Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 22 - Evidence
OTTAWA, Wednesday, May 2, 2007
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:05 p.m. to examine and report
upon the present state of the domestic and international financial system.
Senator Jerahmiel S. Grafstein (Chairman) in the chair.
The Chairman: Welcome. We are pleased to have the Governor of the Bank of Canada, Mr. David Dodge, appear
today to present his Monetary Policy Report Update: January 2007. He is accompanied by his Senior Deputy
Governor, Mr. Paul Jenkins. The meeting will be broadcast on CPAC for Canadians from coast to coast to coast, and
the witness testimony will reverberate in all the capital markets around the world via the internet.
For the benefit of our listening and viewing audience, pursuant to the Bank of Canada Act, the Bank of Canada has
the specific objectives to regulate credit and currency in the best interests of the economic life of the nation; to control
and protect the external value of the national monetary unit; to mitigate, by its influence, fluctuations in the level of
production, trade, prices and employment, so far as possible within the scope of monetary action; and to promote the
economic and financial welfare of Canada.
In practice, the Bank of Canada conducts monetary policy by adjusting the target for overnight interest rates, with
changes in this rate often affecting the banks' prime lending rates as well as mortgage and bond rates, which are
important to all consumers.
Mr. Dodge, we are eager to hear your statement and your views on such timely topics as the relative appreciation of
the value of the Canadian dollar in recent days; recent spikes in gasoline prices and the implications that this might
hold for your next interest rate announcement, which we understand is scheduled for later this month. We are also
eager to have your views on another the topic of hedge funds, which is currently before the committee following your
encouragement, and on your assessment of domestic and international capital markets in this context. Honourable
senators will be interested in your views on regulation and oversight of the hedge fund sector and other issues.
Mr. Dodge, some days ago, we received with regret an announcement that you have decided to retire as the
Governor of the Bank of Canada. We are sorry that you are leaving but we are delighted that you will be here for
another nine months. This will be your penultimate appearance before this committee. We are always fascinated and
taken by your comments and so we welcome you and Mr. Jenkins.
Before we proceed, I will introduce senators at the table today: my distinguished Deputy Chairman Angus, from
Montreal; Senator Johnson, from Manitoba; Senator Moore, from Nova Scotia; and Senator Biron, from Quebec.
Other senators will join us soon.
David A. Dodge, Governor of the Bank of Canada, Bank of Canada: Thank you very much, Mr. Chairman, and good
afternoon, senators. As always, it is a great pleasure to be here. We truly appreciate your giving us this opportunity to
meet with the committee twice each year following the release of our Monetary Policy Report and Monetary Policy
Report Update. Through this committee to all Canadians, we hope that we can keep people informed of the bank's
views on the economy, on the objective of monetary policy and on the actions that we take to achieve our goals.
When Mr. Jenkins and I appeared before your committee last October, we noted then that the outlook for growth in
the Canadian economy had been revised down slightly from earlier expectations.
In our latest monetary policy report, which we released last Thursday, we noted that Canada's economic growth did
indeed slow, but recently, inflation has been higher than expected.
After considering the full range of indicators, the bank now judges that the Canadian economy was operating just
above its production capacity in the first quarter of this year. We expect that, over the projection horizon, domestic
demand will continue to be the main driver of growth in Canada.
With the U.S. slowdown now expected to be somewhat more prolonged than previously projected, net exports
should exert a slightly greater drag on Canada's growth in 2007.
The Canadian economy is now projected to grow by 2.2 per cent in 2007 and 2.7 per cent in both 2008 and 2009.
This would return the economy to its production capacity in the second half of 2007 and keep it there through 2008
Core inflation should remain slightly above 2 per cent in the coming months, given pressures on capacity and the
impact of higher core food prices. With the economy projected to return to its production capacity in the second half of
this year, and with further easing of pressures from housing prices, upward pressure on core inflation is expected to
moderate, bringing core inflation back to 2 per cent by the end of 2007.
Total CPI inflation is projected to rise above the 2 per cent inflation target in the second half of this year, peaking
below 3 per cent near the end of 2007, before returning to target by mid-2008.
We at the bank continue to judge that the risks to our inflation projection are roughly balanced although there is
now a slight tilt to the upside. Last Tuesday, as you are aware, we left our key policy rate unchanged at 4.25 per cent,
and we judged that at the current level the policy interest rate is consistent with achieving the inflation target over the
Mr. Jenkins and I will now be happy to answer your questions and have our usual very good discussion with you.
The Chairman: Governor, thank you very much. I will start the questions with our distinguished deputy chairman,
Senator Angus from Quebec. Governor, we have a long list of questioners and I know you have to be out of here
within 75 minutes. I would urge senators to make their questions sharp and cogent, and Governor, you could respond
in kind. We believe in reciprocity.
Senator Angus: Welcome, Governor and Deputy Governor. I, too, look forward to these séances with you folks at
least twice a year. I always learn a heck of a lot from them and I know I will again today.
In the context of the chair's remarks about your retirement, all I know is that nine months is long time in public life,
and I do not want to focus on your going at all. There is so much that is relevant, and we are interested in hearing your
thoughts. We do not want to focus on the future, but the here and now.
