THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Wednesday, April 10, 2024
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 4:15 p.m. [ET] to study matters relating to banking, trade and commerce generally.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello and welcome, everyone, to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin and I serve as the chair of this committee. I would like to introduce the members with us here today. We have with us today Senator Loffreda, who serves as deputy chair, Senator Bellemare, Senator C. Deacon, Senator Gignac, Senator Marshall, Senator Massicotte, Senator Miville-Dechêne and Senator Yussuff.
Today, we’ll have a discussion on higher interest rates and their impacts over the long term. We have the pleasure of welcoming virtually Paul Beaudry, Professor, Vancouver School of Economics, at the University of British Columbia. He also served as Deputy Governor of the Bank of Canada from February 2019 until his retirement in July 2023.
In a speech in June 2023, he warned about the fact that we are entering a new era of structurally higher interest rates. We have invited him today to share his views. We appreciate your time and insights. We will turn the floor over to you, Mr. Beaudry. Welcome.
Paul Beaudry, Professor, Vancouver School of Economics, University of British Columbia, as an individual: Thank you very much. It’s a pleasure to be here today.
I’ll start with a few comments. Obviously, there is a whole set of questions on interest rates. There is the shorter-term view that gets a lot of the highlights, but there are a lot of long-term aspects, and I do want to talk about those.
In the short term, we received more news this morning that there are indications that there will be a reduction in interest rates over the next little while. It could be as early as June, if things continue as they are right now. A lot of measures of inflation are pointing in the right direction, so we could see that soon. It might take a little bit longer. It might go to July, but whatever happens, most likely we will be seeing cuts to interest rates over the next little while. There are aspects of how the U.S. is moving a bit differently than Canada that might create extra tensions; still, that’s the general pattern.
The much more interesting question to ask is: Where it will go? Even if it gets cut a little, it’s really the aspect of where we might see things happening in the longer run and those longer rates that are very important. Those are the rates that really affect asset prices, housing and many other things in Canada that people care about. To understand the situation we are in now, it’s important to look back a bit to where we were pre-COVID and how we got there.
To put things in perspective, in the pre-COVID era, the interest rate, at least the policy rate as set by the Bank of Canada, was at 1.75% and inflation was at 2%. In that environment, real rates were basically at 0%. That was a very particular type of environment; it was very different. It really changed over 30 years. If we go back 30 years, it gradually decreased from 3% to 4% of these real rates down to 0%, and that was not particularly Canada driven. It was very much shared by a whole set of countries. Most advanced economies had a very similar pattern because capital markets are very integrated.
This is not generally viewed as being driven by central banks. It’s much more the general structural forces in the economy: the idea of how much people need and want to save, how many good opportunities there are to save and what kind of assets they can use to save. It’s a combination of those factors at an international level that creates a lot of the pressure that determines those longer rates.
A lot of things that pushed rates down over that 30-year period prior to COVID were things like the aging population in many of the advanced economies. That was true even in China, so there are demographic factors. The demographics resulted in people who could save wanting to save for retirement, and that was a lot of savings.
There was also the integration of China into the world system. The Chinese have a tradition of having very high savings rates. That created a lot of pressure, a lot of aspects of increased savings during that period and a lot of appetite for what we might call risk-free assets, which are in relatively short supply in the world. That meant that bonds from less risky countries like Canada benefited from that, and that pushed down rates. There was also an increase in equality in the world. Generally, richer people tend to save more. Those were also pressures that were pushing rates down. There were a lot of things resulting in a lot of savings in the system.
On the flip side, while we talk a lot about technological change during that period, the surprising part seemed to be that despite falling interest rates in most countries, investment opportunities that could create a lot of profits were not very abundant. There was a lack of investment relative to all those savings, and that is what pushed down interest rates. I want to emphasize the way China had a real appetite for safe assets — especially for U.S. bonds but even for Canadian bonds — and that pushed rates down.
Those are all things that happened for 30 years before COVID. Then we entered into COVID and a lot of things changed around the same time, some directly. We actually have a greater supply of assets in the economy in the sense that many countries around the world, including Canada, reasonably went into big deficit spending during COVID, which created more assets that have to be absorbed in the system. That is upward pressure on those longer rates.
The trends and some of the demographics have also shifted. While a lot of Baby Boomers were of age to save during that pre-COVID period, a lot are in retirement and dissaving. Also, the geopolitical aspects made things different, with China reducing its exposure to a lot of advanced economy debts. Altogether, that pushed things down.
The Chair: We’ll stop there and get into our questions, because you’re going to be asked about those very things. Thank you very much, Mr. Beaudry. We will begin our questioning with Senator Loffreda, the deputy chair.
