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Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 49 - Evidence, April 20, 1999


OTTAWA, Tuesday, April 20, 1999

The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:30 a.m. to examine the present state of the financial system in Canada.

Senator Michael Kirby (Chairman) in the Chair.

[English]

The Chairman: Senators, we are here this morning for our semi-annual meeting with the Governor of the Bank of Canada to discuss a variety of issues related to the Canadian economy. Some of you may want to ask the governor questions related to the study we are also doing at the present moment, which involves considering the question of the advantages and disadvantages, the pros and cons, of having a common North American currency.

As is traditional, the governor meets with this committee in the weeks following the presentation of the budget to talk about macro-economic policy in the country as a whole, and then last year we started having a fall meeting with him as well.

Welcome, governor, and thank you very much for coming.

Senators, in addition to Mr. Thiessen, we welcome today Mr. Paul Jenkins, the Deputy Governor of the Bank of Canada.

Please proceed, Mr. Thiessen.

Mr. Gordon Thiessen, Governor, Bank of Canada: Mr. Chairman, we are pleased to appear before your committee to provide an update on the economy and monetary policy, as well as to discuss with you other economic policy questions. Since we have recently tabled the Bank of Canada's annual report in Parliament, I would also be happy to answer any questions you may have about our stewardship of the bank.

When we last met in November, a cloud of uncertainty was hanging over global financial markets and the world economy, although it did appear to be slowly lifting at the time. I noted in November that the growth of the Canadian economy in 1999 would depend on how long that uncertainty lingered and how soon domestic financial markets stabilized. That was particularly important given that household and business confidence in Canada had been undermined by the heightened financial turbulence of last fall.

I also suggested to you then that Canada was weathering the international crisis better on that occasion than in the past because of the progress that we had made in restructuring the private sector of our economy to become more competitive, in getting our fiscal house in order and in keeping inflation low and stable.

Since November, the sky has become somewhat clearer, although uncertainty still persists in a number of areas. The interest rate reductions in the United States last autumn, and in other industrial countries since then, have really helped to calm financial markets and to support economic activity. The most recent cuts occurred in early April: 50 basis points by the European central bank and 25 basis points by the Bank of England. These latest interest rate reductions should help support confidence and domestic spending throughout Europe, but they are also a positive element for the international economy more generally.

As well, there has been some firming in primary commodity prices so far in the first quarter of this year.

[Translation]

Perhaps the most important positive external development from a Canadian perspective has been the remarkable performance of the U.S. economy. That economy ended 1998 on a much stronger note than expected. And because of that, the momentum of U.S. economic activity in early 1999 is greater than most forecasters had predicted.

The Canadian economy also regained vigour in the fourth quarter of 1998. Although this partly reflected the rebound from labour disruptions in the previous quarter, surging exports were the main factor behind the pickup in activity. And there was particularly strong employment growth in the closing months of 1998.

With this, greater financial stability and improved consumer confidence, all indications are that the Canadian economy has continued to expand at a healthy pace in the first part of 1999.

Inflation in Canada has been fluctuating around the bottom of the Bank's target range of 1 to 3 per cent This low rate of inflation and increased stability in financial markets prompted the Bank to reduce interest rates on four occasions between September and March.

These reductions completely reverse the one percentage point increase in the Bank Rate that was needed to bolster investor confidence last August, in the wake of heightened global financial volatility.

As we look forward, the ongoing strength of the U S. economy and the low level of the Canadian dollar should continue to underpin growth in our exports. And more stable financial markets and accommodative monetary conditions should support increased spending by Canadian households and businesses.

However, the economic stagnation in Japan and some lingering uncertainty in Latin America, associated with the financial problems Brazil is coping with, are constraining world economic activity and the recovery of those primary commodity markets that are so important to Canada.

Still, all in all, while uncertainties remain, the outlook for the world economy and for Canada is more positive than it was last November.

[English]

All in all, the outlook has improved.

Finally, Mr. Chairman, I know that with the recent successful launch of the euro as a common currency for the 11 countries participating in the European Economic and Monetary Union, your committee has been discussing alternative exchange-rate regimes. My colleague and I will be happy to respond to your questions on the issue, but perhaps it will be useful if I briefly restate the views that I have already expressed.

I must say that the smooth introduction of the euro has been a major political, administrative and technical achievement. However, I do not believe that the euro provides a blueprint for a North American monetary union. There are no parallels here to the profound political forces that have been behind the move to greater integration in Europe over the past 50 years.

Unlike the currency union in Europe, which encompasses three large countries and eight medium- and smaller-sized participants, any North American monetary arrangement would surely mean that Canada would have to adopt the U.S. currency. Moreover, our present flexible exchange-rate regime plays an important role in helping us to adjust to economic shocks that affect Canada differently than the United States. The most important shocks of this character have been fluctuations in primary commodity prices.

The marked decline in primary commodity prices over the last two years has meant that Canada as a whole is relatively less well off than before. That is a reality that we must face and adjust to no matter what currency regime is in place. If the exchange rate for the Canadian dollar is allowed to move in response to that reality, the adjustment process is smoother and faster. Without exchange-rate flexibility, the adjustment would have to take place primarily through declines in wages and prices, which would tend to cost us more in terms of losses of output and employment.

There is a tendency in Canada to blame movements in the Canadian dollar as the cause of economic problems. The fact is that currency movements are a consequence of such problems, not a cause. In my assessment, our flexible exchange-rate regime is serving Canada well.

Mr. Jenkins and I will be pleased to answer your questions.

The Chairman: As usual, many of my colleagues want to ask you questions.

Senator Kelleher: I wish to welcome, once again, our favourite witness.

In recent months, we have heard conflicting stories about whether or not Canada has a productivity problem. For example, the Minister of Industry says that we need to reverse a 25-year slide in declining competitiveness, while the Prime Minister appears to be downplaying the issue. We heard rumours that the next budget would focus on productivity but the latest word is that it will be a children's budget.

We have now learned about a report recently delivered to deputy ministers entitled, "Growth, Human Development and Social Cohesion." The April 19 National Post tells us that that report is being used to prepare the government's agenda for the second half of the mandate. According to the report, we are trailing the U.S. and other major trading partners and the gap is widening. The report draws a link between Canada's poor productivity growth and various social issues that, if not combated, could lead to a downward spiral of deteriorating economic performance.

Does the governor side with those who feel that Canada has a serious productivity problem or does he side with those who feel that the problem is not that serious?

Mr. Thiessen: You are making me nervous that I might get into political waters that I would sooner not get into.

Senator Kelleher: Far be it from me to attempt to lead the governor of the bank into those troubled waters. That is not my nature!

Mr. Thiessen: There is no doubt that productivity growth has fallen off substantially since the early 1970s. That is true not only in Canada but also in the United States. We do not fully understand that. We do not fully understand whether we should be looking for what caused productivity growth since the early 1970s to be very low, or whether it is the case that the period after the Second World War through to the early 1970s was quite a remarkable period and thus the rapid productivity growth we achieved at that time was somehow special and unsustainable. We are not sure about that.

As you noted, the recent productivity numbers suggest that the difference in growth rates that earlier studies appeared to show existed between Canada and the U.S. over the last 20 or 25 years do not really seem to be there. The growth rates do seem to be roughly comparable. I am talking about growth rates, not levels of productivity. Frequently, discussions confuse the issue of growth rates with levels of productivity. It is quite clear that the absolute level of productivity in the U.S. continues to be substantially higher than that in Canada. Those are difficult calculations to make. You should have a sense that they point to a range of likelihood around any given estimate of productivity.

There is an ongoing difference in the level of productivity. Why have we not closed some of that gap? We were closing the gap during the 1960s, when productivity was growing slightly faster in Canada than in the U.S. However, we have not closed much of the gap since then. Why is that? You might expect that we would have closed that gap. I think there are some puzzles left there.

In my opinion, the notions that you hear that we are into a downward slide that will leave us in some kind of profoundly poorer state are not justified. Having said that, productivity is important. It is the way, over long periods of time, that a country raises its standard of living.

I may not have answered your question, but I do not know that there are nice, neat answers here.