I have two quick questions and then one that might generate more discussion. I was quite disappointed to read in
the press today Alberta has said that it is officially against a single national securities regulator. That statement was
made through the premier, apparently in contradiction to the advice of his financial advisors.
In earlier séances, we have discussed how not having a single national securities regulator is an impediment to
productivity in Canada. It is a glitch in an otherwise pretty good financial services system. I just wondered if you had
any particular comment on that particular situation.
Mr. Dodge: Senator, I think one ought to be very careful about jumping to too many conclusions on press reports,
and what will happen in the future. We all recognize that a national single system of securities regulation would be a
great advantage. It has to be the right system, the right regulations and the right set of rules. Perhaps even more
important, we recognize that we need to enforce the rules in a way that gives people more confidence that the rules are
being enforced. That clearly would be a lot easier in a single national system.
The precise form of that system, for us at the bank is of less concern, than the fact that there be a single system,
appropriate for large as well as small public firms in raising capital in this country, and that the rules are enforced to
give investors confidence, faith and trust in the way the markets operate.
Senator Angus: I would take that to mean we should not lose heart and continue in our endeavours with the Minister
of Finance to try to work towards that end.
Mr. Dodge: I think so.
Senator Angus: Notwithstanding that press notice.
Still on the subject of press notices, I happened to see in today's press, that after your opening statement at House of
Commons Standing Committee on Finance yesterday, you would have been queried in some regard about what is
becoming a rather controversial element of the recent Budget 2007 on deductibility of interest in certain international
I am wondering if I can believe what I read in the press, that you felt that all these measures are difficult, that this
was to the extent that it was aimed at closing certain loopholes, was a positive step in your view. Is that correct?
Mr. Dodge: Yes, senator. This is an extraordinarily difficult area of taxation policy. It involves all sorts of parts of
the act; it includes foreign affiliate rules, it involves thin cap rules, and a whole pile of rules that are extraordinarily
complex. I took the minister very much at his word. He wants ``. . . to track down and deal with those who try to use
aggressive international tax planning to shirk their tax obligations and increase the burden on other Canadians.'' That
seems to me to be a pretty good single objective, although not an easy objective to achieve. I also noted that what he
thought in terms of revenue loss, he added in tens of millions, which does not imply we will have a root and branch
uprooting of the act. I took that at its face value, and as he works away to try to deal with this very complex issue that
he understands very well, that the objective is, in fact, to promote the economic welfare of Canada.
Senator Angus: I appreciate that answer, sir. In a larger sense, and flowing from my colleague, Senator Grafstein's
comment, one of our major current preoccupations is the hedge fund industry, or perhaps now we are learning to refer
to the part that concerns us as the leverage debt circumstance. We have had various witnesses. We have traveled to the
U.S. to interview people and to see what the legislators south of the border are thinking in light of rapidly unfolding
global events in this area.
We were told last week that the notional, or underlying value of the money that is out there in these structured
highly leveraged products, is in the range of $350 trillion. It is a number that is just makes all of our heads spin and we
cannot really get a handle on it.
A gentleman from Toronto, who I think is widely regarded as knowledgeable, conservative and thoughtful on the
subject, told us that he was very concerned at the moment at the state to which matters have evolved, particularly
because of what he characterized as a ``lending mania.''
He indicated that margins were higher than he felt were healthy and that there was, once again, a revisitation of the
failure of investors and people to follow the old rules of risk management and the real elements of caveat emptor. He
thought we were in a very precarious situation.
I wonder what you have to say about that.
Mr. Dodge: Well, let us be careful of those words ``very precarious.''
Senator Angus: Okay. Precarious.
Mr. Dodge: First, I am very pleased that this committee has taken up this issue. Over history, central bankers and
regulators worry about leverage. Leverage is an enormous advantage to the economy. Through banks and markets we
can spread the risks and pool the risks in such a way that it is of enormous advantage.
On the other hand leverage is, or can be, a dangerous instrument when credit is not managed carefully. Certainly, all
of us as central bankers around the world have become a little bit nervous about the extent to which the spreads on
market debt, the spreads on CDOs, and the spreads on a number of other products have become very narrow.
The Chairman: Governor, since you are speaking to the public, tell them what you mean by CDOs.
Mr. Dodge: That is the additional interest demanded over government bonds or other risk-less securities. It is the
additional interest demanded by lenders on what could be risky investments. That amount of extra interest has become
very small and may not well represent the real risk that is out there in the market.
When there is a lot of money available at pretty thin spreads over, let us say, Government of Canada, or U.S.
Treasury or British gilt bonds, then there is a temptation to lever up, as you indicated in your remarks, and maybe lever
up without due regard to the underlying credit risk.
This is expressed in various different ways, as you go around the world. One set of words is: There is a wall of money
out there. Indeed, it is true on a global basis that savings are relatively high, but one would not have expected that the
spreads might have become quite as narrow on types of investments that carry more risk.
