Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 18 - Evidence - Meeting of May 1, 2008
OTTAWA, Thursday, May 1, 2008
The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:45 a.m. to examine the
present state of the domestic and international financial system. Subject: the Bank of Canada Report.
Senator W. David Angus (Chair) in the chair.
The Chair: Good morning, ladies and gentlemen. This morning we are privileged to have as our guests the new
Governor of the Bank of Canada and the Deputy Governor, an old and dear friend of ours, Paul Jenkins. On behalf of
all senators, I wish to congratulate you, Governor Carney, on your recent appointment to the Bank of Canada.
Obviously, you have arrived in the position in turbulent times. However, as you have stated publicly, you felt
privileged to come within the framework of a sound and robust inflation targeting and floating exchange rate for
monetary policy. I gather this has given you some reassurance as you face difficult times.
I will introduce the honourable senators present: Senator Michael Meighen from Ontario; Senator Francis Fox from
Quebec; Senator Len Gustafson from Saskatchewan; Senator David Tkachuk from Saskatchewan, Senator Trevor
Eyton from Ontario; Senator Dennis Dawson from Quebec; Senator Pierrette Ringuette from New Brunswick; Senator
Yoine Goldstein from Quebec, who is the deputy chair; Senator Paul Massicotte from Quebec, also the former director
of the Bank of Canada; and Senator Mac Harb from Ontario. We also have our efficient clerk, Line Gravel, and from
the Library of Parliament, Philippe Bergevin, who helps us in our research.
If you will share some of your thoughts with us first, then we will open the floor for questions.
I remind all my colleagues that there is a slight history here. According to my research, prior to 1994-95, the
Governor of the Bank of Canada made periodic visits to the House of Commons Standing Committee on Finance with
a view to sharing with Canadians the current state of the economy. The medium was a useful one.
Senator Kirby, then Chair of the Standing Senate Committee on Banking, Trade and Commerce, had a dialogue
with the new governor of the Bank of Canada at that time and asked about following the U.S. model of having the
governor come periodically to the Standing Senate Committee on Banking, Trade and Commerce. It was worked out
that the governor would be delighted to come and to continue to come as long as it was understood between our two
organizations that we would deal in our questioning with macroeconomic issues. We would not get down to the
minutiae of micromanagement or politicization of the process. Thus far, honourable senators, we have honoured that
understanding. We have made that commitment and I hope we do not deviate from it today and that we have a fruitful
Please proceed; we are anxious to hear what have you to say.
Mark J. Carney, Governor, Bank of Canada: Thank you, chair and committee members, for taking the time to meet
with us today. It is a pleasure to appear for the first time as Governor of the Bank of Canada. I know, as you alluded
to, that these discussions have been valuable to the bank. They are an important part of our accountability to
Canadians, and we appreciate your role in holding us to account to Canadians. As you referenced, chair, we have a
sound monetary policy framework but the core is the accountability within that framework. I look forward to
continuing these meetings during my tenure. Before I make a few comments on our monetary policy report, I want to
acknowledge the important work of this committee to address longer term economic and financial issues that face our
Before Mr. Jenkins and I begin to answer your questions, I want to review briefly the conclusions of our latest
Monetary Policy Report, released last week.
The world economy's growth rate has weakened since the Monetary Policy Report Update was published in January.
This was due to a sharp slowdown in the U.S. economy and ongoing dislocations in global financial markets. Growth
in the Canadian economy has also moderated. Buoyant growth in domestic demand, supported by high employment
levels and improved terms of trade, has been substantially offset by a fall in net exports.
Both total and core CPI inflation were running at about 1.5 per cent at the end of the first quarter, but the
underlying trend of inflation is judged to be about 2 per cent, which is consistent with an economy that is running just
above its production capacity.
The U.S. economic slowdown is now projected to be deeper and more protracted than was expected at the time of
the January update. Our latest projection reflects a more pronounced impact on consumer spending from the
contraction in the U.S. housing market and from significantly tighter credit conditions.
