growth. Growth for the next three quarters is roughly zero, which means we’re just about as likely to have a couple of quarters of negative growth as we are to have a couple of quarters of positive growth. So it’s not a severe recession, it’s not a major contraction, but you could certainly get a couple of quarters of negative growth.
We’ve been very clear about our forecast.
Our model or projection does have a path for interest rates that brings inflation back. We’ve been very clear, as I said in my opening statement, that we think we’re getting closer to the end of this tightening phase, but we’re not there yet. We think interest rates will need to go up further.
Senator Ringuette: But my question is very specific.
Mr. Macklem: I’m not going to give you a number, because I don’t know what that —
Senator Ringuette: That’s what I want.
Mr. Macklem: I’m not going to give you a number. We take these decisions each time, as we move forward, with the best available information. I’m not going to give you a number now, because we’re going to get more information before our next decision. It will be a better-informed decision.
We have a good idea of the direction. I think it’s pretty clear: We think it needs to go up, but we think we’re getting closer to the end. That gives you a broad indication.
Yes, there is a bit of space within that, and as we get closer and as we get more information, we’ll take those decisions in real time.
The Chair: Ms. Rogers, do you have a comment?
Carolyn Rogers, Senior Deputy Governor, Bank of Canada: Ultimately, Senator Ringuette, the number that we target is the inflation number, and the interest rate is the number that gets us there. So we don’t have a target in mind that we put in the model.
The Chair: As a reminder, when you’ve asked your question, please shut the microphone off while the guest is answering. Thank you very much. And thank you for jumping in there, Ms. Rogers.
[Translation]
Senator Bellemare: Thank you for being here. As I’m sure you can guess, my question doesn’t have to do with the sustained market. It’s about the labour market. I looked at the indicators you identified to determine that inflationary pressures are now domestic, that inflation is here. You said there was excess demand for products and services, but your indicators are based mostly on the labour market. You mentioned job vacancies, the non-accelerating-inflation rate of unemployment and the price of services, but services are directly tied to wages and job vacancy pressures. Job vacancy data show that job vacancies are not tied to inflation. Jobs were vacant even before inflationary pressures. Back in 2018, Quebec had two unemployed workers for every job vacancy, and there was no inflation. Now, there’s inflation, and the strategy is to raise interest rates.
With a serious labour shortage stemming from an aging population, if nothing is done to deal with the problem, production will drop. Don’t you think that an aggressive monetary policy vis-à-vis interest rates could hurt much more targeted labour market policies? I’m talking about policies aimed at increasing labour force participation, encouraging immigration, supporting training and enhancing productivity, for instance. In that regard, the Governor of the Bank of Canada should work with the government while continuing to run the bank in a manner that is separate from the political process. Cooperation and independence are two different things. Don’t you think you should move in that direction?
Mr. Macklem: You’re absolutely right that there are two sides: demand and supply. To answer the first part of your question, about job vacancies, I would say that, yes, of course, some sectors of the economy were experiencing labour shortages pre-pandemic, but what we are seeing now is more widespread. Job vacancies have hit an all-time high. The good news is that we are seeing that number start to come down, but it’s still very high. Our business outlook surveys indicate that the labour shortage is being felt everywhere. You’re right that it started in Quebec. It’s one of the tightest labour markets, but every province is feeling the labour shortage now, not just Quebec. It’s pretty clear that the economy is in excess demand.
As for the second part of your question, I completely agree. As a country, we should work to address supply and demand. Interest rates affect demand. We have a clear mandate, and our tools will slow demand. According to our forecasts, we should see a fairly significant increase in supply.
That really comes from two places. First, the level of immigration was very low during the pandemic, for obvious reasons. The government has now raised immigration levels considerably, announcing yet another increase today. That will increase the supply of labour. Second, productivity was low during the pandemic, because of all the restrictions that were in place and the disruptions to the supply chain. With things getting back to normal, businesses can do a better job of planning and productivity should bounce back.
We are already forecasting an increase in supply, but it’s not enough to fix the problem. Supply takes time. We need both: a slowdown in inflation and softening demand. If federal and provincial policies result in increased supply, then, yes, there will be less to do on the demand side, but I think we still need to work on demand. With inflation at 7%, we can’t fix everything through supply.
Senator Bellemare: Won’t an aggressive approach to monetary policy and interest rate hikes prevent businesses from bringing on new immigrants to work and hinder the construction of homes to alleviate the housing shortage? In other words, aggressive policy can also have the effect of further reducing — as opposed to increasing — supply.
Mr. Macklem: The other thing is that we need to control inflation expectations. If everyone thinks inflation will remain high, nothing will be all that effective. When people start to believe that inflation is going to stay high, they accept price increases. Businesses, for their part, can simply increase their prices without any competition. That happened in the 1970s.
If we look at a number of different countries over different periods, what we find is that quicker tightening cycles result in an overall interest rate increase that is lower, and the same goes for the economic downturn.
We raised interest rates quickly, because we felt it was the best way to avoid even larger increases in the future and a more serious market downturn.
[English]
Senator Loffreda: Welcome, Governor Macklem and Senior Deputy Rogers. Great to see you again.
You’re predicting the annual average GDP growth is projected to decline this year from 3.25% to just under 1% next year and about 2% in 2024, and the economy will move into excess supply in 2023. My question is also around labour.
One, how do you see the supply disruptions corrected from labour once again? I do speak to many entrepreneurs in the service industry, and they are having the hardest time ever. They can’t find employees anywhere. Wages are rising. Despite wages rising — and I don’t want to get into numbers — they still can’t find employees, and that’s in the service industry.
How do you see those labour shortages corrected? Yes, of course, increasing interest rates will lower demand, but you said it, and we all know that debt levels are very high, so the increasing interest rates are not sustainable for the long term.
Why are these forecasts better than previous forecasts, given the global, worldwide uncertainty that we have, ranging from geopolitical to supply disruptions to energy crises? Do you have the tools to tame inflation, or do the factors outside your control just play too big of a role at this point in time?
Ms. Rogers: Many things you point out are the things that the governor just discussed with Senator Bellemare. There are two sides to the equation here.
We have an economy in Canada that is running in excess demand, above its capacity to produce goods and services. The tightened monetary policy and higher interest rates will help to reduce that demand, but there are supply factors that can also help. Those are not tools within the central bank’s capacity; those are with other policy-makers. They will help.
To your specific question around labour, you point out, in particular, entry-level positions, and that is consistent with what we hear from businesses too. Immigration has been constrained throughout the pandemic. It is going to get started again. That will help. Some of the adjustments companies had to make throughout the pandemic to deal with restrictions have lifted now. I think companies are getting back into full capacity. We are dealing with departures from the labour force, so there are a number of factors that are contributing to a constrained labour force, but absolutely one of them is excess demand.