Senator Loffreda: Thank you for being here, Mr. Beaudry. Although the relationship between interest rates and systemic risks is complex and can be influenced by various factors, high interest rates can lead to systemic risks in the financial system. The most worrisome systemic risks for the Canadian economy presently include the vulnerabilities in the housing market, high household debt levels — in Canada, the debt level of the consumer, who is the vehicle and the motor of the economy, is particularly high — potential economic shocks from global events, geopolitical uncertainties and the ongoing challenge of climate change impacts on various sectors.
What aspects concern you the most? What strategies do you think could effectively mitigate or manage that risk?
Mr. Beaudry: I think you’re exactly right in thinking about some of these risks. They are very relevant. It really depends a lot on these movements of long-term rates. That’s why I pushed that aspect to frame our discussion.
Obviously, the big part of the debt in Canada is mortgage debt. We have debt with respect to other things — credit card debt, car debt — but the big amounts are in housing. We always have to look at the housing market and think about what risks there are. In many ways, we talk a lot about the lack of supply right now, and that’s very relevant — but getting a good idea of how house prices have changed over time and why we’re in a more vulnerable space right now is about looking back.
Over the 30 years prior to this period, while interest rates were falling, house prices were rising. If you multiplied the two, it was rather constant. That’s usually what we call the debt service ratio that households are paying. The surprising thing is that, despite all the aspects that we’re talking about, like the greater debt levels and higher house prices, the debt service ratio was staying very constant.
What has happened after COVID is exactly that. The debt service ratio, after being constant for 30 years, has really increased. That is because we have had higher prices. They really increased. House prices went up at the beginning of COVID — they came back down a bit, but not anywhere near where they were at the beginning — and then interest rates increased. It’s that combination.
Now, if you multiply the two, it’s really gone up. That’s really the biggest vulnerability out there. I’ll put that in perspective. Prior to COVID, although we had issues, it kind of balanced out and there was always a similar debt service ratio. Now we have to think about how that is going to adjust.
One easy thing is if interest rates go back down to where they were, then maybe that will be an adjustment. But if they stay at these higher levels — not exactly at 5% right now, but if it only went down to 4%, that would still be doubling relative to the pre-COVID era — that makes it difficult to sustain those debt payments. Over time, especially if immigration reduces a bit and things readjust, we might have an important adjustment in the housing market.
In general, our underwriting standards are very strong in Canada, and a lot of the ways banks have operated to try to ensure that consumers could take on higher interest rates was important, but that focus has to remain on keeping it that way. We need a system where people who are buying have the capacity to hold those payments at potentially higher rates than we had pre-COVID. That would be the thing that I think is the most important to help through that process.
Senator Loffreda: Thank you.
Senator Marshall: I want to talk a little bit about the psychology of the rates. A few years ago, everyone said that rates were going to stay low, and people went out and borrowed. Now people are getting the message that they’re a little bit high now but are going to go down in June, so people are still out there borrowing, thinking that if they can just make it to June when the rates drop, they’ll be okay.
Why is there an inclination for economists to tell people there will be good news in the future — even the government and the Bank of Canada said the rates would remain low — when we don’t know if there will be? Even the 5% we’re at now — if you look back over the last 40 years, I renewed my mortgage rate at 22% back in the mid 1980s. Why is there this desire or need to say that the rates are going to come down? Why isn’t the message more muted? Why isn’t it, “We hope rates will come down, but maybe they won’t, so be prepared”? Why is the message like that?
Mr. Beaudry: That’s a hard question to answer. I do think there have been messages that have been repeatedly changing. First of all, let’s put it that there is an aspect of how it came down. In general, it was surprising how much it came down prior to COVID. There was that aspect that kind of stayed there. Then there is the aspect that when COVID came in, there was this idea of keeping rates low for a while to help rebound. Now I think the message is more mixed, though maybe not enough for your liking.
I agree with you. I have repeatedly said over time to be more careful about this. I’m very much in line with what you’re saying and the idea of being careful.
Even if we’re talking about a rate reduction right now, it might not be a very big reduction. It might go down from 5% to 4.5%, maybe 4.25%, and it could stay there for a while, especially when you consider the U.S. situation right now. We are also influenced by the U.S. in this type of situation, and the U.S. economy is growing quite quickly. If anything, inflation pressures are still there. The U.S. will not be in a position to rapidly decrease rates either, and that influences Canada. I completely agree with you.
As to why it’s not more, again, we saw some of the news today. Mark Carney was talking about it being slower again. There were other people who came up. It’s not as if no one is saying it, but maybe not enough people are saying it in terms of bringing it up. Again, we have to be honest about what we don’t know, but I’ve always said that people should be prepared for them to stay higher, though I’m not saying I have crystal ball and am sure they won’t come back down.
Senator Marshall: It reminds me of the Newfoundland weather. Everyone says that good weather in Newfoundland is always in the future. Now we’re saying that the low rates are always in the future.
The Chair: We also heard from the bank in the lead-up — of course, before anyone anticipated COVID — “Go ahead and borrow; the rates are down,” and people did.
Senator Marshall: Yes, they did, and they’re still borrowing because they think rates are going to come down again.
