THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, April 20, 2023
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 and commerce generally.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello to everyone. Welcome. My name is Pamela Wallin and I’m chair of this committee.
Let me introduce the other members of the committee: Senator Bellemare, Senator Gignac, Senator Loffreda, Senator Marshall, Senator Massicotte, Senator Marwah, Senator Ringuette, Senator Simons, Senator Smith and Senator Yussuff.
Today, we have the pleasure of welcoming Mr. Tiff Macklem, Governor of the Bank of Canada, along with Senior Deputy Governor Carolyn Rogers. We welcome you back again. It’s always a pleasure. We know we can count on you at this time of year to update us on the Monetary Policy Report for April 2023. We’ll begin, followed by questions. Governor Macklem, the floor is yours.
Tiff Macklem, Governor, Bank of Canada: Thank you, chair, and good morning to the committee. Senior Deputy Governor Rogers and I are very pleased to be here to discuss our recent policy announcement and our Monetary Policy Report, which we issued last week.
Last week, we maintained the policy rate at 4.5% as we continue to assess whether monetary policy is restrictive enough to bring inflation back to the 2% target. Since the last time we were all here, we’ve seen steady improvement in inflation and modest economic growth.
Inflation is coming down quickly — the data this week shows it fell to 4.3% in March — and we forecast inflation will be around 3% this summer. We’re encouraged by that, but we’re also seized with the importance of staying the course and restoring price stability for Canadians.
Several things have to happen to get inflation all the way back to the 2% target. Inflation expectations need to come down further. Service price inflation and wage growth need to moderate, and corporate pricing behaviour has to normalize. We’re focused on these indicators and the evolution of core inflation to ensure that CPI — Consumer Price Index — inflation continues to progress towards the target. If monetary policy is not restrictive enough to get us all the way back to the 2% target, we are prepared to raise the policy rate further to get there.
Before I take your questions, let me give you some economic and financial context for our decisions.
[Translation]
The Canadian economy remains in excess demand. Gross domestic product (GDP) growth in the first quarter of the year appears stronger than we projected in January, and the labour market is still tight. The unemployment rate, at 5%, remains near its record low, and wages continue to grow in the 4% to 5% range. Employment growth has been surprisingly strong, reflecting continued demand and increases in labour supply.
[English]
Past policy rate increases are working their way through the economy and restraining demand. Households are slowing their spending, particularly on big-ticket items. As mortgages are renewed at higher rates, more households are feeling the restraining effects of monetary policy. Taking these forces into consideration, we expect Canadian GDP growth to be weak for the rest of this year before beginning to pick up gradually through 2024 and 2025.
What does all this mean for inflation? We’ve come a long way from 8.1% inflation last summer. As I mentioned, annual CPI inflation was down to 4.3% in March, and this was led by falling goods price inflation, and we see further declines ahead. That is good news.
But we are conscious that many Canadians are still struggling to manage with the rising cost of living, and the prices of many things that Canadians need to buy are still rising too quickly. Food price inflation is just under 10%. We expect food price inflation to come down in the months ahead, but service price inflation will likely take longer.
Continued strong demand and the tightness in the labour market are putting upward pressure on many service prices, and those are expected to decline only gradually. We expect it will take to the end of 2024 to get inflation all the way back to the 2% target.
When the governing council met last week, we discussed whether we’ve raised interest rates enough, and we considered the likelihood that the policy rate may need to remain restrictive for longer to return inflation to the 2% target.
[Translation]
Governing council also discussed the risks around our projection. The biggest upside risk is one I just mentioned — that services price inflation could be stickier than projected. The key downside risk is a global recession. If global banking stress re-emerges, we could be facing a more severe global slowdown and much lower commodity prices.
Overall, we view the risks around our inflation forecast to be roughly balanced, but with inflation still well above our target, we continue to be more concerned about the upside risks.
[English]
Let me conclude: Our job at the Bank of Canada is to get inflation all the way back to the 2% target. We’re encouraged by the progress so far. Seeing inflation get down to around 3% this summer will be a welcome relief for Canadians. But we want to assure Canadians that we know our job is not done until we restore price stability. Price stability is important because it restores the competitive forces in the economy and it allows Canadians to plan and invest with confidence that their money will hold its value. That’s the destination. We’re on our way, and we will stay the course.
With that, Madam Chair, I would be pleased to take the committee’s questions.
The Chair: Thank you very much. I’m wondering as we begin here if you could give us a little bit of context for some of the mixed signals we’re seeing out there. There are lots of good news stories that, in the end, might not be good news: a hot job market putting upward pressure on wages and prices; a hot U.S. economy, which keeps upward pressure on inflation and all the things we import here and billions in Canadian government spending, which, again, creates upward pressure on inflation and interest rates. We have some economists saying that these things, which might, in the short term, look like some good signals, could lead, with all of the conflicting pressures, to a recession in the fourth quarter. Do you have any such fears?
Mr. Macklem: It’s our job to worry, so, yes, we’re always worried. But we’re seeing inflation coming down. It’s coming down quickly and the economy is growing. Its modest, weak growth, but it’s at least positive growth.
If you look at our forecast, growth is probably going to be a little stronger than we expected in the first quarter, although the first quarter is over, but as it comes in, the data looks like it will come in stronger than we expected. But for the rest of the year, we do expect growth to be pretty weak at 1% or less. It’s small positives.
And just referring to some of those indicators you mentioned, the reality is we actually need a period of weak growth to let supply catch up to demand, take the steam out of our overheated economy and relieve those price pressures. That’s what is going to get inflation back to the target.
Our forecast is small, positive growth, and if you’re forecasting small positives, you can’t rule out there might be some small negatives. But I certainly think our base case is not a severe contraction. It’s not what people think of when they say the word “recession.” We’re not talking about large increases in unemployment like we’ve seen in past recessions.
There are risks around that outlook, and the biggest risk we highlighted is there could be a global recession, and we are very integrated with the global economy. If there is a global recession, it will spill into Canada, but that is not the base case. The base case is for pretty positive but weak growth this year, with growth picking up gradually next year and more into 2025.
The Chair: What is your biggest concern? Oil prices? What would push it from slightly positive to slightly negative?
Mr. Macklem: Well, there are a lot of things that could happen in the global economy. I’m just back from the IMF, or International Monetary Fund, meetings last week. The issue that is getting a lot of discussion recently is the stress we’ve seen in banks. As you’re well aware, three banks in the U.S. failed and have been taken over by the Federal Deposit Insurance Corporation. A very large bank in Europe, Credit Suisse, what we call a globally systemic bank, came under severe stress, and there was a takeover by the other big Swiss bank UBS.
The good news there is that authorities reacted swiftly, forcefully and against a background of a system where, for the last dozen or so years, there has been a series of reforms to improve capital, reduce leverage and enhance liquidity buffers. The global system is more resilient and, combined with those forceful actions, the system has stabilized.
It is a reminder that there are vulnerabilities in the financial system. We can’t rule out that there will be future events, and I think it does put a premium on sound risk management and careful supervision.
I’ll just stress that, from the Bank of Canada’s point of view, one of the reasons you have a central bank is that if you have a severe liquidity emergency, the Bank of Canada stands ready to provide liquidity against good collateral, if needed.
The Chair: Thank you very much for that overview.
[Translation]
Senator Bellemare: Thank you for being with us, Mr. Macklem and Ms. Rogers.
I will start with the good news. From what we’ve learned about monetary policy, it seems that what you told us a few months ago about inflation being transitory is proving to be correct. It may be true that inflation is transitory and that the situation is being resolved. The less good news, in my opinion, is your emphasis on wage increases in setting your interest rate.
I’m wondering why and to what extent you’re going to rely on wage increases to set interest rates, when the indicators you use to decide your monetary policy, as we see in the brief, are not necessarily appropriate. You talk about wage increases of 4% to 5%. The Labour Force Survey, which is the indicator you have chosen to use, is mostly about employment. Yet you are using an indicator that is not weighted by changes in employment. The best indicator — which comes to us from the Survey of Employment, Payrolls, and Hours — if you weight it by changes in employment, gives us an almost 2% increase, according to the latest numbers.
So I am wondering why you are using this indicator. Also, when you look at the consumer price index, you see that mortgage costs have increased by 26.4%. If you continue to raise interest rates, you will fuel inflation.
Mr. Macklem: I would not use the word “transitory.” On the subject of wages, you are right. There are many ways to measure wages. In chart 13 of our Monetary Policy Report, you can see several of these measures.