As the governor said, and I’ll use the same hand gestures he did, our job and our tool kit lets us affect supply, and that’s what we’re focusing on. There are other policies that can contribute to demand, and there are policies that can contribute to the supply, but they’re not substitutes for each other. We see them as complementary. We need to do our job, other policy-makers need to do their job, and together we can get inflation back down.
Senator Loffreda: We had expert witnesses tell us that 75% of the cause of inflation was supply-driven. Do you feel the world’s central banks had a role to play with quantitative easing and maybe increasing interest rates a little too late, with maybe a little blur between monetary and fiscal policy? Was the QE, quantitative easing, there to finance the government’s deficit, or was there a clear distinction between the monetary and the fiscal policies there?
Mr. Macklem: It was very clear in my mind. You packed a lot in there.
I would say, first of all, let’s be clear about QE. Many central banks around the world use QE, and we all did it for the same reason. We lowered our policy rate as low as it could go. If we could have lowered our policy rate more to pull rates down further at the yield curve, we would have, but we got it as low as it could go.
QE basically provides a different way to lower interest rates further at the yield curve. If you buy bonds at five years, for example, that drives up their price and pulls the yield down. When people typically get a mortgage and companies typically borrow, that’s where they borrow. The interest rate we control is one-day money. They don’t borrow one-day money; they borrow five-year money. QE is just another way of lowering interest rates.
The other thing we used, together with QE, is exceptional forward guidance. You have to think of these things as a package. We lowered interest rates, we used exceptional forward guidance and we used QE. We did all those things to lower interest rates across the term structure to provide support for the economy to get back.
There’s nothing kind of special about QE in this whole thing. It’s part of the package. It’s just part of the way we lowered interest rates.
With respect to whether we waited too long to lower interest rates, as I responded, it is fair to say that if a year ago we knew everything we knew today, I think we probably would have started to raise interest rates.
In Canada, we actually unwound QE pretty quickly. We were done with QE a year ago. At our Monetary Policy Report meeting a year ago, we ended QE, and in April we moved to quantitative tightening, so our balance sheet since then has been shrinking. That is now working in the opposite direction. Our primary instrument is the one-day interest rate that we control, but we’re complementing that with QE, which is pushing those longer-term interest rates up.
Did that answer all of your questions?
Senator Loffreda: That’s fine. Thank you.
The Chair: I want to come back to that for a moment, if I could, because a couple of our committee members referenced this. We heard testimony from Steve Hanke, who basically put it this way: Central banks don’t want to talk about money supply because they’re responsible for money supply and they don’t want to be blamed. He put it clearly.
At the same time, I’m also reading The Lords of Easy Money, a critique of central banks, which I’m sure you’re aware of. They had some pretty staggering numbers, such as that the Federal Reserve in the U.S. has printed or created about three times as much money since 2008 as they’ve created in their whole lifetime. The number here in Canada is one in five Canadian dollars that are circulating in our economy didn’t exist pre-pandemic. That’s a money supply issue.
Mr. Macklem: Can you give me a question?
The Chair: You say that everybody was doing quantitative easing, it was the regular thing, and you’ve brought it to an end, but we’ve still got excess demand in the economy and we’ve still got government spending.
Mr. Macklem: A couple of things. Yes, we have excess demand, and we’re working to bring demand and supply and relieve those inflationary pressures.
Look, I think you have to put this in perspective. We’ve gone through an unprecedented series of shocks. This pandemic, the recession, this was the deepest recession we’ve had by a large factor in Canada. GDP was down 15%, 3 million Canadians were unemployed and almost another 3 million were working less than half their regular time. That demanded an exceptional monetary response and an exceptional fiscal response. The good news is it worked. We got the fastest recovery on record.
When I started as governor, we were right at the bottom, and we were very worried about what we call scarring. Basically, there’s a certain amount of evidence that when people are unemployed, particularly if it’s not a short bout of unemployment, they lose skills. This is of particular concern for new entrants into the labour force. You don’t get their first job, you don’t get that first experience working and you don’t get that on-the-job training. It doesn’t just affect you during the recession; it affects your whole earnings over your whole lifetime. We were very worried. This was the deepest recession we’ve ever had, and historically, deep recessions also take longer to recover from.
Yes, we put a lot of stimulus in. The good news is it worked. We had the fastest recovery. It’s not like we got everything right. We didn’t anticipate how serious these global supply chain problems would be. Inflation definitely came up faster than we thought, and we’ve acted forcefully to get it back down.
It’s going to take some time to work, but I do believe we’re going to get there.
The Chair: Thank you for that.
[Translation]
Senator Massicotte: Thank you for being here, governor and Ms. Rogers. I have no doubt about your commitment to bringing down interest rates and inflation. You have done a good job so far, and I commend you. The U.S. announced that its inflation rate was still on the rise, influenced by the upcoming mid-term elections.
Can international market events hurt our success and our commitment to reducing interest rates?
Mr. Macklem: Would you mind repeating the last part of your question, senator?
Senator Massicotte: Could still-rising interest rates in other countries affect interest rates here? Could we be headed for a nasty surprise as a result?
Mr. Macklem: We’ll find out tomorrow what the U.S. Federal Reserve is going to do. We are aware that nearly all central banks are raising their interest rates. North America is slightly ahead of Europe, where interest rates are rising rapidly but are still lower than here.
If countries all tightened their interest rates at the same time, the spillover risk would be higher than if just Canada or the U.S. had done so. That’s something we take into account in our analysis. Central bank governors meet every two months or so in various forums — International Monetary Fund, G7 and G20 meetings, for example — and we talk a lot about the recession and a synchronized upturn. It’s quite helpful to look at and compare what’s happening in other countries.
The other consideration is that, if every country tightened its monetary policy, Canada would have less to do than if it had been the only one to tighten its policy. What would help Canada is for other countries to control their inflation, especially the U.S. That would help to bring down inflation in Canada. Yes, there are risks. In recent weeks, we’ve seen some issues in very specific markets, mainly the U.K., so if there are mistakes, the effects can impact markets more quickly. At this point, the effects of tighter international monetary policies on financial conditions are fairly normal. We aren’t seeing any major problems.
Senator Massicotte: The last time we met, we talked about the current model and the fact that there are all kinds of models. We discussed interest rates and property values. Property values have come down considerably, something that had been anticipated two years ago. I assume property values will continue to drop. What does the model say about that?