The Chair: Then, during COVID, we heard the rates were transitory, and they weren’t.
Senator Marshall: It’s very concerning for the economy.
The Chair: Everyone should be a bit more cautious about statements if they are not already.
[Translation]
Senator Gignac: Welcome, Mr. Beaudry, and thank you for your public service at the Bank of Canada.
I’d like to ask you a question that wasn’t raised today by the journalists at the press conference with the governor, but which concerns a debate that’s taking place within the economist community, namely the measures that the Bank of Canada uses to measure core inflation. The Bank of Canada says that core inflation is still around or above 3%, but if you take the measure that the Bank of Canada used from 2001 to 2016, CPIX, which is 2.5%, or if you adopt the approach of the Central Bank of Sweden, which removes mortgage interest, it’s more like 2%.
Desjardins and the National Bank have mentioned in articles that the Bank of Canada is overestimating core inflation.
Do you think the measures the Bank of Canada uses to measure core inflation are appropriate?
Mr. Beaudry: That’s a good question. Several different measures were used. The bank has done a lot of work to choose these measures and represent what’s happening in the economy.
In fact, in the last few months in particular, there’s a lot less difference than people are saying. If you look at the shorter-term measures, I think the ones the Bank of Canada uses are pretty good, but you really have to look at the changes at a fairly high frequency. If you look at the changes in some of these core measures of inflation that the Bank of Canada uses over three months, which are really the measures that they look at the most, those measures have also come down quite a bit; they’re coming down into the 2% range.
What we heard today, with Governor Macklem opening the door a little bit in terms of lowering interest rates in June, relates to that question.
I don’t think it’s that different. People don’t look at it that differently. I think the measures used are quite good.
It must also be said that the Bank of Canada has these measures, but looks at the whole picture. There’s no question of saying that it’s dogmatic, that we have two measures and that we’re only looking at that. The question is really to see whether a whole set of measures pushing in the same direction can ensure that inflation will return to 2%. Conversely, the worst thing would be for the bank to need to raise interest rates again if inflation isn’t brought back to its target.
Senator Gignac: On the fiscal policy front, a lot of things aren’t helping the Bank of Canada very much. With what’s happening in Ontario and Quebec, with higher deficits and with the federal government’s announcements over the past two weeks, do you think fiscal policy will continue to undermine monetary policy by unnecessarily stimulating the economy in 2024?
Mr. Beaudry: No, not so much. I think we’re in that situation and we’ve really moved beyond having a very tight labour market; we’ve moved from a really overheated economy to one that isn’t really overheated at the moment. So, the current core inflation is not caused by an overheated economy, but is rather a training ground or a habit we’ve had, for some years now, of seeing a lot of inflation.
I had some questions earlier about psychology. Here, I think the question of the psychology of inflation is important. We really want to make sure we’re not in a situation where the psychology of inflation is at 3% or 3.5%; we really want to get back to 2%.
I don’t think the problem is created by demand.
I think we’ll see declines, because everything is pointing in the right direction and indicating that inflation is returning to its target.
[English]
The Chair: What do you think about what Mark Carney said the other day? He wasn’t explicitly criticizing the government, but he suggested that a changing economic environment demands “. . . fiscal discipline and a relentless focus on delivery, rather than a spending reflex that only treats the symptoms but does not cure the disease.”
Would you agree with that statement?
Mr. Beaudry: I’d certainly agree. Again, we have to think about this risk we were talking about before with respect to households, but this also applies for the government — the longer rates. When rates were at 0%, governments could basically borrow as much as they wanted. It wasn’t a big problem because it didn’t accumulate over time. At 0%, when you take it as a percentage of GDP or something, you’re not creating much of a problem. Now real rates are higher, and that becomes a costly situation.
Governments have to readjust, like everything else. When we’re talking about different aspects, that’s an important one. You have to look at the real causes behind things. You don’t want to just throw out your spending. So, yes, I’d agree with both sides of that statement.
[Translation]
Senator Bellemare: Welcome to the committee, Mr. Beaudry. I have a question about the effectiveness of monetary policy in a context of higher real interest rates.
Many economists are saying it now: We won’t be seeing the interest rates we had before the pandemic any time soon. Back then, real interest rates were negative.
If we have higher interest rates in the future and this situation becomes normal, what does that say about the future effectiveness of monetary policy if there are inflationary surges?
Would raising rates further to combat inflation be prohibitively expensive at that point? What are your comments on the effectiveness of monetary policy in the future?
Mr. Beaudry: I would say that efficiency can still exist. If we’re defending efficiency, the ability to control the speed of the economy and to control inflation, I don’t see why being in a slightly higher real interest rate situation would reduce that efficiency. In fact, it might even increase it, in the sense that it might take fewer big changes in interest rates to make the necessary adjustment.
I don’t see why efficiency would become more inefficient.
On the other hand, what could be difficult is a combination of factors in the environment. For example, we’re starting to see changes in the real estate market — right now, everything is so hot that we don’t even think house prices could go down.