You are right to say that business investment has fallen below the level of other indicators recently. It depends on which survey you use.
There is always room for improvement, but we try to create wage measures with fixed weights to avoid problems with structural shifts between high-wage and low-wage jobs. We try to control for that. When we do, most of the measures suggest that the rate of wage growth is between 4% and 5%. Yes, there are a few below that level and we look at all of them.
This wage growth rate is not consistent with our 2% target unless there is a large increase in the growth rate and productivity. Yet, so far, productivity remains weak; it is even declining.
[English]
Senator Bellemare: How are we going to be able to make a transition in the economy if it’s not possible for workers to move into higher-wage sectors, which will increase your indicator?
Mr. Macklem: Just to be clear, we want an economy where wages are going up and productivity is going up. Productivity growth pays for wage increases. When people move to a job that fits their skills better and where they’re more productive, they’re earning that higher wage with higher productivity. That’s fine. That’s the economy working.
Where we get concerned is when wages are running well ahead of productivity growth. Wage growth right now, at 4% to 5%, is running well ahead of aggregate productivity growth. That doesn’t mean some individuals are moving between jobs. That’s the economy finding a better allocation of labour. That’s the economy becoming more productive. That’s what we want to see.
Senator Bellemare: Productivity is very low.
The Chair: Everyone wants to participate in this discussion, so I’ll just ask that the preambles to questions be more limited. With time, we’ll come back for another round.
Senator Smith: Governor, the C.D. Howe Institute estimates the Bank of Canada will incur losses over the next few years, totalling anywhere from $3.6 billion to $9 billion, depending on what happens with interest rates. In the third quarter of 2022, the bank lost over half a billion dollars for the first time in its 87‑year history.
Regarding the real risk in the long term, did the bank consider the positives and negatives at the time that these transactions took place? Do you have projections? How is this going to work out over the next few years? I would hope so, but I will ask: Do you have projections in how you will make out over the next few years as rates could remain higher than anticipated?
Mr. Macklem: I thought the C.D. Howe study laid it out reasonably well. It was reasonably balanced.
If Ms. Rogers wants to lead off with a few points, I might add a few.
Carolyn Rogers, Senior Deputy Governor, Bank of Canada: The most important point we make, Senator Smith, is we don’t operate monetary policy for profit. The issues that we’re dealing with — our balance sheet — are completely separate from our monetary policy. But as you point out, there are some losses.
In the recent budget, the government announced that they’re going to let the bank retain our earnings until such time as we’re back to zero. We think the losses that C.D. Howe put in their study are reasonable. It really depends on the path of interest rates. We don’t tend to forecast our losses in case it gets interpreted as a forecast of interest rates, but I think the way C.D. Howe laid them out is reasonable.
If you use the current market path for interest rates, we would expect we’re back to zero and, therefore, back to remitting our profit to the government somewhere around Q3 2028 or the first part of 2029. We will fairly quickly make up that loss and get back to a point where we’re at a steady state, which is typically remitting about a billion dollars a year to government.
Senator Smith: What are the lessons learned as you review with people you are working with inside your operation?
Ms. Rogers: I would say two things. One is that we have said publicly that we do intend to conduct a broad lessons-learned exercise on the entirety of our response to the pandemic. That is something that we intend to do. Given the path of inflation right now, we’re feeling like it’s probably something we’ll get started later this year. We will look at it holistically.
But, again, when we talk about the impact to our balance sheet and the overall response to the pandemic, it’s important to us that we separate them because we don’t and we won’t make decisions about the right thing for monetary policy based on how it would affect our balance sheet. The fact that we have a solution in place on how to restore the losses is a good first step.
Mr. Macklem: To add to that, you have to evaluate these policies not on the profit and loss at the Bank of Canada but on the benefits to the Canadian economy. It is hard to be precise. We took a whole series of policy actions to get us through this pandemic, but the reality is that combination of policies was very helpful. Yes, we had the deepest recession ever because of the pandemic, but we also had the fastest recovery ever. That saved the Canadian economy billions and billions of dollars.
Senator Smith: Is there one thing that stands out in your mind that you would possibly do differently in the case of the next pandemic?
Mr. Macklem: We will be reflecting; we’ve actually already started. You’ve seen a number of steps. Last July, in our Monetary Policy Report, we published an accounting of our inflation forecast errors and why we were surprised that inflation went up so quickly. More recently, Toni Gravelle, one of the deputy governors, gave a speech, and then we put out a paper that looked at what we learned. We actually set up 11 different facilities through the pandemic. Most of those were not really aimed as monetary policy tools but to restore market functioning, which was completely frozen.
We’ve done an assessment of the effectiveness of what we learned from those tools. We learned there that problems can come in different places and you want to get the money to the right place. If you can’t get it to the right place, you have to do a lot more because it’s more indirect. If you can be more targeted, the quantum can be more effective and you don’t have to do as much. Since then, we have worked to develop more targeted facilities.
The other thing you worry about is moral hazard. You don’t want the private sector to come to the view that the central bank is the liquidity provider of first resort. We are very much the liquidity provider of last report. The private sector has a responsibility to manage their liquidity so that, unless there’s a complete freeze-up, we don’t need to come in. You want to design the programs to minimize those kinds of moral‑hazard problems.
The other part is looking at the monetary policy side — the use of forward guidance, the use of quantitative easing — and that is still to come, but, as I said, we certainly need to discuss how we calibrated it — the timing — but, overall, it was very effective.
Senator Loffreda: Thank you for being here once again. It’s always a treat to have you here.
The Canadian dollar is the softest it’s been in almost three years. We are a nation of traders, as we all know. The weaker Canadian dollar, especially with respect to the U.S. dollar, can be a concern. The great majority of imports are still from the U.S. Although services do play a large part in our economy, the weaker Canadian dollar means higher import prices and higher inflation. That may continue because the gap between key policy rates in Canada and the U.S. is widening as the Fed continues its hiking cycle while the Bank of Canada has announced a conditional pause.
As you know, we can easily absorb that in normal times, but with inflation already as high as it is, the concern is that a weaker Canadian dollar for a nation of trade such as Canada could worsen that burden by higher prices.
Can this influence the Bank of Canada in the future to follow the U.S. Fed and resume rate hikes? Do you see this being a major concern and a major issue, especially if our dollar weakens along with all other global currencies?
Mr. Macklem: You packed quite a few things in there. Let me just start by reminding everybody that we don’t target the Canadian dollar. The Canadian dollar is set in the market. We target inflation.
We do take into account movements in the Canadian dollar as we set monetary policy. When you’re thinking about the movement in the Canadian dollar, you also have to think about why it’s moving.
In the context of the recent cycle, one thing that is different is that, normally, if you raise interest rates as forcefully and as rapidly as we did, you would get an appreciation of the Canadian dollar. In an open economy, that’s an important way that monetary policy works: You raise interest rates, that creates capital inflow and the value of your dollar goes up. That diminishes export demand for Canadian exports, and higher interest rates constrain domestic demand. That slows the economy and gets inflation down.
This time, of course, that hasn’t happened. The Canadian dollar has actually been reasonably stable, and down slightly, recently. That largely reflects the fact that the U.S. has also been raising interest rates very rapidly and so the U.S. dollar has been appreciating against almost every other currency.
For the most part, we’ve gone along for that ride. More recently, the U.S. has raised rates a little further than us, so we haven’t got the last bit of the ride.
What does that mean for monetary policy? On the one hand, on the export side, we’re still getting a reduction in the demand for Canadian exports because when the U.S. tightens, that’s slowing their economy, which is slowing the demand for our exports. That channel is not coming through the exchange rate, but the U.S. is really doing that part for us. What we’re not getting — which you mentioned — is that if the exchange rate were to appreciate, that would put downward pressure on import prices, so we’re not getting that direct pass-through effect. So, on the margin, that does mean there’s potentially more work for interest rates to do than if it were a more typical cycle.
The other part of your question is whether we are concerned that it could cause problems if the Fed raises interest rates more than us. That is not a major concern. We have an independent monetary policy. We have a flexible exchange rate. The flexible exchange rate is actually what allows us to run monetary policy that is geared for what Canada needs.
The market has reasonably built in a higher expectation for U.S. rates than ours, and that’s already reflected in the value of the Canadian dollar that you have now. For sure, there will be some fluctuations in the Canadian dollar. That’s one thing you can be sure of, but, by and large, the flexible exchange rate system works pretty well.