Senator Kelleher: You are still my favourite witness.

I should like to ask you about something that you and I discussed on a previous occasion. I am sure that you have been waiting for this question. Do you feel that our relatively low dollar is masking the productivity problem that we appear to have even though we do not know why?

Mr. Thiessen: I find it difficult to accept arguments that suggest that the low dollar is a source of weak productivity.

Senator Kelleher: I am not asking that.

Mr. Thiessen: I think it is the other way around: If your productivity is not doing all that well, you will tend to see that reflected in your currency.

I find it difficult to see that focusing on the dollar and following a policy of pushing up the dollar would solve any of those problems. The dollar, as I said in my opening statement, is a consequence of those things, not a cause of them.

Senator Austin: You are as welcome on this side as you are on the other. You indicated in your presentation this morning that only last fall the economic chattering classes had agreed that one of the longest periods of economic expansion might be coming to an end. We had had eight years by last fall.

The cause of concern last fall was that manufacturing and export profits were in decline. Russia had defaulted on its debts and was offering two or three cents to its commercial bank lenders; Brazil was hitting the bottom and would have gone through it without international support; the European economy was then and is still stagnating; and the Japanese economy was experiencing negative growth. In fact, the Japanese economy is still experiencing negative growth and is mired in a deflationary black hole. What everyone thought was happening has not happened in North America. The U.S. economy has hardly paused and now its growth rate is accelerating. It is at about 4 per cent GDP, while keeping unemployment and inflation at unbelievable levels by any conventional thinking of the last couple of decades.

While world consumers are cautious in various degrees, the U.S. consumer is spending beyond the domestic savings rate in the United States. Retail sales in the U.S. are up over 6 per cent over last year's monthly numbers after adjusting for inflation. It appears that U.S. consumers have no fear whatsoever that their incomes will be interrupted any time in the foreseeable future.

Given that background, I have the following points. Does the U.S. consumer know something that the economists do not know? Are you concerned about U.S. consumer-spending exceeding their domestic savings rate by an ever-increasing amount?

U.S. inventories have seen the Dow-Jones industrial average increase by 39 per cent since August. Is that irrational exuberance?

If the Federal Reserve Board decides that the U.S. economy needs to be cautioned and raises interest rates, is it possible for Canada, with its much slower economic growth rate, to hold the line on interest rates? If we have to increase interest rates, do you fear deflation more than inflation?

Mr. Thiessen: Senator Austin, the U.S. consumer has certainly been consuming much of current income, but the U.S. consumer has also had a very large increase in net worth because of rising asset prices, particularly the stock market.

You have to take account of more than just the last run-up in the stock market. That stock market has been going up for a long time. There has been a kind of revision in people's views of the values of those assets. Part of that revision of views is not purely excessive exuberance. It is due in part to a much more stable U.S. economy with lower interest rates that allow better planning into the future. It is in part due to the expectation that productivity gains will be larger than they have been in the past. It is partly due to the notion that interest rates will remain lower than they have in the past. As you look at a future stream of profits for any individual company, you discount that back to a present value at a much lower interest rate than you might have five or ten years ago. All of that leads you to have at least a one-off increase in the value of those assets. To some extent, consumers have been spending part of that increase in value.

I must admit, although I hesitate to be very definite about it, it does look to me like the U.S. stock market is taking an extremely positive view of the future, that basically nothing could possibly go wrong. I do not know that you can argue at this stage that if there were to be a correction in that stock market, that you would automatically have a collapse of consumption. I do not think that you can say that consumers have been spending that last run-up in stock prices yet.

One can be just a little more relaxed about that one. I would not want to dismiss it or take it off the table, but I do not think it is quite as worrisome as perhaps it sounded in the way you described it, senator.

The U.S. economy is pushing the limits of capacity; there is no question about that. Unless it slows down, the federal reserve will at some point have to tighten interest rates. The real issue in the period ahead is whether the economy will slow down on its own or whether it will require some tightening of monetary policy. At this stage, most people are betting the economy will slow down on its own. Financial markets are not building in, at this stage, significant increases in interest rates. They do not think the federal reserve will have to tighten. They could be wrong.

Mr. Paul Jenkins, Deputy Governor, Bank of Canada: In thinking about the U.S. economy and its situation from a cyclical point of view, it is important to think about it in a global context. The U.S. economy is operating at a very high level of capacity, but what is surprising is that price and cost pressures are still absent in the U.S. economy. One reason for that is the excess global supply. Part of that is from Asia and certainly from the Japanese situation.

Europe has been slower but I do not think I would characterize it quite as negatively as you might have in your opening remarks. If these inflation pressures were to begin to show through in the United States, it would have to be in the context of other countries, particularly Japan, beginning to move forward at a much more rapid pace. That begins to change the circumstances quite significantly, not only for Canada but for the global economy.

One needs to view the current set of circumstances from a global perspective, not just from the point of view of the situation in the United States. The global situation is having a very important effect on price and cost pressures around the world.

Senator Austin: If the Japanese economy begins to dig itself out of a hole and becomes a demander of capital for economic recovery, the price for capital globally will rise, the price for capital in the United States will rise, and that will tend to slow the U.S. economy. Is that correct?

Mr. Jenkins: One would want to consider that type of scenario.

Mr. Thiessen: That would also change the situation for us, because one of the things keeping commodity prices at a relatively low level, although they have levelled out, is the Japanese economy. If you were to see a pick-up in Japan, you would probably see a pick-up in commodity prices and that would be a source of stimulus to the Canadian economy.

Senator Austin: Would that have an exchange-rate consequence as well?

Mr. Thiessen: It would indeed.

Senator Austin: Would our dollar rise in U.S. dollar terms?

Mr. Thiessen: It would.

Senator Austin: What does that do for the performance of our economy overall?

Mr. Thiessen: We would have to look at it again and say that commodity prices are up, and that makes the Canadian economy look a little stronger. Is the level of the Canadian dollar appropriate? Is it putting too much restraint on the Canadian economy or too much ease? Then we would have to adjust interest rates to balance that out.

Senator Oliver: It is extremely important for a governor of the Bank of Canada to be consistent in the positions that he takes on a number of economic issues. In all of your appearances before this committee, you have been consistent in the policies that you bring forward and maintain. Today is no exception.

You told us today that our present flexible exchange-rate regime plays an important role in helping us adjust to economic shocks that affect Canada differently than the United States. In March of this year, this committee had a seminar involving four eminent economists. They debated the exchange rate and looked at the possibility of a common currency with the United States. It was a brilliant debate. I have questions arising from some of the positions taken by the people involved in that debate.

Professor Tom Courchene of Queen's University felt we should look at moving towards a common currency. All of my questions have a common theme: What is wrong with having a common currency or fixed rates with the United States?

Perhaps I could put suggestions from three thinkers or economists to you and you could rebut them. You can tell us your position and we will see if you still have the consistency that I think you have.

First, Professor Herb Grubel from Simon Fraser University appeared before our committee in March and predicted that interest rates in Canada could decline by as much as one percentage point under a common currency arrangement given the elimination of currency risk for investors. Do you agree with that forecast or do you find it to be reasonable or excessive, and why?

Professor Rick Harris of Simon Fraser University has observed that free trade requires predictable and stable exchange rates. The need for predictability, he points out, is especially critical if trade volumes are large and if a high degree of trade is conducted with one country, such as Canada with the United States. Given the degree of openness of Canada's economy and its increasing integration with its southern neighbour, is it not high time for a move to less exchange-rate volatility and greater fixity with the U.S. dollar?

The final thinker is Professor Robert Mundell from the University of Chicago, and he pointed out that a policy of devaluation and response to adverse shocks cannot work indefinitely.

Could you rebut those three points and maintain consistency with your policy?

Mr. Thiessen: I certainly hope I can, senator, although I am feeling the pressure.

The first point was that if we were to go to a common currency with the U.S., we would have substantially lower interest rates. I think the existing circumstances basically rebut that. Even if you are in a common currency, you will still have different interest rates that different governments and other borrowers must pay. For example, when my home province of Saskatchewan borrows, it must pay 40 to 50 basis points more than the Government of Canada. Similarly, when the Government of Canada borrows in U.S. dollars, it pays 50 basis points more than the U.S. Treasury.