Mr. Macklem: Most of our models are macroeconomic-based, so we don’t have specific forecasts for every sector of the economy. As far as housing is concerned, home prices rose by 50% during the pandemic, but have come down about 10% as of today. Although new interest rate hikes are anticipated, it hasn’t affected the market. Prices will likely continue to come down, but we don’t have any specific forecasts for that sector.
[English]
Senator Yussuff: Thank you to the governor for being here. I don’t think you’ll be surprised about my question. Governor, you’ve spoken a lot about the dangers of wage-price spiral on inflation; however, wage growth so far has not kept pace with inflation over the last year. One thing I have not heard you speak about is the record rate of corporate profits, which is about 20% of GDP. Why have you not issued any warning around the price increase we’re seeing in the country? Canadians are feeling this. You talk to anybody on Main Street, and they’re not confused about what is going on. They’re going to the grocery store and asking themselves some really fundamental questions. In the context of fairness, I don’t mind you criticizing workers — that’s fair — but I think if there’s criticism, it needs to happen both ways.
Mr. Macklem: I can take the first part, and I’ll ask the senior deputy to take the second part.
Let me be clear: I’m not criticizing workers. We need workers. Workers are the backbone of the economy. I’m not criticizing workers.
What I said, which got a lot of attention, is that Canadians, Canadian workers and Canadian businesses should not plan on inflation staying at 7%. We’re resolute in our commitment to restoring price stability, and we’re using our tools to bring it back down.
With respect to the wage-price spiral, this is something we’re worried about, and you can understand why we’re worried about it. Inflation is 6.9, 7%, and it’s been high now for some time, and the longer it stays high, the bigger the risk that people start to expect higher inflation. As I indicated earlier, then competition doesn’t work. It’s easier for companies to pass on higher prices.
What happens in a wage-price spiral is inflation goes up. In a situation where there’s excess demand in your economy, businesses are having trouble attracting workers. They raise wages, and that raises their cost, so they pass that on to still higher inflation. If the economy is still in demand, wages go up further, and you get this — and that is one way that expectations can de-anchor it. That’s basically what happened in the 1970s, and I’ve already talked about how badly that ended.
I would say so far we’ve seen higher inflation, and we’ve seen wages move up. I would not say we’re seeing, so far, a spiral. Core inflation has yet to come down, but has at least levelled off and wage growth has increased and broadened, but it has stopped really moving up. So far, we haven’t seen a spiral.
I do think, though, that we have seen some danger signs in the economy — and this is where I’ll turn it over to Senior Deputy Governor Rogers. The danger signs we’ve seen are that companies have very rapidly passed through higher prices to consumers, and as consumers get used to high inflation, they accept those. So when companies raise prices, they’re not worried about what their competitor is going to do. We need to get back to a situation where companies are more worried that they’ll lose their customers if they raise their prices. When you have an economy in excess demand, if you’re a company and you can deliver the product, then it’s easier to pass through those prices. We have done some work looking at margins, and maybe I’ll ask the senior deputy to say a word about that.
Ms. Rogers: It’s an important question that you have asked. The contribution we can make to this discussion is that what we have seen is the profit margins that companies have made have held fairly steady. There are exceptions, of course, but, by and large, they’ve held steady. What that tells us is that the increased input costs that companies are experiencing are being, basically, passed on to customers. Customers are bearing the full brunt of the cost increases that businesses are experiencing.
As the governor said, that happens and can be sustained in an environment where there’s excess demand and there isn’t a competitive force. Companies can just basically pass their costs through.
One promising observation I would make is that some of the things that have contributed the most to input costs for companies — things like transportation costs, and when it comes to groceries, commodities — those have come down recently. So what we’re looking for, what we should all look for, is for those to also be passed on. Those costs should come down. That will help.
The last point I would make is that this sense of unfairness that people feel — that the environment of inflation means that somebody is winning and somebody is losing and people feel like they’re being treated unfairly — is one of the nasty effects of inflation and one of the reasons we need to get back to our target rate of inflation.
Senator Yussuff: Despite how well the economy has been doing, for a lot of people at the bottom, they haven’t done well for such a long time. For the first time, we’re seeing some competition for people’s wages to go up. I think part of the bank’s policy is to help those people equally to find their footing in the economy. If the bank is not careful, you might force those people to go back to what they have endured for decades, which is stagnant wage growth, and more importantly, not having the ability to at least have access to other jobs that might give them a better footing to improve their own standards.
My worry is the people who have finally made some gains in the economy are not hurt and pushed back to the margins. Recognize that if you’re not careful — you’ve got to echo some of that. For certain segments in this society, inflation is not an issue. If you’re making $200,000 a year, it’s not an issue. The people who are living pay cheque to pay cheque, who have to deal with rent increases and the list goes on, those are the people who will face the harshest reality right now. How do they survive? To a large extent, those people are really hurting right now.
The bank needs to balance this criticism. The people who are doing really well, and some of the companies — I’m not making this up, I think the profit margins are way too large. We live in a free market society, but the fact is that this is simply unfair to the people who are bearing the brunt of it.
Mr. Macklem: I’ll say we share your concern. We’re acutely aware that, unfortunately, the effects of inflation are very unequal. Lower-income Canadians are disproportionately affected by high inflation. The necessities for low-income people make up a much bigger part of their budget, and you can’t cut necessities. Even their opportunities to move to lower-cost purchases — lower-income Canadians are already very careful shoppers, they’re already looking for the lowest-priced goods. It’s harder for them to move down to other goods. We are acutely aware that inflation is disproportionately affecting the lowest-income Canadians.
Unfortunately, there’s no easy out to restore price stability. We do have a labour market that is in excess demand, and to get back to your question, Senator Loffreda, we need a period of low growth. We’ve got zero growth for the next three quarters in our forecast. That is what gives supply the chance to catch up. We’ve got to get the labour market into better balance. We are aware that, unfortunately, that will tend to affect the most vulnerable workers the most. It will be a difficult transition for some, but there’s not really an alternative. We’ve got to get through this period, to relieve those price pressures and to get inflation back down so we can get back to sustainable growth with low inflation.
The Chair: Thank you, governor.
Senator Marshall: Thank you for being here tonight. I’m actually interested in the financial statements of the bank and how they impact the government’s bottom line.
I was looking at your quarterly statements for the end of June, and I read somewhere in the media that you’re expecting some losses over the next couple years. When I look at the quarterly statements, I mean, it’s quite striking, the comparison of your interest expense compared to last year.
What I saw, I think, was a figure of $4 billion or $5 billion that you’re projecting over the next couple years. Is that still the current number? Because as you’re increasing rates, your expenses are going up. Is that $4 billion or $5 billion figure still current, and what is going to happen to it? I’d like to know. Is the government going to give you the money? Is it covered by the indemnity agreement? I think it’s going to end up in the government’s bottom line anyway, but I would just like to know how you’re going to deal with at the bank.