It is not just the spreads. We have gone through a period, which up until now, the covenants on many of these loans
have been relaxed. It is not just that money is being lent relatively cheaply, compared to risk-less securities, but that
some of the covenants which traditionally have been there, are watered down as well.
Other central banks might express it slightly differently, but that is the issue of worry. Whether it is a hedge fund, or
a private equity fund — we now use the expression ``pools of private capital.'' We must worry whether the credit is
being appropriately managed.
The worry, of course, that we all have as central banks, is that if something upsets the system and people rush to the
exits, that the liquidity that appears to be there at the moment, because volatility is very low at the moment and
markets are very liquid, could dry up fairly quickly.
It has been about 18 months since the Basel meetings and during that time, we have been trying to turn over the
rocks to find the problems. We have found some particular problems, the back office operations of securities firms for
example. They are relatively fixed up.
There is this overhang or apparent overhang — I have to be careful of my words — of money that is available at low
rates relative to the potential risk, and that worries us. This is not in the banking system. We spent a lot of time globally
looking at the risks inherent in the banking system, because that is where the ultimate leverage lies.
Listening to my colleagues abroad and our own monitoring, indicates that the banking system has been careful. It is
out there in the broader market. You might ask the superintendent about her views on the subject.
The Chairman: We did have the superintendent here. We intend to have her back. As Senator Angus has indicated,
we have heard some troubling evidence that was different than what we heard earlier on, so we will bring her back to
ask exactly those questions.
Senator Moore: I want to follow up on Senator Angus's question concerning the deductibility of interest charges for
investments in foreign acquisitions.
There was a piece published in the National Post today attributed to John McCallum, Liberal finance critic. He says:
The new policy, which is embedded in the federal budget, means that when Canadian companies borrow
money to finance foreign acquisitions, they will no longer be able to tax deduct the interest on that debt. Since
U.S., European and Japanese companies are generally allowed to take such tax deduction, Canadian companies
will be forced to compete with one hand tied behind their back. . . . So, the government's proposal will put any
Canadian company in a big disadvantage compared with almost any foreign company when it comes to foreign
You have stated that you think this policy is a good one. Have you done any research? On what information have
you based that statement, in view of Mr. McCallum's comments?
Mr. Dodge: I took the stated intent of what the minister wants to do, which is to deal with those who try ``. . . to use
aggressive international tax planning to shirk their tax obligations and increase the burden on other Canadian
That is what he said is his prime objective and I take that at face value. He has not said how that is to be done; that
will come in the very detailed legislation. This is a terribly complex area and spreads through many parts of the act.
One should be very careful about jumping to any conclusions as to what will be in there until the minister presents
his draft legislation. We know that because the rules are complicated and because of the international situation with a
number of jurisdictions, with low or zero tax rates, that it is possible to abuse the spirit of the rules. It is very difficult to
deal with this and what I said yesterday is that I really welcome the fact that they are going back to try and deal with
those very difficult issues. He mentioned that perhaps it is several tens of millions of dollars, which in my view does not
indicate a minister who wants to go root and branch at the whole system. I truly think that we must wait to see how
that extraordinarily complicated piece of legislation will be written.
Senator Moore: The government said that it could cost $40 million to $1 billion for Canadian companies. We will
have to wait for further details. On the face of it, it looks like Canadian companies will be put at a disadvantage, but we
will have to see what comes forward. Perhaps it could have been solved some other way; I do not know.
Mr. Dodge: Senator, it is very complicated. Let us not pretend that there are no problems with the way the
legislation works. It is difficult and complex to fix such problems in a way that he would like to fix them. I am sure that
he does not want to put Canadian companies out of business. We need to wait to see the technical part of the
legislation because the devil is in the details of the Income Tax Act.
Senator Moore: In your opening statement, you said that you expect that over the projection horizon, domestic
demand will continue to be the main driver of growth in Canada. The last time you were here, we talked briefly about
the economic agreement between British Columbia and Alberta. Have you kept track of the positive impact of that
Mr. Dodge: No, we have not done so, senator.
Senator Moore: There was mention of Ontario joining this agreement. Have you looked at those numbers to
determine what that might mean in terms of increasing domestic productivity?
Mr. Dodge: No, we have not; however, in essence we can only go with first principles. More flexibility in our market
means tearing down barriers between the provinces. It also introduces that flexibility that is so important in raising
productivity and in mitigating economic fluctuations in the economy.
Senator Moore: As Senator Angus mentioned, the committee heard evidence last week on hedge funds. The figures
on its worth ranged from $1.5 trillion to $340 trillion — a great discrepancy. People do not seem to have a handle on it
because it involves pools of private monies. Are you prepared, or do you wish, to offer any comment on oversight of
the hedge fund industry?
Mr. Dodge: ``Industry'' is a funny word. The Bank of Canada, as a banking regulator, focuses primarily on the
intermediary institutions that, by their nature, drive much leverage. Again, by their nature, if they were to get into
trouble, it would have enormous repercussions across the system. Senator, you are absolutely correct in saying that in
respect of the unregulated part of the world, which has grown bigger, we have considerably less information.
Currently, part of the G7 finance ministers' efforts is to find ways to get more information that would be truly useful.