On the other hand, within a few years, there could be major changes. The situation would become complicated if there were an adjustment in house prices and inflation, and if rates had to be raised at the same time. It wouldn’t be easy. I think these are situations we’ll have to consider. I don’t think it’s necessarily going to happen, but I don’t think I’d question the efficiency as such.
Senator Bellemare: Do you think it’s the unemployment rate that will increase the cost of monetary policy?
Mr. Beaudry: On the efficiency side, we might only need to raise interest rates a little to make exactly the adjustment needed. It’s always the labour market that does most of the adjusting. That’s how monetary policy works, but I don’t think it would change much.
You may see things differently.
Senator Bellemare: Thank you.
[English]
Senator C. Deacon: Thank you very much for being with us, Mr. Beaudry.
I want to focus on the effect that interest rates have on exporters and on the Canadian and U.S. dollars. It plays a big role. I certainly hugely benefited when US$1 delivered C$1.60. It was easy to increase sales. It was a wonderful thing until the next seven or eight years after 2000, where it went to par; I didn’t have the same benefit, and sales growth was a little tougher.
We’ve had an exchange rate in the range of C$1.30 or C$1.40 for US$1 for the last seven years or so. As we disengage our interest rate policy — if we do — from the United States, have you thought through the implications in that regard? Because it certainly can have a big effect on business.
Mr. Beaudry: Certainly. One of the big risks I’m questioning right now is the different speeds between Canada and the U.S. and how the exchange rate will adjust to that. Right now, everything in the U.S. is pointing to delaying a reduction in interest rates. It could be that the U.S. stays at the current rates, or close to them, for quite a while. It could change, it could slow down a lot in the U.S., but right now it’s growing quite quickly and inflation is not coming down anymore, so it could stay.
In Canada, everything is pointing in the direction of a reduction in some of these rates. Because our mortgage market is very different, interest rates have impacted households a lot more quickly, and it has really slowed down the Canadian economy. So we might be decreasing rates. When you have that spread between Canadian and U.S. rates getting quite big, so if it starts increasing 50, 75, 100 basis points, you generally start getting a depreciation of the Canadian dollar. Now, there are different parts that this helps and hurts. As exporters, there are aspects that it helps; as consumers, there are parts that are difficult, and there is the inflation part that directly increases the prices of a lot of imported goods. So there are a lot of ramifications there, and it is one of the risks that I think is there in the background.
As we go forward, if we have this two-speed aspect between Canada and the U.S., I’m worried that there could be an adjustment on the exchange rate. And there’s not only a good side. You’ve pointed to the good side, but we import a lot of capital goods and they become more expensive, so it’s not as simple as that.
Senator C. Deacon: I’d love to follow up briefly, chair.
For me, that’s sort of the risk. The United States is seeing tremendous productivity growth that we are not. If you’re getting increases in sales and everything looks great based purely on interest rates, the trouble is the cost of goods we’re importing is going to be much higher, which is going to create inflationary pressure. There could be a crack in the system at a certain point in time that would be quite worrisome if we allow ourselves to disengage too much from U.S. rates.
Mr. Beaudry: I completely agree with you. I mentioned a little bit in my opening statement that one of the reasons things might be slower in decreasing the rates in Canada is exactly that. Once we get a little bit further away from the U.S. rates, I think that pressure is going to mount. You can’t get too far away without having a really big adjustment on the Canadian dollar. Yes, I completely agree that is a danger, and in some sense, it has to be that some aspects of growth have to pick up in Canada to be more in line and get away from that risk. But it’s not easy to see where that will come from.
Senator Martin: Thank you, Mr. Beaudry. In your June 2023 speech to the Greater Victoria Chamber of Commerce, you suggested that long-term interest rates in Canada could remain higher than they were in the pre-pandemic period. We’ve been talking about that. You mentioned four key forces that kept interest rates lower in the pre-pandemic years that have now shifted post-pandemic.
My question is this: In addition to those four points, what role or impact does rising government debt play in this outlook? Will this increase in public debt exacerbate efforts to bring interest rates down? If so, how much of a factor will it be?
Mr. Beaudry: When we look at a lot of these long-term rates aspects, it really is the international market. Debt matters, but almost like an international aspect, because all the open capital markets make it so that a lot of this gets moved across borders and things. So with respect to how much Canadian debt is affecting the Canadian long-term rates, it’s not a big effect. Now, if we got to a level where there was a sense of default in Canada or Canada couldn’t pay its debt, that would be a different thing. But just the mass of Canadian debt doesn’t directly make a big difference.
Where it makes a difference is when looking at all the countries together, so Canada, the U.S., Europe, Japan, putting out this amount of debt, that together plays a role of saying in the overall system — again, when I was talking about this balance between savings and investment, it’s savings and kind of using these different things. If there are more and more objects that have to be held, the overall debt in the world does play a role. So one of the forces that pushes up these longer rates is the amount of debt, but on a world level. So the Canadian part of that, unless it’s getting to a point where we start worrying we can’t pay it back and people get to a point of non-confidence, I don’t think it has a large effect on those longer rates.