Mr. Macklem: All good questions, and I’ll let the CPA at the table answer them.
Ms. Rogers: Senator Marshall, you’re always interested in our balance sheet. From one accountant to another, it’s not a conventional balance sheet and it’s not easy to understand.
Over the last couple years, our balance sheet has grown significantly. We have more assets on our balance sheet than we normally would. Those assets are interest-bearing, so they are producing some income. We also have liabilities in our balance sheet that are variable, so the losses that we’re experiencing right now are what we would call “interest rate risk.” So yes, it’s a mismatch.
The thing about the bank is that with the legislation that we operate under, we don’t retain any of our income. We don’t build up a reserve to manage losses, which is as it should be in normal times. In a typical year, we would return about a billion dollars every year to the government’s bottom line. In the last couple years, as our balance sheet has grown, we’ve had more assets. We’ve turned over an excess $2.5 billion for the last couple of years, so over the last few years, somewhere close to $10 billion.
Over the next three years, for a very temporary period of time, we will experience operating losses because of that mismatch. You asked specifically about the indemnity —
Senator Marshall: Do the indemnity agreements cover that $4, $5 or $6 billion, or whatever it’s going to be?
Ms. Rogers: It doesn’t. The indemnity we have in place now that you see on our balance she covers the mark-to-market losses. The operating losses from the mismatch are not part of that indemnity. This is not a unique problem to the Bank of Canada. Our fellow central banks — as the governor described — the quantitative easing response to the pandemic was something most developed countries and most central banks undertook. So this is something that most of our peer central banks are dealing with. They’re solving it in a variety of different ways. In some cases, the governments are giving them indemnity that covers operating losses. That’s one way.
Senator Marshall: I saw that.
Ms. Rogers: In the U.S., the Fed uses U.S. GAAP. What they do is they take the operating loss and turn it into a deferred asset, and then they run that deferred asset down over time, future earnings. Other central banks retain their earnings, so they have something to offset the losses. There is a variety of different ways you can solve this. The decision is ultimately for the government to make.
Senator Marshall: Have they made a commitment they’re going to send you a cheque? Or are you just going to carry those losses, with the intent that in the future they’ll turn around? I’m trying to get handle on how it’s going to impact the government’s bottom line. If they don’t give you the money for it, they’re going to consolidate it.
Ms. Rogers: Yes. They’re still evaluating the different options. They’ve looked at the different ways central banks have done this.
Senator Marshall: The $33 billion or $35 billion that is on the balance sheet that’s covered by the indemnity agreement, as rates go up — because you’ve said that rates are going to go up again — that will also increase, won’t it?
Ms. Rogers: Yes. It’s a mark-to-market.
Mr. Macklem: The balance sheet is running down, so that will diminish it. If rates go up, that will increase it. There is some offsetting effect. As rates have gone up, it has gone up.
Senator Marshall: You’re going to continue to let them roll off. You’re not going to sell them.
Mr. Macklem: That’s our intention.
Senator Smith: Welcome again, governor and deputy governor. I just want get back to what Senator Massicotte was talking about, namely, mortgage defaults. The Office of the Superintendent of Financial Institutions, or OSFI, has raised alarms about mortgage defaults and advised banks and lenders to be prepared to handle the consequences.
What type of system are you looking at in terms of the level of mortgage defaults increasing? Are you watching and monitoring that? Have there been any surprises? Where do you see that going and the impact it will have? At the end of the day, if it gets to too high a level, the Canada Mortgage and Housing Corporation, or CMHC, is the backstop behind the central bank. How do you look at that? How concerned are you, and do you have any comments about managing through that particular storm?
Mr. Macklem: I’m looking at the senior deputy governor.
Senator Smith: I saw you looking over your shoulder there.
Ms. Rogers: Just one point of clarification: the CMHC backstops the mortgages held on commercial banks.
Your question is a good one. I think we’re acutely aware that interest rate increases are feeding through in particular right now at the outset to the housing market and to people’s mortgage payments.
Most mortgages in Canada, up until quite recently, were fixed-rate mortgages. There was a period over the last year when there were more variable rate mortgages on a flow basis. We’ve been told by most commercial banks that many of those mortgages have since been converted to fixed-rate mortgages. Many Canadians’ mortgages are locked in at this point.
With respect to what we are hearing from banks and seeing in the data that we gather, we aren’t seeing an uptick in defaults, but we’re conscious there is a lag. Defaults are a lagging indicator; any good bank regulator will tell you that.
Banks are being proactive in reaching out to their borrowers — that’s the other thing they’re telling us — and making sure they work with borrowers. It’s not in a bank’s interest for borrowers to go into default, so I think they are actively working with the portion of borrowers who are feeling stress with the higher rate.
It’s OSFI’s job to be proactive, and that’s what they’re doing. They’re telling banks to be careful. What OSFI would also tell you, and what we would tell you, is we regularly stress test our banks for severe economic downturns, and they pass. Our banks are very well capitalized, even in a highly stressed event.
If you’re speaking about just the banks, I think they’ll be fine.
I think what we’re focused on and what banks are focused on is making sure their borrowers can weather the increase in interest rates.
The Chair: Just on that point, we had a witness here from the Bank of Montreal, Mr. Kavcic, who was saying — and I think it was Senator Marshall who had asked the question — that compared to the 1980s when interest rates were 18%, 20%, et cetera, this looks a lot easier to deal with. He said it’s not any easier, because it’s the level that matters, the change, for economic growth. We can’t look at this and say, “Oh, well, I think we’ll weather this storm in the short term.” He is saying this is every bit as serious as it was then.
Do you agree or disagree?
Ms. Rogers: There are two ways to look at that. I think your question, Senator Smith, was about the strength of the banks to withstand this.
The comparison I would make to previous downturns is that the banks are better capitalized now. They’re more prudent.
Your question, Senator Wallin, was more about the broader effect on the economy.
A colleague of mine in testimony here or maybe in the House made a very valid point, which is that Canadians pay their mortgages. What we worry about on a macro level is that’s all they pay, so it does slow down the economy. Certainly, as more of your income goes to your mortgage payment, it does weigh on the economy, but we have factored that into our forecast. That is the slowing in demand that comes with an increase in interest rates, and it is the thing we need right now to get the economy back in balance.
Homes are the thing that most of us borrow to buy, so they’re always going to be the thing that is affected first and most by increases in interest rates. It’s an intended outcome. It is stressful for some borrowers. We absolutely understand that.
The Chair: Yes. He was making that same point that banks don’t worry because Canadians are very diligent about paying bills when it comes to their homes.