There is a sense that the federal government in the country issuing the currency tends to get the best rate. That will not go away if you are in a common currency arrangement. Just as Saskatchewan does not get the same rate as the Government of Canada, the Government of Canada in a common currency arrangement with the U.S. would not get the same interest rates as the U.S. Treasury.

However, if you look at what the Government of Canada pays now on its borrowings in Canadian dollars compared with what the U.S. government pays in its borrowings in U.S. dollars, the Canadian government pays less. If you consider, for example, a 10-year bond issue, the Government of Canada pays 20 basis points less by borrowing in Canadian dollars in Canada than the U.S. government pays borrowing in U.S. dollars in the U.S. In fact, by borrowing in Canadian rather than in U.S. dollars, the Government of Canada currently saves 70 basis points.

I do not agree with the notion that you will have a huge gain by bringing U.S. dollars to Canada by making the U.S. dollar the Canadian currency.

These things will vary over time. One reason Canadian interest rates are lower than American interest rates right now is that we have a lower inflation rate and our economy is not pressing the limits of capacity the way theirs is. If we were in a reverse situation, that would be reflected in our interest rates perfectly legitimately.

I just do not see a huge gain.

However, if you take for example Argentina, which in recent history has had the most terrible time getting inflation under control and getting budgetary affairs under control, even if they adopt the U.S. dollar or have a currency-board arrangement, as they now have, it is very difficult to get interest rates down. There is some talk of adopting the U.S. dollar formally in Argentina, but that relates to their unfortunate history.

Senator Oliver: What about Brazil and Mexico? You must add the other countries as well.

Mr. Thiessen: There again, the situation is similar. In their history, their government policies have not had the same kind of credibility that we have in Canada.

The second issue was that free trade requires predictable and stable exchange rates. The trade between Canada and the U.S. is probably the largest flow of trade in the world over any border. It has been one of the largest if not the largest for a very long time. We have had a floating exchange rate through most of that period. Out of the whole period of 55 years since the end of the Second World War, we have had a floating exchange rate through all but 14 years. That has not inhibited the development of the largest trade flow in the world.

Senator Oliver: Have we lost anything by having it?

Mr. Thiessen: That is difficult to demonstrate, quite frankly. People who engage in trade can take account of exchange-rate movements. There are ways of hedging your business against those currency movements. I just do not think that you can rightly assert that free trade needs currency fixity.

The final issue was that you cannot devalue your way to prosperity. Of course you cannot. With commodity prices, we are talking about responding to the fluctuations. It is true that commodity prices have had a downward trend to them, but it is responding to those fluctuations that really matters. It can be both up and down.

I remind you that when we floated our exchange rate in 1950 and again in 1970, it was in response to rising commodity prices. In both cases, we floated so that the Canadian dollar could go up. It can go both ways.

An argument that says that flexible exchange rates help you to deal with shocks means those shocks can be either positive or negative. They come and they go, and the currency will move in response to that.

Senator Oliver: In the United States, there are 12 different federal reserve districts. Even if they have a problem in Texas or California or New England, they still must go by the federal reserve's position, so they have nothing to absorb the shocks. They are not doing too badly.

Mr. Thiessen: No, they are not. I am not saying that it is an impossible situation.However, it is nonetheless the case that if you look at Canada as a whole and you look at the U.S. as a whole, when commodity prices go up, we are a net beneficiary and they are a net loser. When commodity prices go down, it is the reverse. For the country as a whole, it is helpful to us. That does not mean that it is impossible to operate on a fixed exchange rate but, on balance, it is helpful to us.

If the Canadian dollar had been held at 72 cents through this whole Asian shock, how would we have done? I think we would have had quite a lot of difficulty compared to what we have already been through.

The Chairman: Could I ask Senator Oliver's question in a slightly different way?

In your response, you stressed the importance of flexibility. Some people in this country believe that we do not have much flexibility, that flexibility is something we have in theory but not in practice. They believe that while in theory one can have a made-in-Canada monetary policy, because of the close relationship with the United States, the fact is that our margin of manoeuvring room is extremely limited.

I am interested in the extent to which your response to Senator Oliver is based on the theoretical flexibility versus the practical reality of how much flexibility we really have.

Mr. Thiessen: The problem many people have is that when they talk about an independent monetary policy, they are frequently talking about an interest rate that is somehow completely divorced from what is going on in the rest of the world and from the U.S. in particular. That will never happen. International financial markets are closely integrated. That does not mean that you cannot have an independent monetary policy. Monetary policy has its effects over time on the price level and the inflation rate. A flexible exchange rate allows us to choose our own independent view of what inflation and prices should do in this country.

We went through a period from the early 1970s to the early 1990s where we had a higher inflation rate than the Americans, and we have since then had a lower inflation rate than the Americans. It is quite evident to me that the flexible exchange rate adjusts to all of that and, in fact, allows it to take place. I think that that is how you define an independent monetary policy. Remember, it is not just the interest rates that have the effects of monetary policy that carry them through to the economy; it is the exchange rate as well.

It is also true, I must say, that without a floating exchange rate it is even more difficult to have different interest rates. To get a little technical for a moment, it is only if you have a Canadian dollar that goes down and is seen to be undervalued that you can have interest rates lower in Canada than in the United States, because investors do their comparison between investment in the U.S. and investment in Canada. Why would you accept the lower interest rate in Canada than in the U.S.? It would be because you think the dollar will go up. A floating exchange rate allows you to have some differences in interest rates. Without it, it is very difficult to have any differences.

Mr. Jenkins: If I might add a couple of comments, Mr. Chairman, I think the point the governor was making regarding what might have happened if Canada had been on a fixed exchange rate through this recent episode is a very important one. There are two elements to it. One is the type of shock that we were experiencing, in that case mainly in commodity prices. We are still a major commodity producer; the United States is a major commodity consumer. That is an important difference. That shock to the Canadian economy had to be absorbed one way or another.

There are two ways of adjusting to it. A fixed exchange-rate regime would have meant weaker employment and weaker wages. We would have regained our competitiveness internationally through a much more difficult process than a flexible exchange rate provides. That flexible exchange rate allows you to absorb that shock in a much more even and efficient manner than would have been the case had we been on a fixed exchange rate. To have held a fixed exchange rate through that period would have required higher interest rates, weaker employment and declining wages. It would have been a much more difficult adjustment process. One way or another, the economy would have had to adjust to that shock.

The Chairman: What exactly do you mean by "a more difficult adjustment process"?

Mr. Jenkins: What I mean is that employment would likely have been much lower. There would have been considerable downward pressure on wages and prices generally throughout the economy.

Senator Kolber: As you get lower on the question totem pole here, the good questions are already asked. All of mine have been asked, so I should like to try something a little different that I really have not prepared, but please indulge me. It is not terribly scientific.

Last night I had dinner with two colleagues. Among us, we have seven grown children, all of whom have first-class educations, six of whom now live in the United States and will never come back. I have worked the phones for a few weeks on this particular problem, speaking to CEOs across the country, and they all tell me the same thing. The biggest pressure they have is executives wanting to be relocated where they can make what they think is a better living with a better tax regime, and so on. Does that concern the Bank of Canada? Certainly, in the long term, it has to be a major concern for our country.

The situation is deteriorating from that point of view. I have a feeling that we are making short-term policies. Even Robert Brown, who is a consultant to the Department of Finance, said in their retreat about 10 days ago that politics was getting in the way of good tax policy. I do not know if that concerns the Bank of Canada. If I am out of line, please say so, but if it does concern you, please tell me if there is something that the Bank of Canada can do to alleviate the situation.

Mr. Thiessen: Of course, senator, it has to be a concern. Losing well-educated Canadians is a significant loss to Canada. You would not like to see that. Going from there to deciding what to do about it is a very big step and not an easy one to take.

The strength of the U.S. economy, and the fact that it has been remarkably strong for a significant period, makes it a very attractive place indeed, and not just for Canadians but for people from around the world. There is a huge influx of people into the U.S. for that very reason. I do not think we are unique in that sense.