The deterioration in economic and financial conditions in the United States will have direct consequences for the
Canadian economy. First, exports are projected to decline, exerting a significant drag on growth in 2008. Second,
turbulence in global financial markets will continue to affect the cost and availability of credit. Third, business and
consumer sentiment in Canada is expected to soften somewhat. Nevertheless, domestic demand is projected to remain
strong, supported by firm commodity prices, high employment levels, and the effect of the cumulative easing in
We at the bank project that the Canadian economy will grow by 1.4 per cent in 2008, by 2.4 per cent in 2009, and by
3.3 per cent in 2010. The emergence of excess supply in the economy should keep inflation below 2 per cent through
2009. Both core and total inflation are projected to move up to 2 per cent in 2010 as the economy moves back into
balance. There are both upside and downside risks to our new projection for inflation. These risks appear to be
In line with this outlook, further monetary stimulus will likely be required to achieve the inflation target over the
medium term. Given the cumulative reduction in the target for the overnight rate of 150 basis points since December,
including the 50 basis point reduction announced last week, the timing of any further monetary stimulus will depend
on the evolution of the global economy and domestic demand, and their impact on inflation in Canada.
Mr. Jenkins and I will be happy to take your questions.
The Chair: Thank you very much gentlemen. I want to exercise a slight chair's prerogative, which I rarely do, and
provoke a comment from you on whether you plan to follow the same general framework to which I referred in terms
of inflation targeting and floating exchange rate that your predecessors followed. Did Governor Dodge leave with you
any specific advice, and did things turn out as you expected them to?
Mr. Carney: The first part of your question is extremely important. It is absolutely my intention and that of Paul
Jenkins to continue to follow the monetary policy framework that has served us extremely well since it was put in place.
For the benefit of reinforcing that framework, an agreement between the Bank of Canada and the Government of
Canada sets a target of 2 per cent annual overall inflation measured by the total Consumer Price Index.
The floating exchange rate is a key part of our monetary policy framework. It facilitates adjustment. It is an
important relative price in the economy. It is not a target of monetary policy. Rather, it supports monetary policy. We
intend to keep that framework. We will conduct longer term research on whether this is the end of monetary policy
history and when it comes time to renew the agreement four years hence, it will be determined whether there are
potential improvements. We will welcome the opportunity to discuss that research with this committee.
With respect to the advice from former Governor Dodge, for whom I have immense respect, his counsel was in the
way that he conducted himself throughout his career as a civil servant and as Governor of the Bank of Canada in terms
of inclusiveness in decision-making and in the importance of taking difficult decisions. The advice is by example as
opposed to specific advice for the current situation.
Senator Tkachuk: Welcome, governor. It is a new year and it seems that the dollar has gained, since the beginning of
last year, almost 16 per cent. Although the Canadian economy has been strong, the U.S. economy has weakened at the
same time. Is the current value of the Canadian dollar vis-à-vis the U.S. dollar is the result of our economy being
strong or the U.S. economy being weak? If it is a combination, what is the split?
Mr. Carney: The level of the dollar is a price set by markets. Part of the execution of a monetary policy framework
with a flexible currency is ensuring that the value of the currency is determined by a well-functioning market.
Unfortunately, the value of the dollar can be influenced temporarily by comments by officials such as myself and Mr.
Jenkins. One has to be careful not to make value judgments, in my opinion, about the level of the currency, and
certainly not on a running basis in terms of judgments on the level of the currency because it influences markets,
distorts the prices, and can create excess volatility in and of itself.
Vis-à-vis the role of the dollar in our framework, it is an important relative price in our economy and it helps to
facilitate adjustment in our economy. We intend to continue to pursue a flexible exchange rate mechanism, as we
discussed at the start.
Senator Tkachuk: So many things are priced in American dollars, for example, oil. If the U.S. dollar were at the
same strength it was at a year ago, it would affect what we pay for oil. If our dollar were worth U.S. 65 cents, it would
affect how much we pay for oil. It is important that you comment on this. It has taken a long time for that change in
the dollar value to be reflected in prices in Canada. Many companies tell us that it takes time and that they have their
inventory. If the change had happened in reverse, the prices in Canada would jump the next day.