Senator Woo: Thank you, governor and senior deputy, for being here. Canada is an open economy, highly dependent on trade and has looked to global markets for inputs of all sorts, essentially based on efficiency criteria. But our government seems to be taking us in a different direction in terms of the future of our trading relationships. We have heard senior ministers talk about re-shoring, friend-shoring and even decoupling.
What effect will this much more limited approach to international trade have on inflation? One would have to expect that costs will go up. If, in fact, you agree that there will be an impact on inflation, can you give us a sense of the orders of magnitude and the duration of this structural change in the way we interact with the world?
Mr. Macklem: I think it’s more speculation than precise estimate.
I would say two things. We actually reflected this in our recent Monetary Policy Report. At the beginning of the pandemic, we saw that supply chains were very disrupted. We did not expect that this was going to last two years; we thought they would go back to normal. However, the longer this has lasted and the more pervasive these supply issues have been for companies, regardless of what governments do, you’re seeing changes in behaviour in companies. Companies are looking to simplify their supply chains. They’re looking to diversify their supply chains. They’re looking to standardize their supply chains. They’re planning to hold more inventory than they used to because some people say it’s more “just in case” now than “just in time.”
That is going to have an effect. That means that the system will be more resilient but less efficient, so it will be more costly. That will build a permanently higher-cost structure. Certainly, for a period, it could have some inflationary consequences. Basically, the supply side is not going to be as elastic as it was, so as we adjust to that higher-cost structure for a period, it will create some inflationary pressures.
Inflation, remember, is an ongoing increase in prices. Once you have adjusted, it’s not inflationary anymore, but the cost is permanently higher.
I think it is fair to say that we have somewhat changed our view. We thought it was going to go more back to normal, but the longer this has lasted we’ve increasingly come to the view that these effects are going to be more permanent.
Coming back to governments, the reality is that the global geopolitical situation has become much more complicated. Regardless of what governments do, we’re hearing that if companies have trade relationships in places where they’re nervous about the geopolitical future, they’re not putting money toward deepening that trade relationship; they’re pulling back.
You’re absolutely right: Canada is a trading nation. Our biggest trading partner by far is the United States. One thing we do need to look at is that we have very privileged trade access in the world; we’ve got among the best trade access in the world, as you’re well aware. That is serving us very well, but our trade is very concentrated. I’ve been at this committee before in other capacities saying that we need to diversify our trade. That is looking tougher now. So if we can’t diversify our trade, maybe we can deepen our trade relationships with our biggest trading partners and get as much benefit from globalization as we can.
The world is changing. Companies are reacting, and governments need to look at what is the best way forward.
Senator Woo: That’s right. Your models would be right to predict that there would be some reversion to the previous supply chain models, with modifications, because companies’ behaviours change because circumstances have changed.
But what appears to be happening is not that the government is following the private sector, but the government is actually trying to lead the private sector to consciously stay away from certain markets on the basis of — I’m not sure what terms they’ve used — whether they are democracies, autocracies, whether they’re friends, et cetera.
To me, that would dramatically reduce the set of options for businesses, even businesses that already want to rationalize the supply chains. They went to second source and it all makes sense. But if they can’t second source in a country that’s not on the friends list, surely that will push costs up even more than it would have if they were simply being more precautionary.
Mr. Macklem: Those are decisions for governments and parliamentarians. I’m going to leave it to them.
I’m not disputing that these will have consequences. These will have costs, and you have to find the best way forward. But I do think there are opportunities, even within our own country, to reduce the costs of trade. We could reduce interprovincial trade barriers. We could deepen and lower the cost of trade, even within Canada. That’s totally within our domain. We might be able to do it with some of our largest trading partners, which are large, friendly democracies.
Senator C. Deacon: Thank you again, governor and deputy governor.
We live in an oligopolistic economy, and your October report identified that core inflation remains persistent, yet a lot of the core input costs in some areas have really started to reduce. Even agricultural commodities are seeing a drop. The Competition Bureau has just initiated a study of grocery store pricing, and we saw the banks increase their profits at six times the rate of inflation through the pandemic.
Interest rate changes are a blunt instrument that take effect 12 to 18 months down the line and certainly have a negative effect on people’s lives on the way up and a good effect on the way down.
Do you find evidence that increased competition might make your job easier by bringing prices down faster as we start to get through these periods of inflation?
Ms. Rogers: Yes. This goes back to the previous comments. Certainly, in an environment of high inflation and excess demand, competitive forces don’t function well, and we’re seeing that in the sense that companies are passing the full impact of input prices on to customers.
The Competition Bureau is the right organization to investigate this. The contribution that the Bank of Canada can make to this situation is to bring demand down, get the economy back in balance and get inflation back to target, because that’s an environment where companies feel competitive pressure, and that results in price competition for consumers.
Senator C. Deacon: Have you found places where competitive forces on a sectoral basis respond more rapidly due to increased competition? Have you done any analysis into this as you look around globally? That would make your job easier if you could count on that actually helping to accelerate your efforts on the far side of this.
Mr. Macklem: What I’ll say is we have done research on how prices behave in different regimes. When you have high inflation, and particularly when you have excess demand, as we’ve been discussing, what you see is that the price behaviour changes. Price changes become more rapid. Things get passed through very quickly, and it’s easy for companies to basically pass through all their higher costs to their consumers.
This is like the fundamental problem with inflation. We work in a market-based economy. Prices are signals, but inflation just blurs all that signal. Normally, when you see the price of something go up at one store, you think, “I’m going to go look at another store and see if I can get this at a better deal.” But when all prices are going up, you give up. You say, “Well, this is just what it costs.” Then that makes it still easier for companies to pass through.
We’ve seen this in different countries and different periods of time. The questions that the Competition Bureau has posed are good questions. We’re looking forward to seeing the output.
I think the contribution the Bank of Canada can make is to get demand and supply better balanced, get inflation coming down and restore the role of competition in the economy so that when companies are taking a pricing decision, they’re thinking, “Boy, if I raise my price, I’m going to lose some customers because they’re going to go somewhere else.” We’ve got to get that back.
Senator C. Deacon: Over the long haul, increased competition is a very important ally in your work. Thank you very much.
The Chair: So we have several people on second round and our time is fleeting. So it’s about a minute for question and answer on each one. Senator Gignac, go ahead.
Senator Gignac: Just to follow up with the interesting discussion you had with our colleague Senator Yussuff about the record profit margin and the ability so far of the companies to translate the costs, including wages acceleration, to the consumer. I remember in the 1970s how it finished. It was that interest rate had to exceed inflation. It was finally the only way to fight inflation.