What you really want out of all of this is a stronger Canadian economy, one that will provide incentives for people to stay here. I must say that I think we are on track to getting there. I think many of the changes that have happened in Canada over the course of the 1990s are helpful, but the process is slow. Along the way, we got hit by this major shock -- the Asian financial crisis -- and what that did to commodity prices. That really held us back from getting to that type of booming economy that the Americans have.

If and when that turns around -- and I think it will turn around -- I think circumstances will feel better in Canada than in the United States. People will always look at the comparisons. They will consider relative incomes, taxes and the basket of public goods, and they will ask themselves whether it is better in Canada than in the United States. They will respond to that. In the long run, a stronger, healthy Canadian economy will help reduce that problem.

Senator Kolber: That is not the answer I was hoping for, but thank you very much.

Senator Angus: It is refreshing to hear that you are still very optimistic in your outlook, and more so than you said you were in November. I assume therefore that you consider that the fundamentals of our economy are still good. Is that a fair assumption for me to make?

Mr. Thiessen: Yes.

Senator Angus: As you know, I have always focused with you, to the extent that I could in previous sessions here, on this belief that you have and that you continue to articulate about the fundamentals being good. I try to understand where you are coming from on this subject. I go away feeling quite uplifted, but then I go back to reality. We all represent different regions of Canada, and I am hearing from people, as Senator Kolber has said, that we are facing quite a distressing brain drain. I will not go into details. It is on the front pages of almost every newspaper, magazine and economic periodical. We are losing our highly skilled doctors, nurses and medical students to other countries, in particular the United States. Our education system is under strain and stress. We have stagnation in income, even falling income at the family level. More than 100 per cent of family income, I gather, is in consumer debt now. I could go on and on.

This problem seems to be measured in ways that Canadians can understand and relate to, namely, the fact that the standard of living of ordinary Canadians has fallen from third in the OECD grouping to ninth. There is a general malaise among Canadians, and I see it everywhere I go and in everything I read about these things.

Those circumstances do not seem to be consistent with your statement that the fundamentals of our economy are good. People out there do not seem to be as bullish as you are that our economy is good. It seems to be a fact that our economy is underperforming. Why is that? That is despite the low inflation that you have achieved. I am puzzled.

Mr. Thiessen: Much of it must be attributed to that decline in commodity prices to which I keep returning. Those commodity prices declined by 20 per cent over the course of the period from early 1997 to the end of 1998.

Senator Angus: Forgive me for a brief interruption on this point, but the last time you were here I asked you about the commodity prices. I said that I think that our currency is commodity-based. You replied, "No, senator. That was years ago. We are in the new economy. Fundamentals are good; we are not a commodity-based economy."

When I listened to you earlier this morning, I felt that you had changed your position. We all change our positions and I do not criticize you for that. However, I am trying to understand why you are putting out a positive message when we seem to be in such bad shape in the country.

Mr. Thiessen: Once again, we are not completely dependent upon commodities. We are less dependent than we used to be. There is no question that the manufacturing side of our exports has been growing quite rapidly. Nonetheless, about 30 per cent of our exports are still in commodities. If you include some of the more highly processed commodities, you can get up to 40 per cent. That is a significant part of our gross domestic product. Those prices, as I said, have gone down substantially. As a country, that makes us less well off than we otherwise would be.

That is part of what you are seeing and feeling, although that is not all of it. I am talking about the fundamentals being good. That means that we are in a stronger position to do well in the future. I am not arguing that our economy is going perfectly right now. Of course, I would not argue that.

Senator Angus: I think it is important to say that.

Mr. Thiessen: That is not the case.

As I said in my opening statement, we have coped with that shock and with the difficulties caused by the Asian financial crisis much better on this occasion than in the past because of those much stronger fundamentals. We had more difficulty getting through the Mexican currency crisis, for example, in late 1994-95, than we have had on this occasion.

Senator Angus: Governor, I think it is a bad fundamental when so much of our economy is still of the drawer-of-water sort. We are far behind some of our trading partners in adapting to the new economy. There has been a terrible lag in this country because our manufacturing sector has not upgraded their technology to take advantage of these new things.

Senator Kelleher dealt with a subject that is quite hackneyed these days among the thinkers and economists, and that is the floating exchange rate shielding low productivity and weak fundamentals in the economy. Having the most punitive tax system in the industrialized world seems to bad fundamentals. It is certainly bad politics. I think that that will come home to roost.

I will have problem leaving today feeling uplifted, as I have at other times, because what we are hearing about taxes and everything I have just listed is very strong and loud.

Mr. Thiessen: I do not want to say that there are no problems and that there is no room for improvement; of course there is. I still believe, however, that if we were in a situation, for example, where our fiscal position was out of control, basically not in balance, and where the debt-to-GDP ratio was not coming down, then we would be in much more difficult circumstances. If our inflation rate were 6 per cent to 8 per cent rather than 1 per cent to 2 per cent, or close to 1 per cent, we would be in much worse circumstances. If we had not had the investment that we have had in new equipment and new technology over the course of the last number of years, we would also be in much worse circumstances. I believe that those are the foundation of an economy. If you do not have those in good shape, then your ability to take advantage of potential growth in productivity and of opening world markets is not there.

Part of what is affecting us in Canada is the U.S., which is going through one of the most sensational periods of economic growth in its history. That has been quite remarkable. They are getting productivity growth and they have their unemployment rate down. Things have gone extraordinarily well.

Senator Angus: They have good fundamentals, and low taxes.

Mr. Thiessen: Yes, they have good fundamentals. They have benefited from what has gone on in the rest of the world, which has allowed them to keep their inflation rate lower than otherwise. We are making all of our comparisons with them. That tends to put most Canadians in a slightly more sour mood than otherwise. I am not saying that you should not make those comparisons, but it might be instructive to look at some other countries as well. Then, by comparison, we look much stronger.

Senator Angus: We are right in the same economic zone. Frankly, we should not be saying, "Well, it is great in the U.S.; therefore, we pale by comparison." There are fairly consistent economic conditions among the major OECD countries in the European community, although I agree with you that that is not a perfect analogy.

We debated the other day the concept of a monetary union in this continent. Many of these issues surfaced, including productivity and the idea that a floating exchange rate was masking some of the fundamental problems that exist in our Canadian economic structure. I realize that monetary policy can deal with certain things, while other things that I consider fundamental are outside of your mandate. However, there is something fundamentally wrong in this country right now. The people who live in the Senate district of Alma, where I come from, for example, are just a few miles from the border. They go for a Sunday drive and they make comparisons and they say, "We have problems here."

Mr. Thiessen: I would not say that we do not have problems. I do think it is easy to overstate them. I certainly would not accept the notion that, somehow, if we fixed the exchange rate we would solve those problems. I simply do not believe that that is true. I think that, as I said earlier, the exchange rate is a consequence, not a cause.

Senator Angus: I am not suggesting that it is the exchange rate. I am saying that there are serious problems with the fundamentals here.

[Translation]

Senator Hervieux-Payette: When we talk about productivity, we talk about competition, better prices and, therefore, competitiveness on foreign markets. Studies have been made on the financial sectors. Some actors in the financial sector are a bit worried about the arrival of some newcomers. As we know, the Mackay report from the Senate and the report of the House of Commons recommended that the telecommunications market should be opened to competition. Billions of dollars have been invested in Canada. The service has been improved. Our prices are the lowest in the world.

With regard to productivity, a better telecommunications system has an impact on businesses. I draw an analogy with the financial sector. We are starting the first round of negotiations with the World Trade Organization.

What advice could the Bank of Canada give when it looks at that whole issue? We made concessions in the area of agriculture. Our partners did not necessarily follow suit. They have not been opening up markets with the same commitment as Canada. Therefore, we have been penalized and our farmers are in dire financial straits. The province of Quebec has been penalized in the area of commodities, for example for lumber. That market is open, but not completely so.

Everybody remembers that, a few years ago, in the shoe and textile industries, we cancelled all protective measures for all practical purposes. The impact was such that, to this day, the resulting unemployment has not fully disappeared in various regions in Quebec.