Senator Moore: Do you say ``useful'' in terms of quantity or oversight?
Mr. Dodge: It would be useful in terms of understanding the risks building up in the system as a whole.
Senator Moore: We heard evidence that for 20 per cent you can leverage up to 80 per cent. What is behind that? I
found it rather unsettling to think of that paper transaction growing 30 per cent per year. In a couple of years' time, we
will be talking about figures in the quadrillion range.
Mr. Dodge: One must be careful.
Senator Moore: That is leveraged investing and not necessarily the hedge funds.
Mr. Dodge: Again, you must be careful. High-risk debt has always existed. Those instruments have traditionally
carried premium over risk-less securities of 1,000 or 1,200 or 1,500 basis points. If we look at the broad measures that
we have historically considered riskier instruments, the spreads are quite narrow in comparison. The cost of levering up
in this way is quite low, not just because treasuries or Canada's banks are trading at 4 per cent but because these
instruments are trading at 200 down to 100 points over. These issues are worrying in terms of whether that credit is
being appropriately managed.
Senator Eyton: Mr. Dodge, I want to raise the matter of income trusts, which has been the subject of much
discussion in recent months. In particular, I want to refer to some of the comments you made to this committee last
fall. You said at that time, ``The work we have done in terms of capital markets per se is that probably, on balance,
income trusts make markets somewhat more complete and somewhat more efficient.'' You went on to say that has
nothing to do with the tax treatment and that it is appropriate that businesses face a level playing field in choosing the
form of corporate organizations that allow capital to be allocated for its most efficient use.
The committee deemed those words to be most reassuring. I also note that your name appeared in a one-half page
ad sponsored by the Coalition of Canadian Energy Trusts, who fought a valiant campaign.
This appeared in the April 12 edition of the Toronto Star. The heading said that leading experts have told
government the decision to tax trusts is wrong. It then went on to say that, ``Mr. David Dodge said that the income
trust structure may be very appropriate where firms need only to manage existing assets efficiently.''
It is hard to challenge that comment but used as it was in that context, were your words taken out of context or were
they misleading in any way?
Mr. Dodge: Senator, when I first joined the navy Mr. Diefenbaker was Prime Minister. We had pencils on which was
printed, ``Misuse is abuse.'' The way my words were used in that ad reflects perfectly the printed message on our pencils
in the Diefenbaker era.
Senator Eyton: I would like to pick up on two observations that you made before the House of Commons committee
in February. The first was that the different risk-return characteristics of income trusts might not enhance market
completeness if they arise from differences in tax treatment. The second comment was that the problem is that
inappropriate business decisions have been made in an effort to save on taxes. Could you elaborate on those two
Mr. Dodge: Yes, that goes back to the first quote from my comments last fall, senator. The income trust form of
organization is entirely appropriate in certain business situations that manage a pool of assets to try to maximize the
return over the life of the assets.
Absolutely, it is an appropriate form of organization. It provides the investor with confidence that the managers
have the incentive to manage those assets to maximize the return from those assets over time. That is why the form of
the organization actually completes markets. It is absolutely correct.
There is a problem when a tax system is designed in such a way that it provides an undue incentive to use one form
of organization over another form. What happens next is well understood: At the margin, people select a form of
organization that is not the most appropriate for business purposes but might be the most appropriate because of the
reduction in tax payable that can be achieved. It is reasonably straightforward in that regard.
There is nothing wrong with trusts as a form of organization but there does not appear to be any good reason to
bias corporations to make a decision to use that form of organization as opposed to a standard corporate form of
Senator Eyton: You used the term ``pool of private capital.'' There is some concern about the governance of those
pools and the manner in which they are being used today. I find it ironic that those pools of private capital are
expedited or supported by massive pension funds, such as the government pension funds. While government might be
concerned about the problem, part of it might come from the gigantic pension funds, including the Canada Pension
Plan and others, that work with hedge funds on a daily basis to permit the kinds of transactions about which we are
concerned. Could you comment on that?
Mr. Dodge: It is entirely appropriate that pension funds, whether public or private, make investments in alternative
assets. A pension plan manager of funds for a defined benefit plan has a horizon that is much broader than the one that
you, most investors or I would have. It is absolutely appropriate that they invest in some of these assets that might have
a long payoff period and might have a bit of volatility in their day-to-day market value. One of the great advantages of
a defined benefit plan is that you know you will not have to pay out tomorrow because you will be paying out over an
infinitely long history. You are pooling the funds over current, past and future employees.
There are real reasons for these funds to invest in alternative assets. Historically, they have confined themselves to
real estate. Hedge funds are exactly the kind of asset that has an extremely long payoff period. The values may
fluctuate a great deal from one month to the next or from one year to the next but they have a long-term horizon.
One must be very careful about saying that these are inappropriate assets for funds to invest in. The issue is the one
that Senator Angus raised, on which Senator Moore followed up, about whether the credit is managed appropriately.
Are managers assessing carefully enough the underlying credit characteristics of these investments? Getting into
collateralized debt obligations, et cetera, demands a tremendous amount of management skill and, historically, most of
that skill resides in banks as a credit management function.