So in the context that provincial governments will send more money to the taxpayer — it will be the case in Quebec and even the federal government will send more money — that will contribute to stimulate demand. In the context you mentioned yourself that so far the Consumer Price Index, or CPI — is related to energy, so it’s not —
The Chair: Let’s get to our question.
Senator Gignac: Why have you surprised the market by increasing only 50 basis points rather than 70? We don’t know what the fed will do tomorrow, but you have taken that bet and signalled that most of that job is almost done. So we are very far. We are still at huge negative real rates as we speak.
Mr. Macklem: We are still at negative real rates at the short end of the curve, but as you go out longer, inflation expectations come down. So we’re at positive real rates at the borrowing horizons that most people are borrowing. Based on expectations, yes, but that’s how you measure them.
Why did we do 50 versus something else? Well, first of all, I would stress 50 basis points is a bigger than normal step. It’s a big step. I mean we normally move in steps of 25. So it’s already a big step, and we judge that we needed a big step for the very reasons we’ve been talking about. Inflation is too high, it’s generalized, the economy is in excess demand — it is slowing but it’s still in excess demand; demand is still running ahead of supply — and that is creating those price pressures. To get back where we started, we still have excess demand and that’s still creating upward pressure. Right now short-term expectations of inflation are high, and the longer they are high, the bigger the risk that it bleeds into higher long-run expectations. So, for all of those reasons, we judged it appropriate to take a bigger than normal step.
But to get to your question about 50 versus 75, we are starting see evidence that the economy is slowing. In July, we increased by 100; in September we increased by 50. Coming into this decision, interest rates were already a lot higher and the effects of those — we’re starting to see the effects.
Senator Gignac: Unless you don’t believe that we have the risk to repeat the 1970s experience.
Mr. Macklem: I think we do have that risk, and that’s an important reason we moved rates up very rapidly, but we are starting to see the effects. We’ve now moved rates up rapidly, and in our judgment, we went 100, we went 50, and we felt 50 was appropriate. Looking forward, we have indicated we think interest rates need to go up, and that’s maybe a bigger than normal step or maybe we can go to more normal steps, but we still have more to go.
The Chair: If you have a short question, let’s put the questions very briefly and then give the final word to the governor.
[Translation]
Senator Bellemare: My question is about a short paragraph you added to the agreement. I was quite glad to see it, but I feel as though it’s missing something. It’s at the very end of the document.
—recognizing the limits of monetary policy, the Government and the Bank also acknowledge their joint responsibility for achieving the inflation target and promoting maximum sustainable employment.
It’s the last paragraph on the last page, page 2. I thought it was worthwhile, but it seemed to me that something was missing, something along the lines of “and the Bank and the Government will work together accordingly in a sustainable way to achieve the targets.”
Mr. Macklem: An important aspect of our system, here in Canada, is that this joint statement is made by the Government of Canada and the Bank of Canada. This is not the case in all countries. In some countries, the central bank makes this type of statement. Here in Canada, it’s a joint statement. In my opinion, this adds credibility to the mandate, because it gives legitimacy to elected officials. That last sentence reflects the fact that it is a shared responsibility.
As for the degree of cooperation between the government and the Bank of Canada, in our legislation, it is very clear that the Department of Finance and the Governor of the Bank of Canada must speak regularly. I can tell you that this is the case. We share perspectives. Also, the staff at the bank and the Department of Finance share their research on forecasts, on domestic issues, and I think that’s a good thing. We all work for Canadians. The bank’s independence presupposes that we must make this joint statement every five years. Between these five-year periods, this means that the bank has operational independence to make decisions as per its mandate.
Therefore, they don’t tell us what we should do, and we don’t tell them what to do.
[English]
Senator Loffreda: So we talked about the real estate market, and to continue on that topic, it’s been a concern in Canada for almost two decades, since the years leading up to the financial crisis of 2008. I do agree that Canadian banks are solid. The last thing Canadians stop paying is mortgages. The second-to-last is car payments, so when we see car payments start to default, we start to worry. We’ve monitored both for years.
I would like to have your thoughts on commercial real estate. I’m saying that because I read an article in Forbes in September 2022 about a commercial real estate apocalypse and the effect on the post-pandemic economy, with increasing interest rates.
Do you see increasing interest rates as a concern? I was reading that in the U.S. it creates close to 10 million jobs, 9.2 million jobs. In Canada, let’s say about a tenth of that. We have a million vacancies and a million unemployed. It does create jobs. I would like to have your thoughts and comments on that and the effect of increasing interest rates. Are you concerned about what you do see with commercial real estate?
And quickly, if I look at your report on monetary policy in October 2022, and I look at inflation across the G20 economies, we’re in the middle of the pack. Any learnings from countries performing better? Or is it strictly global factors? I look at some of the countries where inflation is way higher, such as the European Union and Germany, where energy is a huge factor. I don’t want to mention all of the ones that are performing well, but France and Australia are performing better. Any learnings from there? Or is it strictly that inflation is more global than domestic, and there’s nothing that can be done on that side and there are no learnings?
Mr. Macklem: Maybe I’ll take the second part of your question and ask Senior Deputy Governor Rogers to talk about the commercial real estate part.
You say we’re in the middle of the pack. I think we’re in the better half of the pack.
Senator Loffreda: We’re ninth among 20, but yes.
Mr. Macklem: If you looked at the numbers that came out today, most European inflation rates just went up. In fact, Netherlands is at 17.1, Italy is at 12.8, Germany is at 10.9 and France is at 7.1.
Particularly their natural gas prices have really moved up. Natural gas markets aren’t linked the way global oil markets are because it’s difficult to transport natural gas. You can do it through liquified natural gas, but there’s not enough capacity to equalize prices. They’re being affected by higher energy prices, so you’re seeing higher inflation in Europe.
I think what is striking about this experience is that we all went through a pandemic, we’ve all seen a very severe recession and we’ve all faced a lot of downward pressure on inflation. Most countries have had a very rapid recovery, and now we’re all facing the other side of that.
In some places, it is worse than others. Speaking about monetary policy, we were among the very first to stop quantitative easing. We were among the first to start reducing our balance sheet. We’ve had one of the most rapid increases in interest rates, and I do think we’re at least in the better half of that distribution. I don’t think those things are unrelated.
I also think that we do have some advantages in Canada, which I think will make the slowdown in Canada less severe than some other countries. If you look at our forecast, we’re forecasting a recession in Europe, with the very dramatic effects this war has had on energy prices and the uncertainty it’s creating. The disruption in their supply chain is much more profound in Europe than it is in North America. We are fortunate this war is a bit farther away from us.