The other question deals with investments. We have a good working force. My colleagues think that everybody is leaving, but some well-educated people are still remaining here.

We have at our disposal an almost unlimited quantity of primary commodities and competitive services. We have an efficient transportation system. The corporate tax system is competitive as well.

On one hand, the tax base must be increased in Canada in order to promote employment, because, even if we are below 10 per cent, conditions can always be improved. To improve productivity, new investments and the upgrading of equipment in the primary sector are needed.

With all the positive factors in the KPMG study, why did we not have a large influx of foreign investors? Did the political uncertainty we have in Canada penalize the whole country and particularly the province of Quebec?

Should we be worried as we start negotiating with the World trade Organization? We always negotiate in good faith. I feel that the previous phases were rather harsh for Canada, when we were following the rules and others did not.

What guarantees or demands should Canada have so as not to be the only one to open up its borders to foreign goods without being penalized?

Mr. Thiessen: I am not an expert on the rules governing international trade. In general, it can be said that a competitive economy is perhaps the best way to increase productivity. If the others do not follow the rules, what should we do in Canada? The decline of foreign investment in Canada results from the drop in the prices of primary commodity prices. International investors do not find it attractive when a drop in commodity prices affects our industries. Political uncertainty is never helpful. It is always better for a country to always have a very stable political situation. I think it is difficult to say more than that.

[English]

In general, it is always difficult for me to comment on political uncertainty. It is always easy for comments to be misinterpreted. Generally, I can just say that political uncertainty is not helpful. I apologize for finding it difficult to say more than that but, to be consistent, as Senator Oliver says, I must stay with that.

In that general area of international trade, I do not feel competent to comment. Those are difficult questions. It needs someone more expert than I to reply to them.

Senator Meighen: Welcome, Governor Thiessen and Deputy Governor Jenkins. I will get away from any political implications at all, which will be a novel experience for the governor and for me.

I appreciate the answers that you have given. I think I heard you say, "Look, we may be having a little trouble measuring up to the Americans, who are going through a most extraordinary and unprecedented boom; however, we are not doing so badly against other economies."

Taking last year, from December to December, the dollar -- which is some measure of how we are doing, I guess -- fell by 4.5 cents or 6.5 per cent against the American dollar. There has been a recovery since then to some extent, but that was the record last year.

In the same time, last year our dollar fell by 13 per cent against the Austrian schilling, the Belgian franc, the French franc and the Bulgarian leva. I will not belabour the point in Western Europe, but let us go elsewhere. It fell just under 19 per cent vis-à-vis the Czech koruna and the Japanese yen; 11.6 per cent against the Philippine peso; 28.4 per cent against the Thai baht.

The Chairman: You forgot the Irish punt.

Senator Austin: I think the point has been made.

Governor, could you comment as to why our record is so apparently dismal against other economies in terms of the strength of our dollar?

I will slip in another short question, if I may. To what extent do you feel that that is due to the debt gap, which is the ratio of net debt to GDP, between the United States and us? That gap went from 10 per cent in 1972 to 65 per cent in 1997. To what extent does that affect the exchange rate of our dollar vis-à-vis the United States?

Mr. Thiessen: Senator, you can always find various time periods in which you can make the point that you have made. Nonetheless, it is the case that, given the shock that we have absorbed, the fact that we have subsequently recovered to some extent on our currency shows that the movement in the currency reflected a certain situation. As that shock to commodity prices has eased, you have seen some recovery in the currency. That is exactly what you would want to happen.

Implicit in your question is a sense that this weakness will go on forever. I do not believe that it will go on forever. I believe that we will have some recovery in commodity prices. I believe that our economy will continue to improve, though perhaps not as rapidly as we should like. That improvement will be reflected in our currency.

I did not wish to sound quite as indifferent to our problems as you perhaps have described me. I accept the fact that there are some difficult issues that we must handle. I certainly accept that Canadians will typically make their comparisons to the U.S. I do react to any sense that all is lost, that we are in terrible trouble and are wondering how we will recover. I do not believe that that describes our situation.

Once again, as I said to Senator Angus, the foundations of the economy are stronger than they have been for some time. The private sector in Canada seems more oriented to being internationally competitive than they were for a good period of time in the 1970s and 1980s. That is terribly important. Fiscal and monetary policy are much more sound than they were in the past.

Those are important things that will allow us to get through this difficult shock and come out stronger at the other end. That is a cause for being positive.

Senator Meighen: Let me be clear, too. I share your fundamental optimism. I find the extent to which the commodity price fall has seemingly affected our economy, the value of our dollar, et cetera, disturbing. You are making a very strong case that that was perhaps a more serious event than we at least here had appreciated initially and that the so-called Asian crisis had a very serious and marked effect on our economy that we are just now starting to come out of.

I should like to move from the Asian crisis to another event noir, another area of ongoing interest: the question of inflation. That is an issue with which we have been wrestling longer than the World Wrestling Federation has been on television, and we have been quite successful in our wrestling match against inflation.

Some people are becoming increasingly concerned that our preoccupation with inflation could lead us into a deflationary situation, the consequences of which you are better able to comment on than I. After the Bank of Canada's 25 basis-point reduction at the end of March, one economist said that the rate cut is strikingly at odds with recent statements in which you had indicated that you were convinced that core inflation would soon move back into the target bands. That economist suggested that the bank essentially is signalling that it is really concerned that inflation in Canada is too low right now, and that the bank is doing whatever is necessary to push inflation back up into the target range.

Is inflation too low in Canada, governor? Are we flirting with real, honest-to-goodness deflation, particularly if the dollar goes up, bringing with it the falling of prices, presumably? What are the implications for our economy of a lower-than-target-band inflationary rate?

Mr. Thiessen: Senator, the Bank of Canada's commitment is to seek to hold inflation within a 1 per cent to 3 per cent band. We take both sides of that target band equally seriously. Thus, just as we would be very concerned if it looked like inflation was heading through 3 per cent, we are also concerned if it is heading below 1 per cent.

Our job is to provide the Canadian public and people who must make economic decisions in their everyday lives as individuals or businesses as much stability and as much certainty about the future as we can. Just as rapidly rising prices get in the way of making those decisions about the future, so too do rapidly falling prices. We try to avoid both.

If the inflation rate is low, we must ask ourselves, "Is it likely to come back inside the band? Are there risks that it will fall further?"

One reason we sometimes get misinterpretations is that monetary policy must always look into the future. We say, "What will happen a year or two from now, and what should we be doing now to respond to that?" We ask ourselves not what inflation is doing now, although that can be important in your view of the future, but what it will do a year or two from now and whether or not it will be inside the band. That is the crucial point. Will it be up at the top or at the bottom? We calibrate monetary policy in response to that.

At the last reduction in interest rates, we tended to make something of the point that it was unwinding, the last of the increase that we had undertaken in August when financial markets were so terribly disturbed and volatile. Having responded to that volatility, and now that it has disappeared at least for the most part, we felt able to unwind that.

Mr. Jenkins: If I might add another observation: In the policy framework that we use, various measures of inflation expectations are important. At the moment, depending on the different measures you look at, you would see that inflation expectations, whether measured through private sector forecasts or through financial markets, are all pretty much anchored at 2 per cent or a little bit below that. There is no sense in that measure, at least, that there is a downward trend in inflation.

Mr. Thiessen: I did not answer Senator Meighen's question on the debt gap. I must say I did not understand it.

Senator Meighen: My question was the following: To what extent does the size of our debt have an impact on our low dollar vis-à-vis the American dollar?

Mr. Thiessen: Are you speaking about public debt or international debt?

Senator Meighen: I am referring to public debt. In other words, if we were, with a magic wand, able to reduce our debt in half, would the dollar, in your view, respond dramatically?

Mr. Thiessen: There is a fear that that level of debt is rising and will not come down again. That is when you have the big impact, as we had in the beginning of 1995 with the Mexican currency crisis. That is when debt levels have a big impact. They make you vulnerable when the world is in a difficult circumstance.