Western Canada has been paying for high exports because of the low Canadian dollar for a long time. We import a
lot of products and depend on imports to sustain our economy because we produce resources. We have not noticed the
same kind of dramatic decrease in prices as we should have noted, particularly in the half-ton trucks, cars and farm
machinery that we buy from the United States. Something is happening here that does not make economic sense to me,
but perhaps it does to you.
Mr. Carney: You made a number of important points. First, you refer to the price of commodities and the impact of
the higher Canadian dollar — we certainly do recognize the impact. One fundamental factor that affects the level of the
currency is the evolution in terms of trade in the economy. Canadian terms of trade have increased sharply. The value
of our exports relative to the price we pay for our imports increased about 25 per cent since 2002.
A number of factors drive commodity prices. The supply shortages or supply levels relative to consumption are
relatively low across a range of base metals. In the oil market, it has been low and we are seeing some broadening into
food, where there are supply issues.
Our research shows that the demand from emerging market economies, which are more energy intensive in their use
— particularly for energy and base metal commodities — is playing a bigger role relative to demand from
industrialized or G7 economies. As you alluded to, commodities are priced in U.S. dollars, and as the U.S. dollar
depreciates, an adjustment comes from that depreciation. The strength in terms of trade has been one factor that has
been reflected appropriately in the strength of the Canadian dollar.
The second part of your question related to the pass-through of the appreciation in the Canadian dollar to import
prices in Canada. There are a couple of things to say there. One is that there are lags around pass-through; there is no
question of that. To a certain extent, pass-through is absorbed in margins of retailers.
We have seen pass-through start, particularly as the dollar reached parity — I will speed up —
The Chair: You are doing fine.
Mr. Carney: — with respect to autos where, over the last year, we have seen a marked reduction in automobile
prices across the country. One thing — and this is a subtle but important judgment we need to make — is, will we see
that broadening out into other factors in the economy so there is a persistent aspect, or is this reduction a one-time
price level adjustment that we need to look through as we manage monetary policy and try to meet our 2 per cent
The weight of evidence is that we should see it as a one-time adjustment and that is where we are leaning in our
judgment. Obviously, we continue to monitor and follow this change.
Paul Jenkins, Senior Deputy Governor, Bank of Canada: I will give a couple of facts to your question, senator. I am
looking on the page 8 of our Monetary Policy Report, where we present a chart on commodity prices, energy and non-
energy, both in U.S. dollar terms and in Canadian dollar terms. You can see that the increase in Canadian dollar terms
has been substantially less because of the appreciation of the Canadian dollar. So we do see it.
As the governor mentioned, automobile prices are down significantly, 7 per cent, in terms of that component of the
Consumer Price Index. More broadly, when we look at the Consumer Price Index in Canada, we see services growing
at a rate of around 3 per cent, but the goods component is negative year-over-year of about 1.5 per cent to 2 per cent.
Some of that negative component reflects this automobile price factor that the governor mentioned but, more
generally, imported goods prices are declining year on year. We do see, in the numbers themselves, some of what you
are talking about.
Senator Meighen: Governor, welcome. It is good of you to come and we always enjoy these sessions.
We dwelt in the early part of the meeting on inflation — inflation targets and the range. We seem to have followed a
steady and successful course over the years — I think now for over a decade — in keeping our inflation rate somewhere
between 1 per cent and 3 per cent. Am I correct on that?
Mr. Carney: Yes, you are correct. For the record, inflation has averaged 2 per cent over the past 15 years as these
agreements have been in place.
Senator Meighen: For those of us who find ourselves aging more rapidly than others — and there are a lot us in this
country — that is music to our ears if we live on a fixed income.
The United States inflation rate is now at about 4 per cent. To hazard a guess, I suspect it is more likely to go up
than go down from that rate. Time will tell. What effect does the U.S. rate have on inflation considerations in Canada?
Do you see the U.S. rate of inflation as a problem in the near term?
Mr. Carney: It is a good question. I will make a couple of comments on it, and part of the question goes back to
Senator Tkachuk's earlier question.
I make no prediction about where U.S. inflation will go, but if inflation in the United States were to be persistently
higher than inflation in Canada, then the U.S. currency, all else being equal, is appreciating on a real, effective basis
relative to Canada, so there is a bit of an offset there. That is the first point.