The other advantage we have is that we produce many of the commodities that are in short supply. We export oil, natural gas, wheat and potash. The prices of those things are high. For many countries, particularly European countries, they’re big importers of those commodities. They’re getting what we call a negative terms of trade shock. In other words, the stuff they buy is now more expensive. For us, it’s the opposite. The stuff that we sell to the world is now worth more, and that’s bringing more income into our economy.
So we are forecasting a very material slowdown in this country, with growth close to zero for the next three quarters, but it is not as severe as some other countries because of those advantages.
Ms. Rogers: As the governor said earlier, we model a lot of things, but real estate prices aren’t one of them.
I guess I would offer two perspectives on this. Real estate in general, anything you borrow to buy, is one of the first areas impacted by an increase in interest rates. Just as residential real estate is being impacted by rising interest rates, so is commercial real estate.
The other point I would make is back to the stress testing we have done on our bank does not suggest we have a commercial real estate problem any more than a residential real estate problem.
Senator Loffreda: It’s not about the banks but the economy. It’s strictly about the economy.
Ms. Rogers: What I would say is in the early stages of the pandemic, when nobody was going to work anymore, this was a huge concern. There was a forecast that we would never again fill the office towers.
I think there’s some settling out to do yet. We are seeing people come back to work. Where it will end, we have a ways to go yet, I would say. That is one of the things we’re watching.
Senator Loffreda: The Forbes article I was reading was pretty negative on the impact it will have on the economy.
Mr. Macklem: What you’re seeing is some divestment. I think, though, to your point, this has moved a bit more slowly than some people feared. I think if you talk to companies, most have some sort of hybrid work model, and they’re trying to figure out how much space they need and how to reconfigure it. They have been cutting their space, but until they figure it out, they haven’t been doing anything dramatic.
I don’t want to dismiss that there are risks. So far, it hasn’t moved that quickly. I think more generally, I would say, around the world, typically where there’s a severe problem, it’s a combination of — leverage is usually a big point. You can get a lot of leverage in that sector.
There is a fair amount of work going on, looking at where the leverage is in the system. The three blowouts that you’ve seen — the metals market, European energy markets and the British gild market — were all closely related to leverage. Sudden shifts in the market meant that big margin calls couldn’t be met. It created a liquidity crunch, and either the Bank of England had to come to the rescue or the energy markets in Europe, the governments had to come to the rescue.
These have all been caused by what we would call idiosyncratic issues. The U.K. had a big policy blunder. In Europe, there are the effects of the war, with rapid changes in energy prices. So we are certainly — when I say “we,” I’m talking about the Financial Stability Board, central banks and regulators around the world — looking for those pockets of leverage because those are vulnerabilities.
The other thing you want to do is recognize that you’re probably never going to be able to predict what exactly is going to go wrong, so you want to make sure you have enough resilience built into the system. A lot has been done to improve the resilience of the system, and certainly, I think these specific instances highlight that some of the plumbing issues are important.
Senator Loffreda: Thank you for that.
Senator Massicotte: I just want to bring you back to when you made your presentation earlier. You talked about in 2022 we’re going to get inflation down, and in 2023, we’re looking very good. In fact, you were suggesting, as you again suggest, that we’re going to be ahead of the marketplace relative to controlling inflation. You seem to suggest that will cause us some very positive days to follow because we’re probably ahead of the globe relative to controlling inflation, and obviously the environment will be very positive. Talk about 2023-24. What do you see relative to that prediction?
Mr. Macklem: In terms of growth, our forecast is that we have growth close to zero. We’re now already well into the fourth quarter, so we are close to zero this quarter and the first half of next year. As we get into the second half of next year, growth starts to pick up, and then in 2024, we have growth at about 2%. We get to that 2% growth with inflation coming back to our 2% target.
So yes, it is going to take some time to get there, and we don’t want to minimize that there is a difficult transition to go through. But as you highlighted, this gets us back to solid growth, a healthy labour market, with a growing number of jobs and with price stability restored, so that Canadians do not have to deal with the ongoing anxiety of the uncertainty of how they are going to pay their bills when prices keep going up.
Senator Massicotte: Thank you.
Senator Yussuff: Governor, following up on the question my colleague Senator Deacon raised, the Competition Bureau has launched this investigation in regard to whatever you want to call it, an oligopoly or a monopoly, around grocery stores and prices.
Given this reality we’re dealing with — because I don’t think the Competition Bureau is cavalier about what they’re doing, they’re sending a signal that, from their perspective, something looks like it’s not adequate in the context of what is happening in the grocery stores. And it’s not like Canadians have choices; we can’t go across the street to look for competition. Given this reality, and looking at the bottom lines of these companies, it’s certainly showing that the price margins have been quite significant. Their profits have been very significant.
How are Canadians expected to have any confidence when the burden and the pain that they’re suffering is not equal — and unfortunately, you’ve got the blunt instrument that you’re trying to use to get control of inflation — and at the same time, there has been harm happening because of people who are not very conscious about their behaviour? We may get an investigation, we may get a report, but the damage has been done to the people who are really at the bottom of the totem pole having to bear the effects of what is happening in the market.
Mr. Macklem: Senator, there’s no simple solution. As we said, we’re glad that the Competition Bureau is undertaking this investigation, but the best way to protect Canadians from high inflation is to eliminate it.
As the senior deputy underlined, one of the problems with inflation, as we saw in a very big way in the 1970s, is that it creates this feeling of unfairness. Some companies benefit and some companies are actually getting squeezed. Their input costs are going up, and they can’t pass it along as they have a fixed price. They’re getting squeezed. So it’s creating losers and winners, and it’s certainly squeezing households. One day workers get a wage increase and feel good about that, and then they realize that wage increase isn’t going as far as they thought it was. You’ll remember the 1970s. What happened? Inflation was high; unemployment was high; there were a lot of strikes; there was a lot of labour strife; it was a period of a lot of anxiety.
Competition issues need to be dealt with by the competition authorities, but we are acutely aware that we have a responsibility. Our mandate is price stability. We’re a long way from that mandate. We need to restore price stability. It’s been a long time since we’ve had high inflation, and we’re rediscovering that it corrodes the social fabric. It makes people angry. People feel ripped off. That is one of the big problems with inflation, and it’s an important reason why we have to get it back down.
Senator Woo: Governor, you were at the bank International Monetary Fund, or IMF, meetings recently speaking to your colleagues around the world. What is the mood around international financial stability, particularly the risk of a debt crisis in the global south with countries with a lot of U.S. dollar debt, with the dollar value going up and high interest rates going up as well? Is that risk increasing, and what are your thoughts on it?