To the extent that pension funds have that expertise, they should be able to do quite a good job. Managing the credit
is important and, going back to the chairman's introduction, that ability to manage appropriately is the part that
makes central bankers and regulators nervous.
Senator Ringuette: I am a new face on this committee. Your comments on credit management were most interesting.
I have some concerns about the close ties that we have to the U.S. economy. As was said earlier, the lending mania in
the U.S. has focussed on the housing market. However, looking at the U.S. government's deficit makes me wonder
whether the lending mania is not only in the housing market in the U.S. but also across the entire economy, given the
high cost of the war in Iraq and the deficit financing by Chinese lenders.
I look at those elements and the ways in which the Canadian economy is tied to it with 80 per cent of our exports to
the U.S.; the Canadian dollar is based on the American dollar; our export market is shrinking; and our import market
is growing. We can look at the micro-issue of hedge funds but we can also look at the macro-issue of hedge funds,
which would be on a different scale.
Currently, this committee is examining ways to manage hedge funds but my main concern is finding ways to guard
ourselves against a major recession in the U.S. How can we guard Canadian consumers against an American recession?
Mr. Dodge: That is an extraordinarily good question and the answer is found in the matter of global imbalances. I
will ask Mr. Jenkins to respond to your question because that is a topic on which he has been working.
Paul Jenkins, Senior Deputy Governor, Bank of Canada: Senator, you have raised a couple of important issues.
Allow me to begin with the issue of global imbalances. As you indicated, the reflection is very much in terms of the
U.S. current account deficit because they are a ``dis-savings'' nation, if I may put it that way. The flip side of that is
what we are seeing elsewhere in the world, a good part of it in Asia and China. Their accumulation of reserves and
current account surpluses concern us. We have addressed these issues both privately and publicly with officials around
It comes down to issues of wanting to see rotation of demand. That is, you want to see countries like China and
Japan growing with more reliance on their domestic growth rather than through exports. Part of that must be through
more flexibility in exchange rates, so you get into this issue of an exchange rate regime. We have been arguing quite
vigorously that to address these global imbalances we need more exchange rate flexibility. This includes China and we
need other countries outside North America to promote policies that will strengthen domestic demand within their
countries. All of that will work towards addressing these global imbalances.
In our Monetary Policy Report, we continue to point to this as an issue, but we are seeing some evidence that this is
evolving in a positive way. You are beginning to see more growth outside North America, stronger growth in Japan
and somewhat stronger domestic demand growth in China as well. We are beginning to see some evidence that things
are moving in the right direction but this will continue to be a very important issue.
The other part of your question relates to the United States economy. I would not want you to go away thinking
that we are of the view that there will be a recession in the United States because that is not the case. We are looking for
growth in the United States to slow this year to something in the order of 2 per cent to 2.1 per cent and then begin to
pick up in 2008-09. This slowing is very much part of this adjustment process. The housing market in the United States
is going through an adjustment but we are seeing other parts of the U.S. economy, such as the service sector continuing
to grow. Our base case view is that the U.S. economy will continue to grow, the world economy will continue to expand
and Canada will benefit.
In terms of what we can do to continue to position ourselves to grow, we need to continue to have policies that can
promote flexibility to adapt to changing situations including the flexible exchange rate, about which we talked earlier
and the importance of flexibility in moving resources from one sector to another. These are areas we will have to
continue to focus on going forward.
Senator Ringuette: You have indicated that the growth of domestic demand is a key indicator. I can see that Asia
and Western Europe have growth in domestic demand because of the growing revenues per capita. However, the flip
side to that indicator is that for a developed nation like Canada, the growth in domestic demand is not as high as the
growth for import demands. Our import ledger is growing while the export ledger is shrinking. I know that has a lot to
do with an adjustment of the global economy and wage rates, productivity, efficiency, and so forth. However, it is a
concern for me because I see, not tomorrow or next year, but maybe in a decade that this domestic demand indicator
will become a serious impediment to our global competitiveness.
Mr. Jenkins: Domestic demand covers consumption, business fixed investment, investment in residential
construction, and government spending on goods and services. We have had a very robust domestic economy over
the past couple of years and we see that robust growth continuing in Canada. Some of that is generated from the good
policies within Canada but you are also seeing clearly the benefits of a very strong world economy. The most vivid
example of that is through the very high commodity prices which reflect the strength of demand around the world.
That is generating a great deal of income for the Canadian economy. That, of course, in turn supports domestic
We continue to look for exports to grow. You are absolutely right that import growth has been fairly strong because
of the strength of domestic demand. The balance between exports and imports has been a drag in the last year in terms
of contribution to growth. We expect that to continue this year but we do not see that continuing through 2008-09. The
domestic side of our economy has been robust and we think it will continue to remain robust. As we go forward, we
will begin to see that balance between exports and imports no longer being a drag as it has been in the last couple of
The Chairman: I have a factual comment about Senator Ringuette's important question. Based on the materials we
received, imports have been growing more quickly than exports in the last three years. This is based on information we
received from the Department of Finance. In 2005-06, the real growth of imports surpassed that of exports by 5
percentage points. Senator Ringuette is raising the important question as to whether or not this is a serious cycle that
will ultimately, or in the short term, affect us. Is it having a drag on our domestic economy?