I believe we got through this situation better because there is a strong sense that that public debt ratio to the size of our economy, debt to GDP, is falling and will continue to fall. I should like to see it fall a bit further. At these levels, if we had another major crisis in the world, I do not think we would be as protected or as isolated from it as I should like to see us, and I think a lower debt-to-GDP ratio would help.

The Chairman: With regard to your response to Senator Meighen, you said that you are as worried about falling below the 1 per cent lower limit of the band as you are about going above the 3 per cent upper limit. Canadians over the last 10 to 15 years have focussed entirely on the issue of getting inflation down. There is a widely held public perception that, in the end, if you could go all the way to zero, that would be absolutely marvellous. That has been the preoccupation in both public policy and speeches.

Since this program is on CPAC, it might be useful if you explained in terms that would be relevant to the average Canadian why getting inflation to 1.5 per cent is a good thing but getting it down to 0.5 per cent is a bad thing. Canadian public perception is that 0.5 would be much better than 1.5 per cent.

Mr. Thiessen: Mr. Chairman, as I said earlier, the real issue here is one of stability and predictability. Our current commitment is to hold inflation within a band of 1 per cent to 3 per cent. We agreed with the government on that band and agreed to extend it just at the beginning of last year. We have extended that target range out to 2001.

We have committed to providing Canadians with the certainty that holding inflation in that band will provide them.It is a degree of predictability. If you are a business person, you must make judgments. As you are looking at an investment in a piece of machinery or a new plant that will last some years into the future, you must say, "What kind of inflation rate should I take into account? What is that likely to do to interest rates in the future?" We are saying that 1 per cent to 3 per cent, with a centre point of 2 per cent, is the kind of value you ought to use for the change in prices in making your decisions.

We still have an ongoing, long-term commitment to price stability. How is that best defined? The commitment is to do that finally by the year 2001. Then I think we will be able, in a sense, to say something of a longer-term and more definite commitment. In the meantime, 1 per cent to 3 per cent is our commitment, and it is similar to the commitment that most central banks around the world have.

Senator Callbeck: There has been a lot of discussion lately about ways to reform the international financial system. One idea that has received a lot of attention has been the so-called "Tobin tax," the tax on international financial transactions.

I should like to have your views on that tax. Do you feel that it will help control the flow of speculative capital? If so, how would you see that tax being enforced?

Mr. Thiessen: I must admit that I am not a supporter of the Tobin tax. Indeed, I think it is a bad idea. It does not achieve the things that proponents of such a tax hope it will achieve.

The problem is that any level of tax on international financial transactions that you can imagine will not likely be very large. It will discourage those speculative flows of capital that respond to very small differences in interest rates or expected exchange rate movements. Those are exactly the speculative flows of capital that are helpful to us.

Think about the case in Canada, where we are still exporters of primary commodities. Those exports are often kind of lumpy. For example, we may ship a large quantity of wheat in the middle of winter, which gives us big receipts of foreign currency -- in fact, more than we need for the imports we want to buy. If nothing else happened, that could put strong upward pressure on our currency that would last until those receipts all came in. In the meantime, those people who have to import or export other things would find that difficult. The helpful speculative movements in capital help to smooth that out.

When there is a large sale of wheat and the dollar tends to go up, many people out there say that it is not permanent. They then sell the Canadian dollar to prevent it from rising. Similarly, when there is downward pressure, they buy it. They help to stabilize the currency. That is stabilizing speculation. A Tobin tax would likely discourage that.

The kind of speculators that you may not like -- that is, the people who basically believe that you have your economic policies fundamentally wrong and that your currency will go down, and they will sell it to ensure that it does go down -- expect to make huge gains and a small tax will not discourage them.

The Tobin tax is absolutely perverse. It discourages the good capital flows and it does not discourage those that could not be helpful. There are also the issues of how you would implement it. Unless everyone was on side, you would simply move many international investors offshore. I do not think it is a good idea.

Mr. Jenkins: I might usefully describe some of the initiatives that are being taken internationally to deal with some of the issues that are on your mind, senator.

Reflecting back on the international crises, reference has been made to Southeast Asia, Russia, Brazil and Mexico. A considerable amount of work is actually being done in the international community. The Government of Canada is very involved, as is the Bank of Canada. The general themes that we have been addressing include issues such as increased transparency and disclosure and more information for financial markets so that they can function more effectively. A prime example of that is the case of Thailand, where the government had undertaken future contracts in foreign exchange that no one knew about until after the crisis had hit. We are addressing issues of transparency, disclosure and more information so that financial markets, borrowers and lenders can take reasonable assessments.

As well, a great deal of effort is being undertaken in terms of implementing stronger banking systems in all of those countries. Standards have been pulled together by policy-makers around the world, including Canada. Organizations such as the IMF and the Bank of International Settlements are starting to role those systems out to strengthen the banking systems in those countries and, as well, are looking at ways to improve the incentives in the functioning of markets more generally -- for example, issues of exchange rate regimes.

It is not a surprise in many respects that many of the countries that got into difficulties were countries with fixed exchange rates that created one-way bets in many of those markets. Much is happening to try to deal with the problem that you identified.

Senator Callbeck: I should like to ask a short question concerning Atlantic Canada. I read that in 1998, the four Atlantic provinces saw deflation of about one half of 1 per cent. Has that caused you a great deal of concern? What are the ways of making monetary policy regionally sensitive?

Mr. Thiessen: I do not think that there are any ways of differentiating monetary policy region by region. One reason for that low level of inflation and, perhaps, a net decline in Atlantic Canada concerned the harmonization of sales taxes in Atlantic Canada with the GST, which resulted in a decline in indirect taxes. That is what caused the consumer price index to be particularly low.

Although we cannot differentiate region by region on monetary policy, we must take account of the situation in each region. We have to add it all up. Monetary policy must operate at a national level. You simply cannot have differential interest rates or a different exchange rate from one region to the other. When we are setting that national policy, we must ensure that we are dealing with the average across the country, taking into account each region and giving it a weight that is equal to its weight in our economy. That is what we do.

Senator Tkachuk: My questions relate to earlier exchanges on the floating exchange rate and what I think is a lack of confidence in our Canadian dollar, although you attribute it to the lower commodity prices. It seems to me that we have a floating exchange rate to weather our shocks, as you say. However, at the same time, maybe it camouflages our shocks.

If the Canadian dollar is weak because of falling commodity prices, then it would seem that there would be a benefit to manufacturers of products and exporters that would compensate for that. Therefore, our dollar should not drop as dramatically as it has -- at least, theoretically, one would think. Why has that not happened?

Mr. Thiessen: In fact, it has happened. The decline in commodity prices from early 1997 to the end of 1998 was about 20 per cent; the decline in the exchange rate was about 8 per cent. It does not make up for it completely, but that means that primary commodity producers are still in some difficulty. They have not been shielded from this shock. However, it has made the manufacturing industry in Canada more competitive. We have seen very rapid rates of growth of our exports. That is exactly one of the reasons that the Canadian economy has come through this period as well as it has.

Our primary commodity industries have been suffering -- you will see that if you go to B.C. -- whereas the manufacturing sector, in particular in central Canada, has been doing very well. That is exactly what you would expect. It takes a little while for that to happen. When suddenly confronted with a lower exchange rate and a more competitive position, it takes the manufacturing sector a little longer to gear up. Our exports have been getting stronger and stronger as we go along. We would expect that to continue through 1999. The process is happening; it just takes a bit of time.

Senator Tkachuk: Instead of having a shock to the system to make people react, we have this manufactured influence. I would argue that there has been an increase but not a substantial increase considering the competitive edge they get from our dollar. At the same time, the citizens of this country are paying more for imports, not only from the United States but from other parts of the world, as Senator Meighen pointed out, while our dollar is falling against other currencies.

Indirectly, then, Canadians are subsidizing our efforts to become more competitive; are we not? We have to bring stuff back for the stuff we send. All our imports are more expensive and we are paying more for them than we should. Rather than the manufacturers becoming more productive, they are getting used to an exchange rate that gives them a competitive advantage. We as Canadians are paying much more for our imports. That is not good for our country, is it?