Senator Loffreda: So you don’t see that being a factor in increasing inflation to the point where you won’t have to react? Like you said, inflation is your main concern, right?
Mr. Macklem: Yes. It’s something we’ll have to take into account if the dollar were to depreciate considerably. There would be more inflationary pressure; our exports would be stronger. We would certainly have to consider that. We don’t actually forecast the exchange rate in our forecasts. Our convention is to take whatever the current exchange rate is. In our forecast, we have a $74 exchange rate. If it were a lot weaker than that, yes, that’s something we’d have to factor in.
I don’t see a big problem if the U.S. is going a little higher than us. That’s kind of already built into the market.
The Chair: Thank you very much.
[Translation]
Senator Gignac: Welcome, governor, and Senior Deputy Governor Rogers. I want to begin by commending you for your efforts over the past several months to communicate and be transparent, including making public the minutes of your meetings. This is greatly appreciated.
I would like to return to your discussions with Senator Smith. During the pandemic, the Bank of Canada rolled out several new programs. I looked at your review, which was released in March. In essence, you went much further than you did during the financial crisis of 2008-09, when I had the privilege of working alongside you.
What caught my attention most of all was your colleague Deputy Governor Gravelle’s speech in Montreal. In a nutshell, he said that the bar would be much higher next time before the Bank of Canada used quantitative easing again.
Can you say a little more about that? I’d also have a sub‑question about quantitative easing, if time permits.
Mr. Macklem: I have two things to highlight. First, this study and Toni Gravelle’s speech reflected the use of our balance sheet in terms of financial stability. The subject of this study was not monetary policy, but financial stability.
Second, all of this relates to the answers I gave earlier. Since we have more focused programs to determine where the problem is, we believe we will have less need for quantitative tightening. More concretely, we now have a program called the Contingent Term Repo Facility or CTRF. One of the main problems during the pandemic was the pension funds and the large asset managers. We needed a lot of liquidity. The commercial banks were not able to provide enough liquidity, so the whole market froze.
We went back into the market to buy a lot of Government of Canada bonds and put money into the system. At that point, we needed to take extraordinary measures, because we were already putting liquidity in with the CTRF for the banks, but the demand from non-banks was still too great. They couldn’t move money where it was needed.
Now we have the CTRF program. We can put cash directly into the major pension plans. In that sense, the bar is higher, but we will have better tools.
Senator Gignac: I have a second question for you.
Assuming that inflation decelerates rapidly — perhaps more rapidly than you think — and the economy slows further, it can’t be ruled out that you might consider cutting interest rates. What will happen to quantitative tightening? Wouldn’t there be an inconsistency in lowering rates while continuing quantitative tightening? I have never seen a central bank on the planet do both, lower interest rates and do quantitative tightening.
Can you elaborate on that?
Mr. Macklem: This is the first time we’ve done quantitative tightening. Even other banks around the world have very little experience with quantitative tightening.
We’re going to make those decisions going forward when we get there. Frankly, it’s a little early to be talking about cutting interest rates. Whether or not we cut interest rates depends on the economic situation. If inflation is near 2%, if we have potential growth and the output gap is very small, we are in a more normal situation. Inflation has come down and remains stable and growth is potential. In a situation like that, we would start to normalize interest rates toward a neutral rate.
If that’s the spread we’re normalizing, we’re going to continue quantitative tightening. We are going to normalize our balance sheet. That’s consistent with normalized interest rates. If we decide to lower interest rates, it’s because there will be, for example, a global recession and the Canadian economy will be very weak. We will have to add incentives and ease monetary policy. In that case, we will lower interest rates fairly quickly and end quantitative tightening.
[English]
We would go back to reinvestment.
Senator Marwah: Welcome, governor and deputy governor.
My question relates to the inflation target, which you mentioned has been 2% in recent years. Given recent events and where we stand today, is that still a hard target for the bank or are you prepared to live with something higher, like a 2% to 3% range?
Mr. Macklem: We are committed to getting inflation back to the 2% target. The way I would put it is that we need to re-centre inflation on 2%. We have a band of 1% to 3%, but it is important to stress that this band is not a zone of indifference.
The idea of the band is to give Canadians a sense of the normal variation of inflation. Even if we aim for 2%, we can’t literally hit 2% all the time; there will be some variation. The band should give Canadians an idea of what the normal variation in inflation is. If you want to be in the 1% to 3% band most of the time, you need to aim for the middle of the band; you need to aim for 2%.
Why 2%? There are a few reasons. For one, we’ve had 2% for 30 years. It has proven to be very successful. I think there are good reasons why you want a low rate of inflation, probably slightly positive — not zero, but low.
One of the problems we’re having right now is that when inflation is high, people come to expect that it’s high and companies aren’t too worried about passing on price increases because they know that everyone expects inflation to continue. It’s easy for them to pass on price increases. That’s what you’ve seen in this period of high inflation. Companies are raising prices more frequently, and by more. They’re passing on their costs very quickly. However, when inflation is low, and when something is more expensive, it stands out and businesses become more concerned that they will lose customers if they raise their prices. It becomes more self-reinforcing.
One of the things we observe empirically — and one of the other deputy governors, Paul Beaudry, talked about this — is that when inflation is higher, it is not just higher; it tends to be more variable. Those reinforcing competitive forces are not working as effectively. So I think you do want a low number.
The other reality is that you want a number low enough so that, from one year to the next, people don’t really notice inflation; it’s not something they have to worry about in their daily lives. If inflation is centred on 2% and it’s reasonably stable, they don’t have to worry about big fluctuations in their cost of living from one year to the next. If you start to bring that higher, then it starts to eat into their cost of living each year.
Senator Marwah: I have a quick follow-up, governor. Let’s say that inflation, hypothetically, is stuck at 2.7%. What happens then?
Mr. Macklem: Hypothetical questions are always very hard because the answer is that it depends on the whole situation.
As inflation gets closer to 2%, obviously, our anxiety level starts to reduce. Right now, inflation at 4.3% is still well above our target. Our forecast is that it’s coming down pretty quickly. But as long as inflation is well above target, we are more worried about the upside risks than the downside risks.
Once you are within your band, and particularly well in the band, you are not as worried about the upside risks as the downside risks. As I said, if you want it to fluctuate normally between 1% and 3%, you need to aim for 2%. If you stay at 2.7%, the normal fluctuation will be 3.7% to 2.3%, if I can do it in my head. That is not price stability.
The Chair: On that question, why are we at 10% food inflation?
Ms. Rogers: It is one of the parts of inflation that’s probably the most frustrating for Canadians right now. It is one that everybody feels. You grocery shop every week, so people feel it. It is very frustrating, we know that.
There are a number of things even in normal times that contribute to food inflation. Food inflation can be a bit more volatile. Weather events have a big impact on food prices. Commodity prices, which fluctuate globally, can affect food prices. Transportation and energy costs can feed into food costs, or labour. As the governor said, we did see a really quick pass‑through of prices, and we saw that in the food sector, too. There were a number of events. We had a number of poor harvests. We had the avian flu, and the war, which affected commodity prices, particularly wheat and fertilizer. There was a confluence of things that really hit food price inflation.
The Chair: How significant is the carbon tax?
Ms. Rogers: It is difficult to break down any one item, particularly on any one part of inflation. I think we have provided data before on the effect of the carbon tax on overall inflation. I don’t have a number for carbon tax on food inflation.
As the governor said, there are two things we are looking for. Some of the effects that I just described are enough in the rearview mirror that we should start to see food price inflation decline. The recent data does have it dipping down a bit. We should see that happening more. And then it is back to the competitive forces, getting people’s expectations reset and getting pricing behaviour reset.
The Chair: Thank you.
Senator Ringuette: I will focus on an entirely different issue: supply chain disruptions caused by the pandemic and geopolitical events. We are now hearing of a new paradigm with regards to supply chains or a new policy among friendly nations. How will this rejigging of supply chains within friendly nations affect inflation — which is your main mandate — and the Canadian business investment scenario?
Mr. Macklem: The short answer is that businesses are focused on making their supply chains more resilient. That will, inevitably, add cost through that adjustment period. That’s going to be a factor that will make it harder to bring inflation down. It is one of the reasons why, in our own forecast, we have it coming down quickly to 3%, but getting from 3% to 2% takes some time. There will be some underlying cost pressures. Ultimately, getting more resilient supply chains will have a benefit. It will have a direct benefit to the economy. Things will work better, and it will also mean fewer supply bottlenecks gumming up the system and impacting prices, so there will be less variability of inflation.