I think the question Senator Ringuette's statistical question bears going on the record.
Mr. Jenkins: The strength of the domestic side of our economy is what has given rise to the strength of imports.
Some of that strength of domestic demand is showing up in terms of import growth, absolutely. You are seeing that in
terms of strength of business fixed investment that has traditionally been an area that has shown strong import growth
when business fixed investment within Canada has been very strong. Yes, indeed, that has been a factor behind the
strength of imports.
Our point is that going forward, that strength of import demand will not continue to be a drag the way it has been
because we are looking for exports to begin to pick up as the U.S. economy shows some strength.
Senator Ringuette: Our Canadian dollar is going up, too, in relative terms.
Mr. Jenkins: You are also looking at a stronger U.S. economy overall. You have very strong commodity prices.
We see domestic demand continuing to be robust. We see the overall growth of the economy remaining very close to
its production capacity and that import growth will not be a drag on overall growth to the extent that you are
The Chairman: Thank you, Senator Ringuette. Do you have anything more?
Senator Ringuette: Much more but I do not want to monopolize the time.
Senator Biron: Could the appreciation of the Canadian dollar change your projections, which indicate that inflation
should be relatively stable in 2007, 2008 and 2009? How can you limit fluctuations and try to keep the Canadian dollar
between $0.85 and $0.90?
Mr. Dodge: I will answer the first question which is simpler. I will leave the second question to my colleague.
Our projections are based on the hypothesis that the Canadian dollar will stay between $0.0865 and $0.0895. This is
a hypothesis that we use for our forecast. Exchange rates are very volatile on a daily and on a weekly basis.
In July, when we will make a new complete analysis, if the exchange rate changes substantially, we will take this into
account and make new projections.
The important thing for our monetary policy is not only the exchange rate as such, but we must see what causes the
fluctuations. When we came before you two years ago, we explained this.
Now I will let Mr. Jenkins respond to your second question.
Mr. Jenkins: I think that in this case, the most important point is our projection of the inflation rate. Inflation, plus
the core consumer price index, should come back to 2 per cent by the end of 2007. This will have an impact on all the
other factors. First, there is the fact that the Canadian economy will strike a balance between supply and demand. Due
to a vigorous world economy, the price of imported goods will rise slightly above its current level. The combination of
these two factors will enable us to keep the inflation rate at 2 per cent until the end of 2007.
Senator Tkachuk: Welcome, Governor Dodge, and I apologize; I was at another meeting and I was not able to be
here for your presentation, but I have read it. I apologize to the questioners to whom I was not paying much attention,
as I was trying to catch up on what you said.
I want to ask about the Canadian dollar. It is hard to believe that in 2002 we were talking about a 62-cent dollar;
today we are talking about a 91-cent dollar. As you know, I am a believer in a strong dollar and was critical of the 62-
cent dollar and thought we were deliberately doing that.
Mr. Dodge: I remember that, senator.
Senator Tkachuk: At the same time, with the dollar rapidly rising, you have held the interest rate stable, and I
congratulate you for that. I was not too much worried about the inflationary rate; I was worried that our
manufacturers would have a difficult time adjusting to the new dollar and the new dollar rate.
There are those who argue that the dollar has risen too far. I am not necessarily in agreement with them;
nonetheless, there are those who are say that the dollar is hurting our ability to export.
Would you like to make some comments about whether you think the dollar has risen too far too fast and what you
see are some of the problems because of that rise?
Mr. Dodge: I can only repeat what I said when we tabled our report, senator. We looked at the appreciation up until
the early part of April, because that is when we were doing the report. Between January and early April, the
appreciation of three cents seemed to reflect firming of all sorts of commodity prices, minerals continued to climb, oil
was climbing and there was a firming of grain and oilseed prices. At the same time, there was some recovery in the
automobile sector from the rather depressed levels of the last quarter of last year as inventories were brought into line.
Our assessment is that the movement largely reflected real economic forces in the market. Our policy, as we
explained a couple of years ago when we were here, is that we do not have to take monetary policy action to offset that
as it is doing what markets do.
There has been a lot of volatility over the last three or four weeks. We will see where things settle out. When we sit
down and look at everything again, prior to our July report, we will have to make another assessment. We cannot
make that assessment on a day-to-day or weekly basis because these movements are fairly volatile.
Senator Tkachuk: While our dollar has held reasonably steady against the Euro, it is the American dollar that is
fluctuating against it quite a bit. The American interest rates are substantially higher than our interest rates, yet our
dollar is increasing in value over theirs. It seems to me that if they take action to strengthen their dollar that will cause
problems for their economy as well. I do not know if they are deliberately dropping the dollar down, but they are
believers in a very strong dollar. I find what is happening a little strange.