Mr. Macklem: Yes, there was quite a bit of discussion, as you would expect, around the IMF table. That’s what the IMF does. I would say there were two themes in the discussion. One was on a positive note that many emerging market countries, like Brazil and Mexico, have done a good job of developing their own domestic debt markets, so they’re less reliant on U.S. debt markets. They were also more proactive than many advanced countries in raising interest rates. Certainly, when you talk to them, I think they would say that they don’t have the long history that we do of low, stable inflation. They have more volatile economies. Their independence on their central banks is a lot newer. They don’t have that history of credibility, so when inflation went up, they moved pretty quickly to move interest rates up. They’ve actually moved interest rates ahead most advanced countries; they’re actually quite a bit higher than they are. If the U.S. had been moving up ahead of them, it could have put more pressure on them, but the fact that they were actually ahead put them in a relatively better position. That’s the good news.
To get back to the pointy parts of your question, are the risks going up? Yes, the risks are going up. There are two things. Financial conditions globally have tightened rapidly, and that’s needed in many of our economies. But for particularly more vulnerable emerging market countries, in a more risk-off environment, they’re seeing even larger tightening in financial conditions. There is some flight to quality, particularly in the U.S. economy, so you are seeing capital outflows and you are seeing some pull back.
The other reality is that if you funded your debt in U.S. dollars, there has been a big appreciation of the U.S. dollar, so you’ve got a lot more money to pay back than you did. That is certainly stressing some countries. You’re seeing some smaller countries moving into default, and the IMF is encouraging countries that could be in stressful situations to use the precautionary facilities; don’t wait until you don’t have any options; take action now. Use facilities while you’ve got some room to maneuver and don’t wait until you’re out of options. That was the message from the IMF, and I think that was good advice.
Senator Woo: Are we stepping up to try to help with some of these precautionary measures, swap lines and other forms of precautionary measures?
Mr. Macklem: The IMF has capital. At the moment, I think their view is that what they have is sufficient. Canada, certainly historically — and I was quite involved in this in previous roles — has stepped up when the IMF has asked its membership for capital contributions, so they have the capacity. Canada has stepped up.
I would say more generally that Canada is really one of the strongest proponents of a rules-based, open, multilateral trading system, and the IMF is one of the pillars, along with the World Trade Organization and the World Bank, of that system. So, yes, I think we’re big supporters. Canada just had its Article IV consultation about a month ago, and when the IMF came to us and had some advice, I told them that I’m glad they’re doing this. Sometimes we don’t like all of their advice, but it’s really important to do this and make sure they hold everybody to a high standard. That’s good for the whole system.
The Chair: Thank you very much.
Senator C. Deacon: U.S. inflation continues to be higher than in Canada, and there are expectations that there may be more tightening by the fed relative to what we’re doing in Canada. Your monetary report assumes a 74-cent dollar over the horizon because you, by convention, don’t like to forecast exchange rates. I assume you’ve got modelling that takes into consideration — and, we’ve done quite well in terms of our exchange rate so far — a further devaluation of the Canadian dollar and rising input costs. Yes, it benefits on the export side, but what are the inflationary and GDP effects of that? Is there anything that you’d be willing to share with us in that regard about how you’re prepping for that possibility?
Mr. Macklem: You clearly read the report carefully, as you highlighted. Previously, we assumed 78; with the depreciation, we assumed 74. So 4 cents of that is already built into our forecast. As you highlighted, the Canadian dollar has actually been pretty strong. The only currency that’s been stronger has been the U.S. dollar. We’ve actually been appreciating against most other currencies, but in the last couple months, we’ve depreciated against the U.S. dollar.
What happens if the Canadian dollar is weaker than we put in our projection? What that means, as you’ve highlighted, is that if you want to buy goods from the United States or go for a holiday in the U.S., it will be more expensive. Other things being equal, as economists like to say, that will create more upward pressure and will make it harder to get inflation back down.
As I’ve said, we’ve already built in a lower dollar in our projection, but, of course, other things are never equal. The other thing we did in our projection was we lowered our growth forecast. We’ve got less demand, so that is pulling inflation down. In the forecast we put out, the track for inflation is a bit lower than it was last time on balance. If the Canadian dollar is weaker still, you will get a little more exports and a little more inflation. Other things being equal, that means we would have more work to do with interest rates.
[Translation]
Senator Gignac: Thank you for your availability. I also thank you for the vocabulary you’re using in the media and here tonight. We understand what you are doing about monetary policy.
I would like to come back to a subject you mentioned, namely that you have a type of agreement with the Minister of Finance. It respects your independence, but you do not tell the government what to do. It was something like that. Now, your colleague at the Bank of England seems to have a little less reserve when commenting on the management of the British government.
My question pertains to a coalition government context. I don’t claim that this is what is happening, because currently, I think that the government has been responsible in managing public finances, despite a coalition with the NDP. However, over the next two years, if the government were to indulge in a spending spree that could threaten Canada’s financial stability, would you be comfortable appearing before the committee and answering questions?
Mr. Macklem: I hope that question is entirely hypothetical.
Senator Gignac: In your conscience and soul, would you be ready to do it?
Mr. Macklem: The situation in the United Kingdom was rather extreme. I’ll let the Governor of the Bank of England speak for himself, but he needed to take exceptional measures to restore price stability. The cause of the instability was quite clear, so I think he didn’t have much choice.
As for Canada, it is very important for our policy to remain stable and sustainable. The government will present its forecast soon; we’ll see then. So far, it’s true that the debt went up significantly during the pandemic, but the forecast in the last budget was for stabilization, even a slight decrease towards the end.
[English]
Compared to other G7 countries, we’re in a good place. We’re certainly among the best fiscal position.
[Translation]
It’s an advantage for Canada, and it’s a good idea to keep it.
Senator Gignac: I understand.
However, as Governor of the Bank of Canada, given your legendary professionalism and your years of service in the Department of Finance and as Canada’s G20 representative, given Canada’s overriding interest in financial stability, if there were a situation in the next two years similar to the one in the United Kingdom, would you have that duty of restraint, or would you speak out publicly and warn the government of the risks it’s running?
Mr. Macklem: Most of the time, I think fiscal policy is for elected officials. If there is a strong contradiction between monetary policy and fiscal policy, yes, I think the Governor of the Bank of Canada has a responsibility to speak out.
Senator Gignac: Thank you, governor.
[English]
The Chair: Thank you very much. You’ve done yeoman service tonight, answering this multitude of questions. We appreciate you being here and look forward to the next visit. Maybe by the time we see you then, the rates will be going the other way. We don’t know.
Thank you very much to Tiff Macklem, the Governor of the Bank of Canada, along with Senior Deputy Governor Carolyn Rogers. My thanks to all the senators. I think we got all of the kinks worked out eventually.
(The committee adjourned.)