Senator Martin: Well, that offers some assurance, but at the same time, I know that our debt-servicing costs are rising and that is a big concern as a Canadian.
Going back, we were talking about how what’s been happening with inflation in the United States is still alive and well. Last June, Statistics Canada published a report suggesting imports from the United States can influence Canada’s domestic inflation by as much as 50%. You were responding earlier to Senator C. Deacon, and I’m just wondering how concerned we should be about that.
Mr. Beaudry: I think it is an important concern. The path through traditionally takes a while. It will depend on the speed a bit. Again, I’m very worried that if Canada and the U.S. stay at these very different speeds, then there is going to be pressure for us to reduce rates, and then you get into the exchange rate, and we talked about the imported goods and how they come back and we get into a real problem there. So I get worried there. We’ll have to see how things run their course.
Still, in the U.S., that growth is doing well. I think it’s going to be sustained for a while, but it might slow down. There are a lot of others who actually think there will be a bit more slowdown, and a bit more pickup in Canada. We might not diverge that much and be okay; however, if we do diverge and keep on diverging, I understand the worries you’re expressing, and the exchange rate could need to adjust. Sometimes we see things in the exchange rate market. It hasn’t been moving a lot for the last several years — though there are ups and downs — but exchange rates are fickle too. If all of a sudden, there is a bad run and everyone starts thinking, “Well, Canada does not look like a great place,” and so on, then, yes, you can get quick movement and that would not be good for inflation.
The Chair: Thank you very much.
[Translation]
Senator Miville-Dechêne: Welcome, Professor Beaudry. As you mentioned, the economy remains stronger than expected, despite slightly higher inflation of 0.5% in the United States.
The Americans are managing to keep their economy strong with sustained consumption and business and government spending that remains robust. Why can’t Canada achieve the same result?
I know my colleague Senator Deacon talked about our productivity difficulties, but are there other factors that explain why we have a poorer economic result?
Mr. Beaudry: Certainly. There are two different things. More fundamentally and in the longer term, I think productivity is one of them.
The exact answer to why we have this productivity deficit…. I can give you some ideas, but I don’t have a crystal ball. If I could answer that challenge, it would be extraordinary.
On the direct and short-term side, we have a mortgage system that is very different from that of the United States. So the fact that the slowdown is greater in Canada than in the U.S. is not really surprising, because here we have a lot more short-term mortgages and a lot more people taking out variable-rate mortgages. The rise in interest rates is fairly similar in the U.S. and Canada, but here it’s hitting a lot more people or households directly, let’s say, because of some of their costs. In the U.S., on the other hand, there are many people who will be almost unaffected. They may have 20- to 25-year fixed-rate mortgages, so there are very few people who are affected directly.
I think in the short term, it’s clear why the same interest rates have affected Canada much more. In the longer term, this growth is really based on productivity. It’s a good question and it’s a very significant challenge for Canada.
Senator Miville-Dechêne: So you said you didn’t want to talk about it, but why don’t you venture to explain why you think our productivity is lower than that of the United States?
Mr. Beaudry: I can talk about it, but you have to look at every element and every aspect.
The most striking thing is that when you divide up the different sectors across Canada, you find that the high-productivity sectors in the U.S., which include the high-tech and IT sectors, are much larger on this side. The sectors that have performed best in the U.S. in terms of productivity are relatively smaller sectors in Canada.
The question is why we haven’t managed over time to invest more in these sectors and why we’ve stayed in sectors where productivity is increasing less. It takes a change or transfer in the economy to move into these sectors.
It’s not easy — it’s not like we’re not going there at all, but it’s still relatively slow.
Senator Miville-Dechêne: Thank you.
[English]
The Chair: Mr. Beaudry, I want to ask you about an issue that I’m surprised nobody has raised. I read the remarks a week or 10 days ago from Senior Deputy Governor Carolyn Rogers. She was talking about productivity but also the economy more generally. She said, “You know those signs that say ‘In an emergency, break the glass?’ Well, it’s time to break the glass . . .”
You know better than most that officials from the Bank of Canada seldom speak so bluntly. Were you surprised, and do you agree?
Mr. Beaudry: I certainly am not surprised, and I do think I agree. If we have one big issue to bring together a lot of people in Canada who can agree there’s a productivity problem, it’s the long-term welfare of Canadians. It’s very hard to think that you’ll have living standards going up in Canada without an increase.
Often, it’s much easier to think about the short-term problems. These are long-term. When you’re going to talk about them, these are things for which we have to find solutions that are not necessarily easy. We have a lot of tensions around figuring out the solutions and which costs we’re ready to cut somewhere else to arrive at them.