I’ll share a couple of words about what we are seeing so far. I think it is still pretty early days. Companies are not massively reshoring their production. That’s not what we’re seeing. They may be reducing their new investments in places that they are worried about. We are seeing that they are looking to diversify their supply chains so they have more alternatives. They are looking to simplify their supply chains and standardize their components so they don’t have so many different pieces that they need so that there’s more substitutability in production.
It’s hard to know right now how profound this change is. I think we know the direction, but we don’t know how big a change it will be.
The last thing I will say is that there’s nothing inconsistent with diversifying and making your supply chain more resilient with an open trading system. Canada does have the benefit of a number of very good trade agreements — USMCA, CETA with the Europeans, CPTPP with a number of Asian countries. Canada has among the best trade access. We have the ability to diversify, and businesses have to figure out how to be part of these busy supply chains as they change. That’s a business opportunity and businesses need to figure out how they will be part of that in Canada. We are reasonably well positioned. We do need to look at and take that opportunity.
Senator Ringuette: Considering that it is a new paradigm or a new zone of discussion, when will you ascertain this new upcoming policy in your assessment in regards to inflation?
Mr. Macklem: I’m not sure I can give you a date. There are really two things going on. People are looking at making supply chains more resilient after the pandemic. They realize there could be more climate events or more geopolitical tensions. Everybody is more alive to the vulnerability of their supply chain.
The other thing, which isn’t totally unrelated, is that the reality is there are geopolitical tensions and there is a risk of more global fragmentation. In the IMF’s World Economic Outlook, they actually spent quite a bit of time on this trying to analyze the global costs to growth of what they call geo-economic fragmentation. The reality is we’ve all benefited from an increasingly integrated global trading and investment system. If that goes in reverse, it will certainly have some costs to global growth. I’m not sure that I can predict any better than anybody else exactly how bad it’s going to be, how quickly it will move and whether countries can come together and work out some of their differences. It is hard to predict.
As developments become more concrete, we will certainly factor those into our outlook and do our best to assess the implications for Canada and take those into account.
The Chair: Thank you.
Senator Simons: Mr. Macklem, you mentioned in your opening comments that people are renewing their mortgages at much higher rates and hence have less spending money. You mentioned that as a good thing in terms of bringing down inflation, but it can be devastating for people, especially in overheated markets like Toronto and Vancouver where people bought homes at historically high prices that they could only finance because of historically low interest rates.
It is hard to talk about a national housing policy because Toronto and Vancouver are so different from Edmonton, where I’m from, or Winnipeg or Halifax. Are there concerns, if you need to raise interest rates again, about what the impact will be on housing markets? There is a danger that if you pop the bubble, lots of people might be able to enter the market, but people will lose tremendous amounts of equity that they have invested. How do you strike that balance?
Mr. Macklem: Ms. Rogers will take that one.
Ms. Rogers: Let me start, senator, by giving you some data that we refer to often when we are thinking about the mortgage market. When you look at the overall Canadian population, about 33% rent and 67% own. About 27% of people own their homes outright, so you are down to about 35% of mortgages.
When you look at the mortgage holders, the vast majority of them, close to 70%, have fixed-rate mortgages, so their payments are not fluctuating with each interest rate decision. About 13% have variable mortgages, and when you get down to the variable mortgages, the vast majority of them have fixed-payment mortgages.
I offer that information not to minimize your point that interest rate changes, as a result of our policy changes, are putting pressure on mortgage holders. That’s absolutely something we think about a lot each time we make a decision. But I offer that information just because we use it often to think about the overall effect, particularly on the economy, and the financial stability effects of increases in mortgage rates.
This is something we look at closely, though. In addition to our Monetary Policy Report, we put out a Financial System Review annually. That’s coming up in about a month. We are taking a deep dive into the effect of mortgage payment changes. We do regularly talk to OSFI, or the Office of the Superintendent of Financial Institutions. I took note that our colleagues from OSFI will be here next week. We talk regularly to banks about how they are working with their mortgage clients to make sure that that pressure can be managed.
We hear from banks that it is putting pressure, but Canadians are adjusting to that pressure. As fixed-rate mortgages renew — the governor said this in his opening remarks — we do know that pressure will move from our variable-rate mortgage holders to our fixed-rate mortgage holders. There are a number of things that Canadians are doing.
Typically, if you are renewing a mortgage that you took out quite some time ago, there is normally an increase in your income that will help with an increase in payment. It’s also important to remember that, for quite a while now, we’ve had policies in place in our banking sector where mortgage borrowers were stressed at a rate 2% higher than their actual mortgage rate. That policy created a buffer for most mortgages in Canada. So there are a number of things, but you make a good point, and a point that we take into account.
Senator Simons: I am here as a guest today, but in my other life, I am the Deputy Chair of the Standing Senate Committee on Agriculture and Forestry. One of the things we’ve been concerned about in looking at food price inflation is corporate concentration, such as concentration at the production level — say, if you look at the concentration in meat packing in this country, it’s hardly fathomable how dependent we are on two packers. But we are also looking at concerns about corporate concentration in the supermarket sector.
Ms. Rogers, that’s not something you talked about at all, but I am wondering if that is not also a major driver of food inflation costs. When you look at beef packing, there hasn’t been an increase for the producers or the feedlot operators. The prices are passed on to the consumer, but they’re not going back to the producer. So somewhere in that production chain, someone is taking profits, and it’s not the ranchers.
Ms. Rogers: You are right; we didn’t mention it. We are not the experts in this field. There is a study, as you know, going on with the Competition Bureau. They are the right people to analyze and provide comment on this.
As the governor said, what we can do is get inflation back to target so that companies, producers and everyone setting pricing contracts will have that competitive pressure and so there isn’t an expectation that prices will just keep going up and allow them to continue to pass through prices, at each step along the way, as you point out.
Senator Simons: It’s hard for there to be competitive pressure if there is no competition.
Ms. Rogers: I understand your point, but as I said, we’re not experts in that field. The contribution that we can make is to get inflation back to target and remove that element in that dynamic.
The Chair: Thank you for that.
Senator Marshall: Regarding the banking sector, you mentioned, Mr. Macklem, that there were some discussions at your meetings last week about the banks. I’m thinking about the banking and financial sector here in Canada.
In last year’s budget, there were two extra tax increases imposed on banks and financial institutions, and I see there is another one in the budget this year. That must be putting pressure on the banking sector. Then if you add in the problem with the mortgages and some concern about loans, whether people will be able to repay their loans, there must be a lot of pressure on the banking and financial sector.
You were saying earlier that you do some sort of analysis. Could you expand on that? There is not much sympathy for the banks, but we do want to have a strong banking sector. I am very concerned. We have the OSFI people coming in, as you said, next week. I am very concerned about the banking sector and that it remains strong.
What sort of analysis do you do? What sort of risk assessment do you do to make sure that there’s not a problem in that area? Do you consult and advise government as to what they are doing?
Mr. Macklem: I will ask the senior deputy to answer.
Ms. Rogers: As I said, our colleagues from OSFI will be able to give you quite a bit more information, but from our current role and from my past role, I would say when we look at the banking sector, there are two indications we always look at — their capital or equity levels and their liquidity levels.
The stress that you saw recently, in the case of the U.S. sector, I would attribute to very particular business models, which made them highly subject to two things. One would be interest rate risk — so their profitability was significantly affected by the change in interest rates — combined with a highly concentrated depositor base, which, by virtue of the effect on their profitability, caused confidence to go down, and those deposits left in very rapid fashion. There were some very unique things about those business models that made them susceptible to some risks.
The changes that we’ve made in the banking sector since the financial crisis are exactly targeted at those two things. They are targeted at liquidity and capital. If you look at the global banking sector overall, it holds twice as much capital, it has half as much leverage and it has three times as much liquidity as it did before all those reforms came in.
In Canada, we’ve always led the way in implementing those reforms. We are usually the first country to comply with those changes. All of our large banks comply with those rules. Importantly, our mid-tier banks are held to most of those standards. The key parts are the capital and liquidity standards, too, which was not the case in the U.S.
There are a number of things about our banking sector — the regulation; the risk management and the prudence of the banks’ management itself and the fact that we have a concentrated banking sector. I know that sometimes creates competitive concerns, but it does make it quite strong. We are continually stress testing our banks. We are continually monitoring our banks. We pay very close attention. But I would say we have one of the strongest banking sectors in the world. The fact that you did not see the stress spill over into Canada is another good sign that our banks are in good condition.