Mr. Thiessen: Remember, we have been hit with a major shock. We must respond to it. Ask yourself what would happen if we just held the exchange rate at 72 cents. That is the thought experiment you must experience.

Suddenly, commodity prices have dropped substantially for all our primary producers. Now, all of a sudden, our export receipts are much less than they used to be because the prices of all those commodity exports have gone down.

We have to make up for that, otherwise we will have a much larger deficit on our current account. If you hold the dollar steady and you do not let it adjust, then you must drive down prices and wages in the whole Canadian economy until such time as we are super-competitive and we can make up for that. Those are the choices that you face. It seems to me that the flexible exchange rate is the preferred alternative when faced with that choice.

Senator Tkachuk: I disagree with you, because I think it makes manufacturers less competitive. They do not have to compete. When the dollar drops, their exports are cheaper. Countries with stronger dollars, like the United States, are still being competitive at a dollar that is substantially higher than ours. In the long run, we will have much more pain than if we had it suddenly. We may disagree on that but that is my opinion.

Mr. Jenkins: I will provide you with a few numbers, although I admit they are somewhat selective. Consider what has happened to numbers like output by sector. In the period since mid-1997 when the Asian crisis first hit, output in the resource sector was basically flat. That is in terms of volume of production. Manufacturing was up over 8.5 per cent, while economy-wide output was up 5 per cent. You will see similar sorts of numbers for employment. You will also see that non-automotive manufacturing exports are up, year on year, in the order of 15 per cent.

Those sectors that are benefiting are shown clearly in those data. That is the adjustment process to which the governor was referring.

Senator Tkachuk: Are you and the Minister of Finance on the same wavelength regarding the Tobin tax?

Mr. Thiessen: I do not know whether we are or not, but it is certainly something that we have examined at the bank. I really do believe it is not a good idea.

Senator Tkachuk: I hope he is listening.

The Chairman: In response to Senator Tkachuk, you said that the advantage of the flexible-exchange-rate policy is that it gives the economy time to adjust. The underlying assumption, therefore, is that the manufacturers are adjusting. That raises several questions. First, is there any evidence of that? It seems to me that, human nature being what it is, if a manufacturer is saved temporarily from a problem by a flexible exchange rate, that manufacturer will not necessarily be inclined to undertake that adjustment.

To get back to your earlier comments, if the Japanese economy recovers, will Canadian manufacturers be competitive? Will they use this current period to make the necessary adjustments to become more competitive? Is there any evidence of that? Are we likely to run into a situation, once the Japanese economy recovers, where our manufacturers become less competitive because they have not made the necessary adjustments? In other words, to what extent does shielding them now lead them to a finding that the shelter was undesirable because they did not take advantage of the opportunity?

Senator Austin: What does your econometric model show as the cross-over point in terms of the Canadian currency and manufacturing competitiveness? In other words, when the dollar rises, how far does it have to rise before that competitor shelter disappears?

Mr. Thiessen: That last question is a very difficult one. I do not know that I have an answer. It would differ between products and companies. In general, we are not shielding anyone from anything here.

With the decline in primary commodity prices, even though our currency has gone down, the situation for primary commodity producers is worse than it was before. They will not be expanding; they will likely be shrinking.

In this process then, you want to move employment out of those shrinking industries and into areas that can potentially expand. At the same time, your net exports have just deteriorated because your export receipts from primary industries are lower. You must then generate more export receipts in your manufacturing sector.

What process will cause that to happen as smoothly and as quickly as possible? A flexible exchange rate really does do that. It provides a huge incentive for the manufacturing sector to expand because their prices, in U.S. dollars, have remained constant, let us say. The Canadian dollar is down. That gives them a big incentive to expand and to attract some of those employees out of the primary commodities industries into the manufacturing industries.

As Mr. Jenkins was saying with some of those numbers that he quoted, that process is happening. It does not happen instantly but it certainly happens much more readily than if you force all of that to happen by driving down wages. The way you drive down wages to become more competitive is by running up your unemployment rate to a very high level.

Senator Joyal: I return to page 3 of your brief on the issue of common currency. As you know, this committee had the benefit of a round table last month. The pros and cons and the importance of various methods were discussed. Was anything expressed in the opinions given on that occasion, either for or against, that was new to you or that led you to investigate further your position?

Mr. Thiessen: No. I think we had heard all the arguments before. We had seen the work by Professors Courchene and Harris before. We had read some of the work done by Professor Grubel as well. No, there was nothing new in all of that. Senator, we have examined this area very carefully over the years. It is an important issue for Canada. The exchange rate is an important thing. We have spent a lot of time -- many years -- looking very carefully at those issues.

When the question of a European monetary union was first being discussed, we looked rather carefully to see how the situation in Europe compared to our situation. If they found monetary union attractive, was there something in their circumstances of which we should be aware? Was there something different that said that monetary union is good for them but not good for us? We examined that range of questions. This is not something that has come to us out of the blue. It is indeed something that we have thought about carefully.

No, I did not see anything new in that discussion. I did read the transcript.

Mr. Jenkins: From my reading of the transcript and from looking at the experience over the last several years around events in emerging markets, I believe that the choice set here really does not include issues such as fixed exchange rates. Look at what happened in Europe in the early 1990s and look at Asia and Brazil. Those countries that have had fixed exchange rates just were not able to sustain that for a number of reasons.

We have been tracking very carefully the basic issues that were discussed around the movement to a European monetary union.

Mr. Thiessen: The real choice is flexible exchange rate on one hand or a currency union or a currency board on the other, and nothing much in between.

Senator Joyal: Is it possible for you to publish all of the reflections and studies that you have done in your department so that the information will be available to the public? You said that you spent ample time thinking about that. Since the thesis of the supporter of the other option is fully available and circulated, would it not be helpful for the Canadian public to have that?

Mr. Thiessen: Much of it is already published. I must admit that some of it is, as is usual in economics, on the technical side.

Professor David Laidler from the University of Western Ontario is spending a year with us as an adviser, and he is about to or has already published a complete review of exchange-rate regimes and monetary policy that I think does cover all of the ground and covers it rather well. I must admit, senator, that, as economists are wont, it is not always as simple and as straightforward as one might like it to be.

Mr. Jenkins: We could certainly make copies of Professor Laidler's working paper available. It was out just last week. It is one of those papers that does not have an equation. From that point of view, it is quite readable.

Senator Joyal: On the issue of monetary policy, you discussed with Senator Callbeck the regional impact of the monetary policy. Would it be fair to say that if you were to sit on behalf of Canada on the new inter-American bank or continental bank, call it what you want, that your impact on that bank's decisions on monetary policy would be perhaps as minimal as Atlantic Canada is in determining Canadian policy?

Mr. Thiessen: No, I do not think so. You must take account of all parts of the country, and you take account of them by their economic weight. That is something that I think we do rather well. Quite evidently, the bigger the economic weight of a region, the more influence it has on the national statistics that we must take into account.

However, I must tell you that I cannot imagine an inter-American central bank. I do not think it would happen. If you are looking at some sort of monetary union, that is simply where people use the U.S. dollar without any influence.

Senator Joyal: In relation to the financial services sector, would it be fair to say that if we had the dollar as our currency, there would be tremendous pressure on the financial sector to be much more open to American ownership than it is now with the limit of 10 per cent and the protection that we have on the financial services sector?

Mr. Thiessen: I do not know whether that necessarily follows or not. It is interesting that in Europe, for example, the mergers to be ready to deal with the common currency area are occurring within France rather than across borders. Whether you would end up having a lot of cross-border movement, I do not know. It is a difficult question. I cannot give you an easy answer on that.

Senator Ghitter: Gentlemen, although I am not, due to my youthfulness, a member of the committee, I am very happy to have an opportunity to meet with you. I always look forward to the opportunity and try to be here because I find the discussion very illuminating and worthwhile.

I must say, though, that today I find some of the comments rather worrisome, because of your dedication or involvement in the commodity price side of things. Coming from the west, I know what commodity prices can do to an economy. It seemed that you were continually referring to commodity prices as being the basic problem and the reason for many of our ills. I do not disagree with that to an extent, but, if that is the case, it speaks to failed economic policies in our country that have been going on for some time.