Yes, it is one of the biggest challenges for Canada to think about and figure out what it’s going to do about right now. We have climate transition on top of that, so we need to think about, within this context, how we’re going to do that and get productivity to better grow. Also, it’s not only relative to the U.S. It’s relative to almost all advanced economies. We’re at the bottom end. Italy seems to be doing as poorly as we are, but that’s about it.
The Chair: How do you interpret “breaking the glass”?
Mr. Beaudry: No solutions were proposed there. She was saying “breaking the glass” without saying what was on the other side.
The way to think about it is to ensure no subject is taboo and open up the discussion on all fronts to say, “Let us be open, create a whole group, think about it, move forward, brainstorm and try to find a way to get around this.” This is not something where you have to hold back. That’s the only part of “breaking the glass” that I see right now.
The Chair: This sounds like every report we’ve done recently, the Banking Committee, asking for that.
Senator Yussuff: Thank you, Mr. Beaudry, for being here.
As you know, we are talking about rates at the national bank in terms of trying to manage inflation. A number of economists have said that the high rates at the bank are contributing to the stubbornness of getting inflation down, given that so many people, through their mortgages and their capacity to service their debt, are having to endure that. That, in itself, is contributing to inflation. The bank seems to be deaf to this point, because it doesn’t think its efforts should include trying to indicate to Canadians that this is an issue they need to tackle on their own.
We’re seeing overall inflation coming down, but if the rates don’t start dropping significantly, isn’t the bank also contributing to inflation, which Canadians are struggling with on a day-to-day basis?
Mr. Beaudry: Mechanically, you’re exactly right. This is a by-product of monetary policy. Part of it raises rates, which includes mortgage costs that go into inflation. However, I think it is too narrow. That’s like saying you’re going to get a treatment for cancer and you’re going to experience side effects. Some of those side effects are very unpleasant. At the same time, that doesn’t mean you stop using that remedy. You recognize those side effects and you figure it out. You don’t want the side effects to dominate the actual treatment, so you keep an eye on them. Many of the core measures remove those interest rates from the measure, so we’re looking at goods that don’t have those parts we’re trying to look at.
That’s exactly what the bank tries to do: cut out some of those parts, bring them through and figure out if they are underlying forces taking that out and bringing us back. Yes, there are indirect side effects of that policy on inflation, but I don’t think the underlying inflation is driven primarily by that force.
Senator Yussuff: Of course. I didn’t say that. I’m just saying it’s contributing to it.
Mr. Beaudry: Exactly. I completely agree. As I said, it contributes to it. It’s like some other kind of treatment where there are side effects. You don’t want the side effects to be worse than the treatment, but you have both at the same time and you’re trying to balance those things.
The Chair: Thank you for that.
I forgot to say this earlier, so let me say it now. I’ll do it again at our next meeting, just as a reminder to all.
Although it’s easy to forget, all public committees are captioned in real time by professional parliamentary reporters. Captions allow members of the public to follow our deliberations, especially those who are deaf or hard of hearing. The text of the meeting captions is also used to prepare official transcripts.
I will take a moment now to recognize and thank parliamentary reporters Mary, Caroline, Mariann and Guylaine. They are not physically in the room with us, but they are following today’s discussions closely and making our meeting accessible to all those who may be watching.
We can help viewers follow along by speaking one at a time, avoiding alternating between English and French in the middle of a sentence and by minimizing background noise. These best practices will help staff ensure accurate interpretation, transcription and captioning of proceedings.
I will remind us again that they don’t want us to slow down too much, but if we can be clear in our enunciation, it helps everybody.
We have about 20 minutes remaining and will briefly go to a second round.
Senator Loffreda: Mr. Beaudry, I’m looking at an interview you recently did with CIBC, on January 30, 2024. As a former deputy governor of the Bank of Canada and a long-time leading light in Canada’s academic circles, you were a significant contributor to the Bank of Canada’s decisions from 2019 to 2023. As Deputy Governor, you left the bank with some interesting research papers and speeches on the long-term outlook of interest rates.
I would like you to elaborate. Given our current environment and putting your research into context, where do you feel interest rates should — and not only will — settle?
Mr. Beaudry: In terms of the “should,” there is an aspect of where we want things. I don’t know if it is where I think they will be. Where the long rates go is much more determined from an international perspective. It’s a bit like saying where the oil price will go — it’s an international perspective. In the long run, interest rates are determined by these international markets.
The “should” is hard to address. That’s why it comes back to where it is, where we see the forces that we have to live with as Canadians, taking that as the general environment we’ll be in and being prepared for that. Coming back to that aspect, interest rates might go back to pre-pandemic levels, but most indicators would tell me that the risk or balance is that they won’t go all the way back — though that doesn’t mean it’s impossible for them to. We have to prepare ourselves for that on all levels — at the household, business and government levels — and take that into account. But I don’t think we should try to think about where they should be. The world is what it is and will give us the interest rates that we will have to live with.