Senator Marshall: What if interest rates go up further? There are people who think now — and I talked to a lot of young people with mortgages — that interest rates will go back down to 1.5% or 2%. If interest rates continue to go up — you may be forced to increase them again — or if they don’t go down to as much as people anticipate, do you take that into consideration in your risk assessment? Is that a factor?
Ms. Rogers: Looking at banks?
Senator Marshall: Yes.
Ms. Rogers: Yes. The banks are put through a variety of stress tests, looking at both their liquidity and their capital. We test them under a variety of different interest rate paths, a variety of different economic scenarios, combinations of those things, so, yes.
I know you have a sharp accounting mind. There were things that were unique about some of the banking losses, about how they account for changes in interest rate risks. Those policies are very different in Canada. Our banks mark their assets held for liquidity to market, so we didn’t have the dynamic which was a big contributor to the U.S. bank stress.
Senator Marshall: I recognize that even the Bank of Canada is incurring losses as a result of what we just went through. I’m very concerned about the banking sector, but thank you very much for your answer.
[Translation]
Senator Massicotte: Thank you for being with us today; it is much appreciated. I congratulate you on the way you have managed the Canadian economy. You’ve done very well so far in terms of controlling inflation, and I wish you luck with the next versions of your forecasts.
My concern is more on the international side and the U.S. side. I don’t think the U.S. has had the same success in controlling inflation. They started later than Canada. There were reactions. As a result, the interest rate increase is greater there. Do you think we can be more confident? Should we be concerned that they are a little late? There are many people who wonder if the inflation rate is adequate or if it will go up again. Can this disrupt the national and international order from an economic standpoint? A player like the United States is very important. I’d like to know your position on that.
Mr. Macklem: With respect to the U.S. economy — The Federal Reserve and the Bank of Canada have raised interest rates very quickly. In Canada, inflation is a little bit lower than in the United States. In the U.S., it’s about 5%, and in Canada, it was 4.3% in March. The biggest difference is in core inflation, so we need to remove the volatile components of the consumer price index.
In Canada, we’re starting to see a decline in our core inflation measures. They were at about 5% and now they’re at about 4.7%, 4.8% or 4.9%, so just a little bit below 5%. More recently, last March, we were at 4.5%, 4.6% or 4.7%.
These are 12-month inflation measures. If you look at the three-month core inflation measures, so more recently, they are at about 3.5%. That means the pace has slowed.
In the U.S., those rates are not down yet. They haven’t gone down yet. That means there is a slightly faster pace in the United States. To follow up on Senator Loffreda’s question, it reflects the fact that they have raised rates more than we have and are in the process of deciding whether they will raise them further. We’ll see.
So, yes, they may have more work to do. We think that in the U.S. economy, as in ours, growth will be weak. The American consumer was more resilient than most people thought. We were a little bit surprised in the first quarter by the U.S. consumption, but we think it will come down. Our forecast for the U.S. is for very weak growth, not a recession, but there are always risks that it will be more severe than we think. If that happens, it will probably affect Canada, and we’ll need to take that into consideration.
We just talked about banking stress. There may be new banking stresses, or new financial stresses, but not banking. It’s something that we have to watch closely. As far as the interest rate adjustment, if you have a mortgage or if you’re dealing with a bank or not, there will be adjustments to make. There may be some areas that are not prepared well enough.
[English]
The Chair: Thank you very much.
Senator Yussuff: Thank you, both governors, for being here. I’ll start with a compliment, which you don’t get too often. It’s been a long road to get inflation to at least look like we’re making progress, and I think that, again, we should thank you for your efforts.
The reality, of course, is that not all of us had to suffer the consequences of inflation. I would say that, without any hesitation, for most people in this room, yes, it’s a problem, but it’s not a huge problem. For working people, it’s a big problem, because grocery prices and housing costs have gone up, and it’s still a problem, because if you’re on the margins, these two things have a significant impact on their daily lives, as we’re seeing in major urban areas. People are still complaining about the fact that food prices are far too high, and if you’re renting, of course, with no control on the rental market, people have faced even harsher challenges to figure out how they’re going to keep a roof over their head.
In the context of where we’re at, the big challenge for people is to figure out how to make up some of the differences they’re having to struggle with in their relationship with employer wages, despite the alarming argument that wages are going to rise, folks have been, I think, fairly responsible. We didn’t see the 8% wage growth. It did go up for a bit, but it seems to have stabilized.
Governor, the big question Canadians are wondering about is whether they should have confidence in where things are at and hoping in their day-to-day lives — the ones that are struggling with this norm that we’re able to say we can get back to the place where we don’t have to worry about that. I do acknowledge that inflation is very devastating for working people, more so than anybody else, because they’re the most vulnerable. Those are the ones I’m concerned about. For those of us in this room, less so. I think it needs to be acknowledged that the impact of inflation has not been the same across the economy, and we need to stress that, because the people who are really struggling are the ones we need to be concerned about.
Mr. Macklem: Thank you for raising that. We are very conscious that inflation is not just about the number. Really, inflation is a generalized increase of prices, and when inflation is generalized the way it has been, there’s no way to avoid it. You can be a really prudent shopper, and be very careful, but if everything is going up in price, there’s no way around it. And it always hits lower-income Canadians and more vulnerable parts of society harder because they don’t have buffers, and the necessities of life — their food, their rent — that’s a much bigger proportion of their budget. You can’t cut back on those things. Those are not discretionary items. As you’ve highlighted, this time around, particularly, food prices were very hard hit, and that reflected in part some exceptional circumstances: Russia’s unprovoked attack on Ukraine, the pandemic caused big increases in energy prices, shipping and transportation went up and there were a lot of bottlenecks; those things are working their way out.
As the senior deputy indicated, if you look at our Monetary Policy Report, we have a chart where we show the input costs for food, relative to the current prices, and you can see the input costs have rolled over; they’re still high, but they’ve rolled over. The grocery store prices have not, really. They’ve ticked down a bit but are still very high. If you look at the normal lag, we think in the coming months you’ll see food price inflation coming down.
Unfortunately, there’s a difference between food price inflation coming down, and food prices coming down. Inflation is the rate of increase in the prices. It’s better than the alternative of them continuing to go up, but it’s not going to entirely solve people’s problems.
We are very conscious of that, and, you know, the best way to protect workers from high inflation is to eliminate it, and really, that’s what we’ve been working very hard on, and we are encouraged by the progress. Inflation is coming down pretty quickly right now, and we think it’s going to be about 3% this summer. We are concerned that getting it from 3% back to 2% will take longer, by our own projection, and could be more difficult. Certainly, that’s what we’re focused on.
We are committed to restoring price stability, as I said earlier, and getting inflation re-centred around 2% so that people don’t have to worry about the kinds of big fluctuations in their cost of living that they’ve had to endure for the last couple years.
Senator Yussuff: We need to get people into the housing market. Owning a home is far better than renting. You have some control and at least you will have some assets at the end of the day. For working people, it is a huge challenge, especially in the big urban centres across the country. It’s been absolutely unacceptable.
I live in Toronto. I’m fortunate enough to own my home, but I know that for young people, this is terrible. You need $500,000 to $1 million to get into the market, much less to sustain it.
Household debt in the country is the highest we’ve seen in a long time. I realize that Canadians took this on with the understanding they would use a low interest rate to do so.
The challenge is there, unless we can make a significant impact in the housing market, and especially in urban areas, given that we have an aging population. There is a challenge for young people to see their future in this country. This will take long-term efforts. I know the bank doesn’t control this, but obviously we need to think through the challenges that the country is faced with. With an aging population, and trying to get new Canadians to come here with these kinds of prices, it will be a huge challenge for the country going forward. I’d like to hear your perspective.
One piece of positive news — which is not one that you want to reveal — is that, for the first time, pension plans are 150% solvent compared to where they were in the past. There’s some good news in the sense that interest rates did go up, which stabilized the pension plan deficit. At the same time, other challenges come with that, and we now have to figure out how to solve some of the bigger questions that the country will be dealing with.
Mr. Macklem: You’ve raised some big questions. Obviously, monetary policy has a significant effect on the housing market, but the fundamental issue is the supply of housing. We’ve had low interest rates and high housing prices. Now interest rates have moved up and housing prices have come down, on a national basis, about 15%, but now the mortgage costs are higher. Affordability was bad when we had low interest rates and the affordability is bad when we have high interest rates. Monetary policy is not going to solve this problem.