Surely we would be much better off as a nation if we were not so reliant on the sale of our resources and were value-adding to those resources. I find it a great concern that, even today, we hear the governor of the Bank of Canada suggesting that the ills that we are facing are a result of our falling commodity prices. I should like your comment on that.

My second question relates to my colleague Senator Oliver's comments on the consistency that we have received from the bank over the last number of years. I recall three or four years ago coming to this same meeting and pushing for reduced interest rates. As I recall, at that time we were told that we had to be careful about reducing interest rates because that would have an impact on our dollar, and we must defend our dollar.

I recall also that I was told after that meeting that we must be careful of our dollar falling too far because, if it does, it encourages the lack of efficiency and the lack of productivity of our industries and our country. It seems to me that I am hearing a somewhat different argument from you today, and I should like you to comment on that as well.

Mr. Thiessen: I need to make it clearer than evidently I have until now. I am not suggesting to you, senators, that a fall in commodity prices is the source of all the problems of an economic sort that we face in Canada. I am saying to you that our economy would be stronger than it is right now if we had not been hit by a commodity price shock. Indeed, I would suggest to you that we would be operating this economy at full capacity right now had it not been for the commodity price shock.

The other thing I am saying to you is that our currency would be higher than it is if we had not been hit by that decline in commodity prices. I am not saying that all the issues that may have to do with long-run productivity growth, issues of taxation, the size of government, are somehow related to commodities.

I am saying that the cyclical state of our economy would be stronger right now and our currency would be higher were it not for commodity prices. That is all that I am saying to you, and nothing more than that.

Senator Ghitter: What is your advice to the government or to the Canadian public as to how, as a country, we could become less reliant on commodity prices?

Mr. Thiessen: That is an interesting question. If we cannot produce commodities and export them and make a good profit and generate good employment and reasonable wages, then we should get out of them, and we will get out of them automatically. If, however, we continue to be rather good at producing them and if we can make good incomes for Canadians in producing them, then I do not see why we should want to get out of them.

Yes, there is a cycle in commodity prices. However, if, on average and over time, it makes this country wealthier than it otherwise would be, I do not see why we should complain about it. Indeed, I would submit to you that Canada would not be as wealthy as it is right now were it not for the fact that we are blessed with a large quantity of primary commodity industries. It may well be that they will continue to decline over time because we can make more money and because we can be more prosperous doing other things. If that is true, that process will happen. However, I am not persuaded that to say that we should somehow make it a matter of government policy that we will get out of those things, which have basically been the underpinnings of Canadian wealth.

Senator Ghitter: I do not think anyone is suggesting that for a moment. I come from an area where we have depleting, non-renewable resources. We must have economic policies that would spread out our position and make us less reliant on those non-renewable resources. In the long term, it is important for the country that we have policies that decrease our reliance on commodities and focus more on the broader spectrum of our economy. That, judging from your remarks this morning, may be lacking.

Mr. Thiessen: It is certainly true that you want to administer non-renewable resources very carefully. I certainly accept that. You want to be mindful of the fact that they are non-renewable. I have no problems with that.

I am reacting just a little to the notion that because we are currently in the down part of a cycle of commodity prices that commodities and our ability to produce them efficiently and profitably is somehow a bad thing.

I hope you mischaracterized, senator, what I said on another occasion concerning the issue of interest rates and defending the dollar because that is not precisely the way I would put it, quite frankly. The Canadian dollar is an important price in this economy. We look at it all the time. As I was saying earlier, we are constantly trying to gauge whether the combined effect on our economy of the level of interest rates and the Canadian dollar will lead to an economy that is moving toward full capacity without inflationary pressures. That is what we are trying to do. Thus, we are always looking at the Canadian dollar.

If the dollar were to fall substantially and it looked to us like that would likely cause our economy to expand incredibly rapidly and lead to inflationary pressures, then we would respond to that, and vice versa.

Senator Ghitter: For future discussions that the governor may have with the Minister of Finance, I bring to your attention a motion that came before Parliament dealing with the Tobin tax. It was moved that the government enact a tax on financial transactions in concert with the world community. I notice that the Minister of Finance voted in favour of that resolution. You might want to know that, sir.

The Chairman: I do not think that that requires a reply.

Senator Austin: I should like to raise two short points. First, you invited a comment on the stewardship of the Bank of Canada. I should like to ask you about your board of directors and whether the board of directors is consulted about the kinds of issues that we have heard raised around this table. Is the interest rate scenario discussed? Is the currency exchange question discussed? Have you discussed, for example, fixed versus floating rates, in the last 12 months? I am not going into the discussion; but what type of discussion takes place at the board level?

Mr. Thiessen: The Bank of Canada Act provides that my colleagues on the governing council and I are responsible for monetary policy. The board is responsible for the overall management of the bank and its stewardship of public funds. What that really comes down to is trying to make a judgment about the quality of our management of monetary policy, the currency and the other things that we do.

If you are on a corporate board, let us say in the chemical industry, you do not pretend that all the board members will be chemists. What they need to know is whether the quality of the decisions of the management is good or not. That is what our board seeks to do. We discuss all of these issues with them, but the decisions are those of the governor and the governing council.

They need to try to benchmark us. If you are talking about human resource management or computers, that is not too difficult to do. When you are talking about monetary policy, it becomes rather more difficult to do. Not only do we provide them with what we do and why we do it in monetary policy, we provide them with the judgment made by the International Monetary Fund and the OECD on Canadian monetary policy. Indeed, a year ago, they had an in camera session with two senior people from the International Monetary Fund who advised our board on the quality of the economic analysis that goes into monetary policy.

Senator Austin: I appreciate your answer, sir.

There is a perception that regional advice is lacking to the management of the Bank of Canada. I am sure that the perception is not actually the case. I am sure that directors from British Columbia or Saskatchewan express a regional view when you debate these questions. However, do you agree that the perception of the regional role or the regional influence is not there and do you feel there is some way of appointing the board of directors that would bring the sense of regionality closer to the community in question? Has that been discussed by your board?

Mr. Thiessen: No. Our board is more active and better known in the members' regions than, perhaps, you give it credit for. We are probably not always high profile. We have regional representatives. There are Bank of Canada representatives in British Columbia, on the Prairies, in Ontario, in Quebec and in Atlantic Canada. Their job is to keep us informed. As you rightly say, our directors are quick to tell us if they think that we do not fully perceive what is going on in their regions.

We also try to get out there as frequently as possible. For example, Paul Jenkins will go out to Vancouver, Victoria, or the Okanagan to meet with our director and our representatives there to discuss what is happening in the economy and with monetary policy. The last place he visited was Prince George. Part of what we do is try to get out and make sure that we understand what happens.

Senator Austin: I take it you do not believe that any changes are required at this stage, on substance.

Mr. Thiessen: I am pretty pleased with the way things are going right now, yes.

Senator Austin: On substance, then, there is no change. Regarding perception, do you think the message is that the Bank of Canada is sensitive to regional concerns?

Mr. Thiessen: I hope that that message will get clearer and louder in the future.

Senator Austin: I am giving you the opportunity to make it so.

My other question has to do with the role of gold as a storehouse of value. It appears that the role of gold has declined dramatically in that sense and that it has become a commodity like any other commodity. Could you comment on the role of gold?

Mr. Thiessen: It certainly is declining. The years in which people felt the need to hold a certain quantity of gold as a backing to their paper currency have disappeared. The last vestige of it in Switzerland was just announced as disappearing this week. They must be, perhaps, the last industrial country that has any kind of link of that sort.

Most central banks and governments still hold a certain amount of gold. The argument for it is, essentially, the question of what would happen if the international financial system completely broke down. The probability of that is minute, but of course if it were to happen it would be disastrous. Gold might well be a useful international currency in this circumstance. Thus, most central banks, most countries, continue to hold a certain amount of gold. In the view of many countries, that amount is not very large. Many countries are getting rid of what they feel are excess holdings of gold.

The Chairman: I wish now to thank the governor and the deputy governor for spending a very interesting two hours with us. We appreciate your doing that.

The committee adjourned.