Senator Loffreda: The reason I ask is because of the government debt levels all over the world and the debt level of the Canadian consumer. Do you feel we could sustain high interest rates on a long-term basis?
Mr. Beaudry: In thinking about that, we can look at the households, businesses and government.
On the household front, some households will not be able to sustain that if we stay within this high-interest-rates regime — the ones that are currently finding a way to get around it. Yes, there would be an adjustment. If interest rates stay at this high level, there will have to be an adjustment in some of the house prices in Canada to make housing more affordable, because it’s a cross-product of that. That’s an adjustment we have to think about and be prepared for. Again, I’m not suggesting a complete crash or anything. It’s just that the debt service ratio is very expensive.
It’s the same thing with governments. If the interest rates stay high, the debt service ratio is higher, and that means adjusting on other fronts and having to cut spending elsewhere. Real adjustments have to be made on many fronts.
At the same time, if you look at the balance sheets of Canadians in general — again, I want to specify that there are some who couldn’t afford this, but many Canadians could. It doesn’t mean they’ll be happy to afford it, but the reality is that the balance sheets of many Canadian households who have houses and things are in very good shape right now. There is a lot of room such that people can live through this, although it won’t be pleasant.
At the same time, you have to remember that interest rates don’t disappear. They’re going to other households that are actually making money too. There are all sorts of aspects that balance out in the end, but it is a real challenge from some parts of it. When it stays high, there is a subset of households that will find it very difficult. The governments will have a lot of adjustments to make too, because they got used to an environment with very low rates.
[Translation]
Senator Gignac: I’d like to touch on a subject that hasn’t been addressed so far: demographics, immigration and its role. Canada is experiencing its strongest growth since 1967, and 98% of this growth is linked to immigration.
I’d like to understand the impact of immigration on productivity gains. Companies seem to be relying more on temporary immigrants to fill their sales needs, rather than investing. Is this significant increase in temporary workers positive or negative in terms of productivity, and what is the impact on the neutral rate? I know this is an abstract economist’s concept. Does all this have an upward or downward impact? If we take GDP per capita, we’re currently in a recession; GDP per capita is back to 2016 levels.
Mr. Beaudry: There are two questions about immigration in general and the recent surge in temporary workers. In my opinion, productivity and the speed of immigration are two different things. Immigration neither helps nor reduces productivity. There are many positive aspects to immigration, such as diversity and other elements, but if you want to ensure productivity growth, it’s not the way to solve the problem.
In the short term, especially when there are a lot of temporary workers — who are not the most skilled workers — it mechanically reduces productivity in Canada.
If you look at the link between productivity growth and population across countries, essentially, it’s zero. That’s not the way to achieve growth. What was your second question?
Senator Gignac: Is there any impact on the neutral rate?
Mr. Beaudry: Canadian deficits or debt for the neutral rate are determined more internationally. Immigration to Canada affects the neutral rate very minimally. It’s for the same reason that I think the national debt, unless you’re on the verge of bankruptcy, doesn’t create a lot of problems with respect to the neutral rate.
We need to know how to live with this rate, which is determined internationally.
Senator Bellemare: Let me take you back to your former life as a banker at the Bank of Canada. I imagine you’re still interested in this subject.
What’s your opinion on the fact that we’re seeing more and more central banks have monetary policy committees made up of external members? In some countries, the number of external members is even higher than the number of internal members.
Don’t you think that if Canada did this, it would solve some of the problems with today’s monetary policy? As Tiff Macklem himself said, econometric models can no longer be trusted. Uncertainty is omnipresent, and making decisions in a small group where everyone thinks alike increases the probability of getting it wrong. If we had a more considered monetary policy, with monetary and economic experts from different backgrounds, would that be preferable? What do you think?
Mr. Beaudry: I think it’s a good idea to have a little more diversity on the committee within the central bank. Mixing internal and external people is a good idea. On the other hand, I’d say I support the idea, because there’s been a little movement in that direction with the addition of an external member. It’s moving a bit in that direction.
Maybe there will be another one added in the future. It’s a very good idea. If you look at the countries that have diversity on these committees and the decisions they’ve made in recent years, I don’t see any correlation. I think it’s a good idea, but I don’t think it would change the final decisions very much.
I don’t believe that countries with a greater diversity of members make very different decisions from other countries.
Senator Bellemare: When you hear that the productivity problem is very serious in Canada, do you think that Canada has had much higher real interest rates than the average of other countries for too long? Is there a relationship between higher real interest rates and weak investment and productivity?
Mr. Beaudry: There’s certainly an element of that, but I don’t think it’s an essential element. It’s been a long time since we had low interest rates, so we should have picked ourselves up then.