We certainly take the housing market into account when we’re doing our projections and considering what we need to do to get inflation back to target and what the impact is on the real economy. The housing sector is one part of a bigger economy, and we don’t have tools to target it specifically. The fundamental issue is supply.
We haven’t talked about this much, but immigration has come back up significantly. That is helping on the labour side. We’ve had intense labour shortages. If you talk to businesses, they’re starting to feel like they’re able to hire. We’re seeing some pretty good employment growth numbers and vacancies are coming down a bit. But, of course, people coming to Canada will need houses. There is an underlying demand for housing, even as the housing market has weakened.
The only thing I can say is that it is good to see that we’ve now got all levels of government — municipal, provincial, federal — talking to each other and looking at the supply side together. I don’t think there will be a quick solution to this problem, but it does require some focus.
The Chair: Thank you very much.
Before we move on to our next round, I want to get a bit of a response from you. Over the last few weeks, maybe even months, this committee has been looking at the question of business investment in Canada or the lack thereof. You have said today — and in other places publicly — that in terms of the state of the economy, monetary policy alone won’t do the job, and I think everybody agrees.
The other big partner in this is the private sector, which, as we have heard from many witnesses, is sitting on their hands because there’s uncertainty. From government, we have — “chaotic” was the word a witness used yesterday, or at least untargeted spending.
You’ve got those two players in the economic equation and, as you say, you’ve got a limited tool with which to work. What would you need from those other two partners to help you to get your job done?
Mr. Macklem: Weak productivity growth has been a long‑standing, chronic problem in Canada. We’re very good at growing by adding to the labour force. We’ve done very well on labour market participation, and particularly female participation. The participation rate of mothers is still going up, which is adding to the labour force. As I mentioned, immigration is also adding new workers. Companies are using the Temporary Foreign Worker Program. We’re good at growing the economy by adding to the labour force and getting more people to participate in the labour force. That’s in relation to the number of workers.
The other piece is the output per worker, or productivity. That’s the area where we’ve struggled. There have been many studies, and you’ve been studying it.
We know that one of the best predictors of productivity growth is business investment, particularly business investment in ICT, or information and communications technology, and R&D. Our business investment, particularly in ICT, is low. The next question is why that is the case, and that’s what you’re looking at.
There are a number of reasons. None of them have simple solutions. Part of it is that smaller companies tend to invest less than bigger companies, and we have a lot of smaller companies, so it’s partly the structure of the economy.
The other thing we know is that export-oriented companies tend to invest more and tend to have higher productivity growth. Of course, they’re exposed to international competition. This suggests — to one of the previous questions — that part of the problem may be competition.
In terms of commercialization, we’re great at inventing things in Canada, but where we struggle is in commercializing them and turning them into scaled businesses. The start-up community has become much more vibrant in the last 15 years or so, but getting those start-ups to scale up to big companies is where we still need to do some work.
As one of the senators mentioned, when you talk to international investors, you often hear, “We love Canada. We’d love to invest more in Canada, but the regulatory approvals are taking too long.”
Those are all things that I think need attention and that we need to work on. As you mentioned, they’re not really things that we can work on from a monetary policy perspective.
We do have some advantages in this country. I mentioned the trade agreements. We have a great labour force, a lot of talent and a good education system. We have new immigrants and we’re good at integrating them into the economy. We need to double down on those advantages and then work on the areas where we’re weak.
Our mandate is to provide low, stable inflation. That doesn’t solve those problems directly, but it creates a foundation and environment where foreign investors look at Canada and say, “This is a country that has their monetary policy in order. It has a good financial system and a stable monetary system. That’s the kind of place where we want to invest.” For businesses here in Canada, it gives them the confidence and certainty so that they can plan going forward. It is a big question and something we’ve struggled with for a long time.
The Chair: I have one quick follow-up on that: As recently as last night, we heard testimony that looking at wealth creation through job creation is an old model. We do have a lot of start‑ups, but we sell; we don’t own the intellectual property. We’ve been hearing this. To look at it merely in terms of the number of jobs created is not a model that will get us from point A to point B.
Mr. Macklem: I would agree with that. Immigration is adding to the labour force and increasing the participation rate, but those things are just offsetting the aging of society and the declining growth of our labour force. Against that background, if we want to sustain the kind of growth we’ve had, the only alternative is productivity growth. We have to get productivity growth up, or our growth rate will be going down.
The Chair: Thank you very much for answering that for us.
[Translation]
Senator Bellemare: I’m going to continue in the same vein as the chair on the work that we do. Listening to you, one concludes that there are major limits to the use of monetary policy in terms of price stability as opposed to all the other objectives.
We need bread and butter on the table. We need jobs, but also growth and stability. I would like to hear you talk about France where, in the context of the problems linked to inflation, there have been winners. The government, through consumption taxes, has gained a little with inflation. There are companies that win with inflation. France decided to lower taxes, to help the economy and to remedy inflationary wage pressures. What do you think about using fiscal policy to accompany a monetary policy that, if it is too restrictive and very unstable, will hurt investment prosperity?
Mr. Macklem: We deal with monetary policy. It’s the legislature and the Senate that are responsible for fiscal policy. I’m going to let them make those decisions. There are all kinds of government priorities and there are different choices to be made. It is not our mandate to make those decisions or even to give advice.
I’d like to say two things, though, because if the decisions affect inflation, that’s part of our job. Governments around the world, like Canada’s, want to protect their citizens from inflation, especially the most vulnerable and low-income people. They are greatly affected, and there are good reasons to protect them.
I think the IMF’s advice on this is very good: If you do this, make sure it’s temporary and targeted to the people who really need it. As Senator Yussuff said, it’s not the people around this table. It’s the people who really need it that we want to target with this support, and it has to be temporary. We are committed to reducing inflation. This is a temporary situation. When inflation is low, we don’t need these protections. The best way to protect citizens from inflation is to eliminate it.
The other thing is that you need a period of low growth to give supply enough time to catch up with demand, and to better balance supply and demand to reduce downward pressure.
In Canada, we raised interest rates quickly to reduce these inflationary pressures. If the government spends too much, it will go in the other direction and there will be more work to do in terms of monetary policy. So it’s important to have some consistency between the two policies.
[English]
Senator Gignac: I have two questions, but in order to have time for my colleagues, please limit your answer to three or four minutes.
In the fiscal update of the government last fall, Minister Freeland surprised the market when the government decided to cancel the real return bonds. The bond trading association was very surprised, as they expressed in their press release. In the last budget, they talked about the potential abolition of commercial mortgage-backed equities.
What is your role? You have a governance committee. Are you involved in this decision, or is this a Department of Finance call and that’s all?
Mr. Macklem: The Bank of Canada has independence from monetary policy. When it comes to issues like the one you raised, the government is basically our client. They take the decisions, and we operationalize the decisions. Decisions on cancelling real return bonds or CMBs — Canada Mortgage Bonds — are decisions of the government. There is a committee of the Bank of Canada and the Department of Finance that does discuss these issues, but the decisions are at the Department of Finance.
Senator Gignac: My second question is an easy one about the fiscal policy role. We know even Ottawa is very divided about the role of fiscal policy on inflation and so on. In your monetary report, you mentioned that compared to January, the fiscal additional measure was $25 billion more than what it was for this year. That includes provincial and federal. It’s 1% of GDP.
Over the last 12 months, did you qualify the fiscal policy as expansionist in contributing to the inflationary pressure?
Mr. Macklem: What we do is take those fiscal projections as given. We take all the federal and provincial budgets, and we put those in our projection. It adds up to about $25 billion, and you can see the impact: We revised up the contribution to growth from government spending.
If you look at government spending going forward in the projection, the growth rate is 2% or 2.5% of GDP. Potential growth in our projection is about 2%. What that means is that growth in government spending is roughly in line with the growth of potential.
The way I would put it is the government is not contributing to the slowing of the economy and not contributing to relieving price pressures, but at the same time, government spending is not growing considerably above the supply growth of the economy, so they’re not getting in the way of getting inflation back to target. You can see in our projection that we do get inflation back to target by the end of 2024.
Senator Gignac: I understand that looking ahead it will not contribute, but is it fair to say that in the last 12 months, they have contributed to stimulate the demand in a significant way? You referred to 3.5%.
Mr. Macklem: For the last half of last year, growth in government spending was running around 3.5%. Certainly, if that had continued, that would be getting in the way of getting inflation back to target.