Second, there is an issue that we are only starting to see in the U.S. in terms of imported goods prices, particularly
from China. As Mr. Jenkins referred to, in general we have seen this decline in manufacturing goods prices in Canada,
the U.S. and Europe. A lot of that decline has been driven, or helped, by displacing production to China — imports
and competition from China.
Chinese inflation is going up. The Chinese currency is going up vis-à-vis the U.S. dollar. It is going up less so against
the Canadian dollar because the Canadian dollar is going up against the U.S. dollar. In fact, the Chinese currency is
not going up versus the Canadian dollar.
In the U.S, we see some of this imported price pressure, which — and this is where the judgment comes — has not
yet been fully passed through to the consumer because a number of these pressures are inputs rather than production.
That is another aspect.
To return to your question, we have an exchange rate issue on a real, effective basis that mutes, to some extent, the
change in the nominal exchange rate. To extend to the U.S. the analogy of China, to the extent we import goods from
the United States, we would import a bit more U.S. goods.
The last point I want to make is that because we have a flexible exchange rate, we are in control of our own
monetary destiny. Our ability to hit our 2 per cent target is not compromised by inflation in other countries, provided
we take it into account and continue to follow a flexible exchange rate. The point is that we cannot get off the hook
because of inflation in other countries.
Senator Meighen: Back on February 1, a quote in the Hamilton Spectator caught my eye, which said:
One area Carney will almost certainly champion, said Drummond, is the issue of financial sector regulation
reform to ensure the world's economies aren't again exposed to the kind of easy money environment that made
the subprime mess possible.
I presume that your meeting with the chartered banks this past week was vindication to Mr. Drummond's
prediction. How crucial to the health of the economy is financial disclosure? Do you see the bank playing any role in
the development of disclosure rules and guidelines?
Mr. Carney: It is an excellent question. Given the time you have targeted, there is obviously more to financial sector
reform than just disclosure, but disclosure is an incredibly important part. It is an important lesson from the causes of
the crisis and it is a big part of moving out of it.
Disclosure was one thing we specifically emphasized and that was part of the FSF report endorsed by G7 ministers
and governors a few weeks ago. It was the focus of the meeting with the banks.
The Chair: When you say the FSF, do you mean the Financial Stability Forum?
Mr. Carney: Yes, that forum is comprised of central banks, regulators and treasuries or departments of finance.
There are 67 recommendations in that report, a number of which focus on disclosure. One of the most important ones
relates to best practices disclosure, effectively around structured products. Ministers and governors have urged major
financial institutions to meet these best practices at their next reporting date.
Our financial institutions are as close to meeting them as any in the world. That is the good news. I should be
clearer: They are closer to meeting them than any in the world. We want to lead on that.
As part of getting out of this process, globally, we need disclosure, which makes clear whether we need additional
capital. Accordingly, there is capital raising. From only the prospect of having best practice disclosure, we have seen in
recent weeks the scale of capital raising that has come from major financial institutions.
The second point on disclosure relates to the Canadian non-bank asset-backed commercial paper issue. There are
many issues related to the cause of this problem. One issue that caught our attention is that the disclosure that existed
for these programs did not appear to reflect fully the risks and seniority of the note holders. More specifically,
derivative counter-parties made up many of the assets for these securities. Also, they were senior to the note holders.
The reason one had to encourage the standstill and the Montreal accord is that the asset providers had the ability to
take almost all the collateral and, effectively, the vast majority of the value around these notes through a margin call in
August and through this entire standstill period, leaving the note holders with nothing.
The reality was that it was not necessarily clear to a note holder when they bought them that it was the case. We
question whether there should be better disclosure principles because we will not have the exact same issue going
forward. However, we need to have a principle around materiality that has teeth, even in exempt markets.
Our role there is to point out that fact. What can we practically do at the bank? It is limited; we are not a regulator,
obviously. Again, around asset-backed commercial paper and, in this case, bank-sponsored asset-backed commercial
paper, we have said we will take this paper as collateral in the overnight market under certain conditions, and the core
of those conditions relates to disclosure.