Mr. Dodge: I do not think it is so strange if you look at what is going on around the world. We talked a moment ago
about commodities. Our domestic economy went through that adjustment in the last quarter of last year to bring
output back into line by the end of the year and it has been growing reasonably well. We have public finances, which
are well under control, and we are pretty clear about how we will run monetary policy and what factors we will take
into account as we do that.
There are many reasons to think that Canada in pretty good shape. Some of that clearly is factored in, but we really
cannot say anything of any value on the day-to-day or week-to-week movements in that currency.
Mr. Jenkins: The U.S. needs to move away from less growth reliance on domestic demand and more reliance on
their net exports. The broad trend of movement of the U.S. dollar is consistent with that macro story we were getting
Senator Tkachuk: Commodity prices are rising and energy prices are increasing rapidly. Canada is an energy user; it
is cold here and the distances are great. We have to heat our plants. It was 30 below zero in the West this year. Housing
prices are increasing at more than the rate of inflation and have over the last recent years. Inflation is 2.2 per cent. I
look at the numbers and I wonder what is going on. Where is that coming from, or is it all from China?
Mr. Dodge: Senator, Canadians ask us that question often. We believe that Statistics Canada produces a consumer
price index that is truly second to none in the world in being representative of the basket of goods that Canadians
consume. It does not underestimate inflation. However, the prices of the goods that we buy every day are moving up
rapidly, such as gasoline, and in a sense, that becomes our mental image of the status of prices. We go to the grocery
store each week and see that the prices of a number of foods move around especially fruits and vegetables, which are
quite high right now. As well, we see the prices of foods that are heavily influenced by grain prices in one way or
another — chickens, dairy products or bakery products — moving in response to the movement in grain prices. We see
daily what happens to the prices of items that we buy regularly. We do not see as regularly what is happening to the
prices of goods that we purchase less frequently, even though they might constitute a big chunk of our basket over the
Going back to the earlier question, the prices of imported goods have been coming down in Canada. When we buy
furniture, kitchen appliances, clothing or footwear, which we do much less frequently than we buy food or gasoline, we
do not appreciate that the price of those items is moving down.
It is natural to have the current perception that prices are moving up faster than the basket indicates.
Senator Goldstein: Mr. Dodge and Mr. Jenkins, it is always informative to hear your comments. The bulk of the
questions that I wanted to ask were asked by Senator Biron and Senator Tkachuk on the exchange rate, which is of
concern. Your hypothesis relates to an exchange rate of 84.5 cents to 89.5 cents to buy U.S. $1. Today, the rate is about
90 cents. I understand that one of the economists is looking at 92.5 cents to buy U.S $1 within the next month or two.
That is a huge differential and has affects on the ability of Canadian manufacturers to export. As well, it has the reverse
affect on our ability to buy imports and on the cost of imports. You are quite right to say that it is part of a world
economy adjustment and so we have to live with it.
Many years ago, the Bank of Canada used to intervene to either buy or sell Canadian dollars in order to ensure an
orderly rise or fall in the dollar rather than sudden rises and falls. Does the bank still buy and sell dollars?
Mr. Dodge: No, since 1998 our policy has been not to intervene on anything other than an extraordinary basis. Since
that time, we have not had an extraordinary basis on which to intervene on behalf of the Canadian dollar.
Senator Goldstein: What would you consider to be extraordinary? Is the rise to 92.5 cents extraordinary from your
Mr. Dodge: No, we have some volatility in that market and when we look at the charts, we can see that we have had
quite a bit of movement over the course of this year, both up and down. It always seems to begin its move on or near
the day that the Bank of Canada is to release its report. I do not know whether that is cause or coincidence. The
markets are relatively orderly. We found that we were not getting additional stability through our intervention and so
we decided to stop.
Senator Angus: One of the things that we have liked about your term as Governor of the Bank of Canada, which
was outlined, in a way, in the full column on Saturday, April 28, in the Financial Post by Mr. Corcoran. He said that
there was a narrowly defined mandate, if you interpret it one way, for the Governor of the Bank of Canada, but there
is also Mr. Dodge who delves into areas of great interest, and he listed many of them. Many are matters that this
committee has picked up on from your statements for studies, including global imbalances, the hedge fund issue,
income trusts and many things discussed today.
Mr. Dodge, you are not going out the door tonight and so the next nine months will be interesting in your area of
expertise. Have you set priorities in terms of what you will focus on and raise over the next nine months?
The Chairman: This will help us to sharpen our activities as well.
Mr. Dodge: We raised the key priority last November in our agreement with the government. We have operated with
an inflation-targeting policy that has been largely unchanged in structure since 1991 and absolutely unchanged in
target since 1994. By the time this current agreement ends in 2011, we will have been with the policy for 20 years. Other
than New Zealand, we will have been the country with the longest experience in this unchanged policy. New Zealand
had to change how they operated along the way.
We raised the issue that we think it is very important that, over the next two or three years so we finish well before
the 2011 end to that agreement, we bear down — both our researchers in the bank and outside the bank and outside
Canada — and look at the fundamentals of the targeting procedure that we have been using. Likely the most
important thing over the course of 2007, because we gave ourselves only three years, is that we get the process well
launched. It is hard work and we need to ensure that we engage people's interest to do the research and that we engage
the Canadian community in it as well.