Senator Gignac: Thank you.
Senator Loffreda: Congratulations once again on your monetary policy. It’s starting to show a lot of progress and success. CPI — Consumer Price Index — inflation is still above target but slower. Wage increases and pressures are also slowing and losing momentum. The housing market remains an issue, but price increases are no longer the main concern.
We’ve covered a lot this morning, but if I were to have a bold prediction on your part, how quickly do you see excess demand turning into excess supply in our economy? How quickly would that lead you to cutting interest rates? Can we say that you’re targeting early 2024 for an interest rate cut in order to alleviate the high consumer debt?
I see your reaction, but if not, what keeps you up at night? We’ve covered a lot of ground this morning. We’ve talked about consumer demand, geopolitical issues, currency, labour markets, household debt and household markets. What would hinder an interest rate cut in early 2024 and give Canadians some hope?
Mr. Macklem: As I indicated in my opening remarks, there are three things we’re really looking at to see if inflation is going to get all the way back to 2%, and it’s inflation expectations. Right now, inflation expectations are coming down with actual inflation, but if you go and survey households and businesses, what they tell us is their inflation expectations are still higher than our own forecasts. So they still have some work to do to come down. As long as they’re running ahead of our own forecast, that’s an upward force.
The declines in inflation we’ve had are mostly coming from the goods side. Service-price inflation has really not come down yet. That’s partly related to wage growth, which has not come down yet. It’s running 4% to 5%. Service-price inflation is about 5%.
If you’re going to get to 2% inflation, you have to see that service-price inflation come down. We’ve already talked quite a bit about corporate pricing behaviour. It is starting to normalize. Price increases are not as frequent or as big. But if you look at the distribution of price changes, it is probably halfway back to normal. It is moving in the right direction, but it’s not there yet.
What worries us is that — we’re pretty confident inflation is coming down to 3%, but we’re worried that getting it from 3% to 2% could be tough and it could get stuck. And that’s why, yes, if we see that’s happening, we would likely have to raise interest rates again to get it back to 2%.
With respect to this issue around cutting interest rates, the reason I was smiling is that we do not decide now what we’re going to do for interest rates six months from now. We will decide in six months when we have the best information. I did say on the day of the press conference that the market at that time, actually — and now it has kind of priced it out — had built in some interest rate cuts this year. We did say that given that we’ve got to see quite a bit more progress on these things, interest rate cuts this year didn’t seem like the most likely scenario to us. We will take those decisions when we get there, but there may be a need to keep interest rates elevated for a period to get inflation all the way back to target.
We are not deciding on those interest rates today, but we’re trying to be very clear on what things we’re watching that are going to be important for our decision, and everybody else can see those too.
The Chair: Thank you.
Senator Simons: I asked my last question about interest rates from the point of view of a mortgage holder. Now I want to ask it from the point of view of a bank. We’ve seen in the last little while banks having longer and longer amortization periods for the mortgages they are holding because of these interest rate hikes. Someone has just kindly forwarded me an article that says:
Major lenders like RBC, BMO, and CIBC are seeing sharply higher percentages of their mortgage portfolios with amortization periods north of 30 years. None of those banks had mortgages with amortization periods over 30 years in October 2021. As of the fourth quarter . . . 30% of their mortgage portfolios had amortization rates above 30 years.
To follow up on Senator Yussuff’s and Senator Marshall’s question, how concerned are you about the stability of banks? You know, I have a friend in Toronto who thought her housing situation was very stable. She has had to take in a paying boarder because of the changes in her mortgage rates.
I was thinking like a consumer, but if I’m thinking like a bank president or if I am thinking like the Governor of the Bank of Canada, how concerned should we be about the impact of potential shocks to the housing markets, especially in the insanely overheated markets in Toronto and Vancouver? What’s the downfall on banks?
Ms. Rogers: Again, I will encourage you to pose these questions to the Superintendent of Financial Institutions when he comes to see you next week.
Senator Simons: We will.
Ms. Rogers: I will give you my perspective, and hopefully it won’t be too different from what he tells you.
Mortgages make up a big chunk of our banks’ balance sheets, and one thing that is unique about Canadian banks is they tend to keep mortgages on their balance sheet. That says a couple of things. One is that they think it is a good risk to take. Canadians pay their mortgages. If you talk to bankers, they will always tell you that Canadians will go to great lengths to make sure they can pay their mortgages.
The regulation around mortgages in Canada is also very strong. One of the key differences is we have always put a lot of focus on debt serviceability versus just collateral value. So our regulation and underwriting that you find in Canadian banks, generally and specifically on mortgages, doesn’t rely solely on the fact of the loan-to-value ratio or the fact that house prices continue to appreciate. We have always put a lot of focus on debt serviceability.
I remember several years back, in a previous job, talking to this committee about what is called Guideline B-20, the regulatory guideline for banks’ underwriting standards for mortgages. That is where we implemented the stress test here in Canada, several years back, when interest rates were very low, for exactly this type of scenario and for the eventuality that interest rates would go up, and we didn’t want borrowers stretched to the point that they could not absorb an increase in interest rates.
Now we’ve had a significant increase in interest rates, and particularly in a market where housing prices are high, that does mean that borrowers have stretched. It is something that we watch closely and something that OSFI watches closely.
The numbers in that article don’t sound quite accurate to me, that 30% of mortgages have amortization over 30 years.
Senator Simons: It is from a magazine called Canadian Mortgage Trends.
Ms. Rogers: You have to be careful with some of these numbers, whether they are talking about stock or flow, things like that — the number of new mortgages being written versus the number of total mortgages in the system.
Again, we were just speaking with some of the large banks last week. We were asking exactly these questions: How are you dealing with these situations? They said that they are working with borrowers, and that is a good thing. You don’t want borrowers to be stretching amortizations or paying only interest. That’s not a sustainable thing over the long term, so it is something we will keep our eye on, for sure.
Senator Marshall: I’m hearing stories from a lot of young people stretching their amortization period and capitalizing their interest into the loan balance. But the question I have for you is about a proposed amendment in the Bank of Canada Act in this year’s budget. Have you looked at it? Have you looked at the amendment? Did you participate in the formulation of the amendment? Do you support the amendment? It is to your act, the Bank of Canada Act. There is an amendment in the budget.
Mr. Macklem: Is this the one to deal with the losses?
Senator Marshall: It is the one to deal with the loss. But my question is: Have you looked at it? Do you agree with it, do you need it —
Mr. Macklem: Yes, we looked at it. We discussed it with them ahead of time too.
Senator Marshall: — and are there any unintended consequences?
Mr. Macklem: No, it is a good solution.
Senator Marshall: You have seen it, have you?
Ms. Rogers: Oh, yes.
Mr. Macklem: It is a good solution. Basically, as the senior deputy mentioned, we will have losses for a few years, and then we’ll go back to profits, and then we can use those profits to rebuild and fill in those losses, and then we will go back to remitting.
Senator Marshall: You need that amendment, do you? I am not —
Mr. Macklem: Yes.
Senator Marshall: — that familiar with the legislation.
Mr. Macklem: We need the amendment because the way the Bank of Canada Act is set up now, as long as we have net gains, we have to remit them. In the current formulation, we don’t have the ability to fill in for the losses. This basically allows the Bank of Canada to deal with its own gains and losses, and —
Senator Marshall: I was thinking that if you have a loss you can’t remit anyway. So do you need the amendment?
Mr. Macklem: We need the amendment.
Ms. Rogers: Yes, we do.
Mr. Macklem: As soon as we go back into net gains or profits, we have no ability to restore the net equity. So if you want to get back to positive equity, we have to have the ability to do that.
Senator Marshall: That loss of revenue from the Bank of Canada is hitting the government in the bottom line. You know that, right?
Mr. Macklem: It is. Look, I don’t want to minimize this, but in the first part of the pandemic when we were growing our balance sheet rapidly, we remitted an extra $2.6 billion. So there is a bit of time shifting here.
Senator Marshall: Negative revenue on the government’s financial statements looks very odd, yes? Okay. Thank you.
Senator Yussuff: Governor, you know one of the big worries is that there is a likelihood of a recession, more so because the Americans might drag us down that rabbit hole. I’m looking at the numbers. I don’t necessarily see it that way, but I may be completely wrong. You folks look at this more intensely than us, where the United States is heading. I just happened to be travelling in the last little bit, and I noticed far more Canadians are on the move, and I assume, for the first time this summer, where the pandemic seems to be a little less restrictive, people are making all kinds of plans to go places. Is the general assumption that we’re not there, and it is just a lot of people speculating about what the consequences might be?