[English]
Senator C. Deacon: Mr. Beaudry, thank you very much. The Rogers speech did get into some specifics. I was pleased with what I saw in that regard. The need for investment to address the mismatch between labour needs and labour skills in Canada — especially amongst new Canadians — a lack of focus on growing high-value applications of technology across our economy, a lack of investment in IP and machinery, and the limited pro-competitive policy stance that we’ve had for a long time that has effectively protected oligopolies and resulted in a lot of corporate concentration: Those were four key points we’ve actually spent a lot of time on in this committee. We released a report last June focused particularly on the last three of those four points.
We are very focused on this transition from a tangible economy that relies on tangible items and exporting tangible items to this intangible economy that relies on data and digital assets. Can you speak to that, in terms of the need to generate more revenue and productivity for every hour worked amongst Canadians so that we can protect prosperity into the future?
Mr. Beaudry: I agree about the issues. It’s easy to say we’re not investing enough in this. The question, in some sense, is this: If this is the symptom there, why are we not investing? Why are we not doing that? Just noticing that we have this mismatch of things — at a minimum, we want to see that, but we also want to understand the deeper reasons for it. There are different hypotheses out there, but it’s difficult to get the aspects and figure out why Canadian firms don’t do more training programs, as other countries do. Why are they not investing in certain areas? It is a very intriguing thing. The problem is certainly there, but finding the solution is a bit more difficult.
I completely agree with what you said. You want to have a competitive system. At the same time, when we look at one of the reasons, just looking mechanically at the differences in distribution, big firms are a very productive area. That’s one of the reasons the U.S. is productive: There are very big firms. It’s true that we have protected too many of our big firms, but it’s not that we don’t want big firms.
We have this difficulty in Canada. We want both big firms and to be competitive, but we’re not that big and can’t have a lot of big, competitive firms. We’d love to have them, but that’s the trade-off. We’re always playing on these two fronts — how to make a Canadian leader that is actually big but feels the competition from outside while allowing it to be big within Canada. That’s what we want to do, rather than saying that in Canada, we’ll just cut all firms to make them smaller, because we almost certainly would not become very productive.
Senator C. Deacon: If we could ask our wonderful and loyal clerk to send a link to our report from June to get some feedback on that, I would be very appreciative. I think all of us would be, Mr. Beaudry. Thank you.
The Chair: We will do that.
[Translation]
Senator Miville-Dechêne: I’d like to know what you think of what National Bank Financial analysts Matthieu Arseneau and Alexandra Ducharme wrote recently, and I quote:
… the official data understates the progress made by the Bank of Canada in controlling inflation, which creates a risk that the central bank is calibrating its monetary policy too restrictively.
Do you think these two analysts are right?
Mr. Beaudry: I don’t think so, and even though I’m no longer there, I think the whole group at the Bank of Canada is trying to take all these steps and absorb the information. I think what’s difficult is to know how important it really is to get back to our 2% target. So, if we’re very attached to this target, we have to be quite careful in order to bring inflation back down. It would be easy to have inflation go through the roof or stabilize at 4% or 5%.
Canadians aren’t happy with inflation at 4% or 5%; they want it back down to 2%. To make sure that happens, we have to be fairly cautious. If we take the measures we like the most to change things, we may go back to inflation.
I feel that yes, it’s difficult; I think we’re very close to having rate cuts, but I’m very happy to see the progress that’s been made lately.
I’m much more confident now, because there’s a drop in relation to the overall inflation measures, and I think it’s much more likely that we’re going to get back to the 2% target.
Senator Miville-Dechêne: Thank you.
[English]
The Chair: Thank you very much, Mr. Beaudry. We really appreciate this. Mr. Beaudry is the former deputy governor of the Bank of Canada. He served from 2019 to 2023 and is now a professor at the Vancouver School of Economics at the University of British Columbia.
So, on this day when we had a decision from the Bank of Canada, we appreciate your insights into what goes on in terms of that decision-making.
Thanks for being our witness today.
I’ll continue with the group here for a moment, just to bring everybody up to speed on what we’re doing next.
Our thanks, Mr. Beaudry.
Mr. Beaudry: Thank you. It was a real pleasure.
The Chair: [Technical difficulties]. If we’re going to talk to the governor of the bank, we’re going to talk about a full range of issues. But these questions have been coming up. We’ve been trying to integrate this.
Senator Gignac: [Technical difficulties]. Is this related to Rosa Galvez’s bill? Correct me if I’m wrong. It’s May 8.
The Chair: Yes. We are going to be dealing with that issue. Although we can’t anticipate it right now, we will obviously be forwarded some budget measures, and we probably have three C bills that are coming to us before the end of June as well. It’s a pretty busy schedule.
Senator Loffreda: Also, Madam Chair, April 18, the Agriculture Carbon Alliance —
The Chair: I just mentioned that, yes.
Senator Loffreda: Senator Galvez is aware of that because I sent a text regarding that. I have been in constant contact with her as to where we’re going.
The Chair: That’s our agenda for now. We are covering all the topics that we have to deal with, and it’s going to be busy between now and the end of June. Thank you all very much for your participation. We will end this meeting now and keep the steering committee with us.
(The committee adjourned.)