We are very happy that the C.D. Howe is going to pick up and try to drive this as well.
One thing that is important from a longer-term perspective is that we do get that homework done on what is our
fundamental role here and where we can make our biggest contribution to the welfare of Canadians if we get it right.
That is probably the most important single thing although there are many other individual issues.
On the international side, we have talked a little bit about it in response to earlier questions. I will continue to try to
push forward the reforms at the IMF and try to create a framework where we, as national authorities, really do talk to
one another under the aegis of the fund. I would say of one domestic issue and one international issue, those would be
The Chairman: Your reports are always fascinating. I am always interested in the relationship of the inflationary
rate to growth. On page 9, growth in Canada, real growth in 2005 was 2.9 per cent; 2006 was 2.7 per cent and then you
have a good discussion about your views on it at the top of page 9. You say that your projections were 2.4 per cent for
2007 and now you are looking at 2.5 per cent for the first quarter.
Then when I turn over to page 27 to look at the discussion, when I look at the print it seems to reflect that, but if I
look at the notes on the side, there is, forgive me, Governor, a bit of a typing error or something, GDP growth is
projected to be 2.2 per cent. I think you mean 2.50 per cent: is that correct.
Mr. Dodge: No, senator, you have put your finger on a problem that we always have.
The Chairman: Please explain, because we believe in clarity in this committee.
Mr. Dodge: This is a tricky issue. There are two ways to calculate growth rates. One is to take, let us say, the fourth
quarter of 2007 and compare it to the fourth quarter of 2006. That is one way. That is where you get these 2.5s. Those
are doing it that way.
The other way, which is what you read most often in the newspapers and what you are seeing in the side column
here because this is a convention, a way of expressing growth rates, is you take the average of the whole year of 2007
and compare it with the average of the whole year of 2006. That is what you see in the pull-out or the marginal thing.
That is that calculation. That is almost always bound to be a different number.
The Chairman: That is the whole year.
Mr. Dodge: The whole year over the whole year, as opposed to the fourth quarter of the year over the fourth
The Chairman: So if I cut to the bottom line in all this, we have gone from 2.9 per cent in 2005 to 2.5 per cent in 2006
to 2.2 per cent in 2007. Am I right? I think it is important for the public to understand what your projections mean.
Mr. Jenkins: On this annual average basis, apples to apples, in 2006 the growth of the Canadian economy, you can
see this on page 26, table 2, right at the very bottom, 2.7 per cent. Then for 2007, this is the 2.2 per cent that you were
quoting, senator, so a slowing from 2006 to 2007, and then we see the economy rebounding to 2.7 per cent in both 2008
and 2009. Mr. Dodge referred to those annual averaged numbers.
Mr. Dodge: This is a real problem. I wish we had one convention that we all used.
The Chairman: That to my mind is a good clarification because people read these reports, we certainly do. You have
made it clearer to me.
I have two other small issues. We are continuing our study at your urging, way back when, about interprovincial
trade barriers. Today I had a conversation with an institute, trying to convince them to come and give witness because
we are seeking evidence on this, and this gentleman replied that there is not really a problem with respect to
interprovincial trade barriers. When he read the MacDonald report from 1985, he said the impact of interprovincial
trade barriers was less than one quarter of one per cent on the economy. Is that your view?
Mr. Dodge: I cannot give you a precise number, but let us go back to what we said at the beginning. The real issue
here is the flexibility of the Canadian economy. We are always going to get hit with shocks of one type or another,
shocks that are inherently unpredictable. What is extraordinarily important is that we be able to adjust rapidly, at the
lowest cost to those shocks, when they come along.
If we have rules and regulations that prevent labour, and particularly skilled labour, to move to where it is needed,
to move from industries that it needs it in one province to another province, if we have rules that force additional costs
on transporters when they are carrying goods across provincial borders, if we have rules that mean you have to
package stuff differently in different provinces it just dramatically slows down the adjustment process.
In equilibrium perhaps everything will work out but we are never in equilibrium, we are always adjusting. The key is
to minimize or to facilitate that adjustment, minimize the cost of those adjustments, whether they are people or goods
and in particular, whether they are services that have to move across provincial boundaries. It is really very important.
We have learned that it is a global issue in terms of international trade and a domestic issue in terms of interprovincial
The Chairman: Governor thank you for that. That is a great commercial for our study. We have been trying to urge
provincial authorities to come forward. We have convinced one or two of them to come and talk to us but we are going
across the country to embarrass provinces to talk about this issue because they talk the talk but do not walk the walk.
Our job will be to try to prod them to walk the walk to improve the economy because we share your strategic and
macroeconomic concerns about that.
I want to again thank you for your advocacy on a single securities regulator. I hope we will be able to take this under
strict advisement and give you some interesting news that you might find a good response to your concerns. Look in
the newspapers next week.
Mr. Dodge: I will not look in the newspapers, I will look at this committee online because then it will be an accurate
The Chairman: Governor, and Deputy Governor Jenkins, thank you. Governor Dodge, when you leave your post
you will not leave Canada behind.