Mr. Macklem: I have a couple of comments. In the second part of your question you talked about Canadians travelling. We are seeing that goods recovered much more quickly in the pandemic because you could buy goods even when you were in lockdown, but you couldn’t enjoy many services until the economy reopened. Canadians are still catching up on some of those services that they couldn’t consume. That has something to do with why the economy is still in excess demand.
Getting back to your question, Senator Loffreda, we expect the economy to move into modest excess supply sometime in the second half of this year, but right now we’re still in excess demand and that’s putting upward pressure on the prices of services. I get it. Canadians missed out on that stuff and they want to catch up, but that is creating ongoing price pressure on services. That’s the part that hasn’t come off yet.
We’re not forecasting a recession. We’re forecasting very weak growth, but it is slightly positive. When you are forecasting small positives, you can’t rule out you are going to get small negatives too.
It’s not going to feel great either way. It’s going to be weak growth, but as I said earlier, that’s not what people think of emotionally. When you say the word “recession,” people think of big job losses and a big decline in the economy. That’s not what we’re forecasting. We have inflation coming back to our target with weak but slightly positive growth. It might end up being weak with slightly negative growth, but it is not a recession.
Senator Yussuff: The job numbers in both the U.S. and Canada have been fairly stable, and for that matter, quite robust in the U.S.
Mr. Macklem: Yes, I can speak more to Canada. In the labour market, certainly if you look at the numbers, the unemployment rate hasn’t budged from 5%, which is basically a historic low; 4.9% is the historic low, and we’re virtually there. At the same time, we have been getting pretty big monthly job growth numbers, and that’s partly related to population growth, improved labour market participation and temporary foreign workers. That means that we can probably sustain higher monthly growth rates in employment without creating more excess demand because we have more immigration and more people coming into the economy.
The other thing I would stress is that if you start an economy in excess demand and you add more supply, that is helpful to relieve some of those labour market pressures, but those people also buy stuff, so you are adding demand. If you start in excess demand and you add supply and demand, you are still in excess demand and there is still work for monetary policy to slow the economy and get inflation down.
Senator Ringuette: You indicated that you have a committee and that you’re in constant dialogue with the Department of Finance, and that’s great. Given that the housing market has such an impact on inflation, do you entertain regular conversations with the Canada Mortgage and Housing Corporation — CMHC?
Ms. Rogers: Let me clarify that the committee that the governor was referring to is one that we use in our capacity as the government’s fiscal agent, but there are other committees that we work with in the Department of Finance on a variety of policy issues.
We do, from time to time, talk to CMHC, yes. As the governor said, we have a whole cacophony of committees that we deal with. There is a committee that oversees OSFI; there is a committee — the Senior Advisory Council, or SAC, as we call it — that deals with policies like housing. CMHC is not an official member of these committees, but if we are talking particularly about housing, they will often be invited to be part of those conversations.
Senator Ringuette: For the sake of transparency, could you supply us with a list of these committees that you are talking about?
Ms. Rogers: Sure. No problem.
Mr. Macklem: There are three main ones. Senator Gignac knows them well. There is one called FISC. Do you remember what it stands for?
Ms. Rogers: Yes, Financial Institutions Supervisory Committee.
Mr. Macklem: That is chaired by the Superintendent of Financial Institutions, Peter Routledge. It includes the Bank of Canada, the Department of Finance, the Canada Deposit Insurance Corporation and FCAC, the Financial Consumer Agency of Canada.
Then there is another committee called SAC, the Senior Advisory Committee — very exciting names — that is chaired by the Deputy Minister of Finance and it has the same members. It deals more with financial vulnerabilities, housing, financial sector policy — more policy issues as opposed to FISC, which is supervisory.
Then the other main committee is the one we talked about, the fiscal agent committee, which is actually quite a small committee that deals with debt auctions and debt strategy, those sorts of things.
The Chair: And the Governor-in-Council?
Mr. Macklem: The Governor-in-Council is just the Bank of Canada. She was asking about committees with the Department of Finance.
Ms. Rogers: It’s one of the strengths of the Canadian system, I would say, the fact that there’s coordination among these different agencies. We call the collection of all of these committees the financial safety net.
The Chair: Thank you.
Senator Marwah: Governor, I hate to ask you another hypothetical question, but this is an easier one.
I want to build on the question that Senator Loffreda had asked, and that’s the linkage between the Bank of Canada rate, the federal funds rate and the Canadian dollar. The bigger the gap, the lower the dollar goes, and a lower dollar directly hits food inflation because a significant amount of our food is imported from the United States.
Given that relationship, is there a differential between the Bank of Canada rate and the federal funds rate beyond which you feel you will have to act?
Mr. Macklem: The problem with these hypothetical questions is it depends on all the other stuff that’s going on. It depends on why the differential is what it is. It is very hard to answer these questions in the hypothetical.
All I can tell you is it’s something that we take into account, but Canada believes in flexible exchange rates, and it is integral to our system. It is what allows the Bank of Canada to take monetary policy decisions in the best interests of Canadians. If we had a fixed exchange rate, basically it would be the U.S. Federal Reserve running monetary policy for Canada. Our economy is different from the U.S. economy. In particular, it has a much bigger commodity sector. Right now, we’ve got much faster population growth and higher rates of immigration. There are important differences.
In terms of monetary policy, when they raise interest rates, it has a big effect on new home buyers but not as much on current consumers because they have 30-year mortgages. As the senior deputy was explaining — you know well as a former banker — our typical mortgage is five years of some variable rate. As those roll through, those higher rates are getting passed through to households, so monetary policy is probably getting more traction on consumers than it is in Canada. These are all things that are different, and the flexible exchange rate allows us to run monetary policy for Canada.
Yes, we take account of what the exchange rate is doing, and that’s part of the transmission of monetary policy, but having a flexible exchange rate is a benefit.
Senator Simons: As an Albertan, I feel it behooves me to ask this question.
At the beginning of the pandemic, oil prices crashed to the point that they were negative numbers. Oil prices have come roaring back up. They have sort of stabilized now between US$75 to US$80 for WTI, or West Texas Intermediate. In Alberta, high oil prices are a good thing, but not such a great thing for inflation elsewhere.
What are you projecting when you talk about the volatility of commodity prices and the impact on the Canadian economy? There are swings and roundabouts, depending on where you live in this country.
Mr. Macklem: You will be disappointed with this answer. We don’t forecast oil prices, either. We don’t forecast the exchange rate or oil prices, so in our projections, we assume that oil prices stay close to where they are. If you look at the futures curve, it is a little below that. Predicting oil prices is very hard, and I think the safest thing to put in our projection — you know the cycles — is to project that wherever it is, it will stay where it is. Obviously, if oil prices come down, inflation of other things that are equal will come down faster.
One of the risks we highlight on the upside is that China is reopening. Their economy is gaining strength. With the reopening in China, the growth has been particularly in the service sector as they’ve reopened. Their manufacturing sector is not going full bore yet. As it picks up momentum, we could start to see global demand for energy go up, and that could boost oil prices. As you say, that would be good for producers in Alberta, but Canadians would see it on inflation.
Senator Simons: And that would be in Europe, also.
Mr. Macklem: Yes. Who knows what Putin will do? Who knows what OPEC — the Organization of the Petroleum Exporting Countries — will do?
The Chair: I will ask one more question. It’s not really a hypothetical question, but in a way it is. Canada has become the first major monetary authority in the developed world to pause interest rates, really. If the chairman of the Fed were to call you and ask what you are doing and why, what would be your one‑word or one-sentence answer to that?
Mr. Macklem: Well, actually, the governors of the major central banks actually do talk pretty regularly. We were all together last week at the IMF and we will see each other at the Basel Committee before too long.
The one-sentence answer is that we raised rates rapidly and it is working. We know there are lags in the effects of monetary policy, and we are using this pause to assess whether we raised interest rates enough to get all the way back to target.
The Chair: Thank you very much. On behalf of all of us, this was a marathon session, and we appreciate your time and your willingness to answer all of our real and hypothetical questions about the state of the economy. Tiff Macklem, Governor of the Bank of Canada, and Carolyn Rogers, Senior Deputy Governor of the Bank of Canada, we really appreciate your time and insights on this.
(The committee adjourned.)