We want a single document that discloses all the risks, and we detail what those risks and asset characteristics will
be. We think, first, that disclosure protects the balance sheet and the taxpayers of Canada, who will be fully protected
and who will know what we are lending against. However, it could set a standard for the market, and it is the decision
of the market whether or not it does, that would help this market to reach proper levels of disclosure and grow from
The Chair: I will ask a point of clarification, Mr. Carney. When you and Senator Meighen used the term
``disclosure,'' is it fair for us to understand ``disclosure'' in the context to mean an explanation in clear terms to the
consumer purchaser of these instruments of the nature and risk involvement of these instruments?
Mr. Carney: Thank you for the clarification. That is the core of the issue. I will underline it. It is always possible,
although not always done, to provide 1,000 pages of disclosure and no information. I caution investors: If they receive
1,000 pages of disclosure and they do not have time to read through it, they should hesitate before they buy.
Mr. Chair, your point is a good one.
Senator Fox: I have two questions about the international situation. I also want to know whether any harm can
come to the Canadian economy.
The first question has to do with the London Interbank Overnight Rate, the famous LIBOR. Recently, the financial
press was saying that some banks had not been transparent in declaring their interest rates outside the LIBOR, so that
the LIBOR was set at 0.3 per cent below its real value. Some say that this could have bad consequences and that it
could even set off a crisis. Perhaps you would like to comment on that.
Second, Canadian economists as well as the IMF recently came up with the same figures. They said that the
international liquidity or credit crisis — I do not know which of these terms is the right one — involves about one
trillion dollars, and that since the beginning of the crisis, only $320 billion have been restored to the system, either
through write-offs, or through investments by sovereign wealth funds, et cetera. Therefore, we could say that there is a
$675-billion shortfall that will have to be taken into account and that this could trigger the second phase of a world
liquidity crisis. My references are the IMF, as well as certain Canadian economists. Could you comment on this
Mr. Carney: Yes, there are two questions and I will begin with the second one. As a matter of fact, the IMF has
made estimations of the size of potential losses. This estimation, in my opinion, is based on hypotheses founded on the
prices in derivative markets. Price fluctuations in derivative markets and the probability of losses in derivative markets
are much higher than on monetary markets. In a certain sense, the IMF estimation could well be more pessimistic than
the situation actually warrants. Let me suggest to you a report of the financial system of the Bank of England that
deals with this aspect.
Your first question is a very important one, because it concerns a gap that exists now and that did not exist before
the turbulence began in August. I would say that there is a growing gap on the monetary or interbank market. In
Canada, the gap now stands at about 35 to 40 base points. As for the American dollar, it is currently at 80 base points,
the famous LIBOR. As for the British pound, it is at about 90 and the Euro is still at 80. There is a big change in the
interbank market and this is causing an increase in the costs incurred by the banks. All the central banks are trying to
understand why this situation is occurring and they are trying to remedy the situation by injecting cash.
Mr. Jenkins: Regarding the second question, it is very difficult to estimate the potential losses. For instance, the
OEDC estimates the potential losses at only 50 per cent of the amount estimated by the IMF.
As the governor said, the transparency of financial institutions is probably the main factor at play. There are some
doubts about the amount, but transparency is crucial.
Senator Massicotte: Welcome, Mr. Governor, and congratulations on your recent appointment. My question is
about the availability of cash. There is a worldwide loss of confidence in the financial markets. Several times, there was
an issue with a shortage of cash in the United States, where more loans were granted. Many Canadians agree that the
Bank of Canada only exists for helping the big banks and they wonder why we should help those banks, which are
already private businesses with shareholders. Could you explain to us why it would be in Canada's interest to assist
these banks that may run out of cash on a more or less long-term basis and that will have to grant further loans?
Mr. Carney: This is an important question. Since last summer's turbulence on the financial markets, a great deal of
work has been done to analyze and to understand the causes of this turbulence and to mitigate the resulting losses.
Legislators, central banks and monitoring agencies like the FSF, have developed a series of measures meant not only
for addressing future financial crises but also for preventing them. The FSF, for instance, presented a report to the
finance ministers and governors of the G7-member countries, on April 12 this year. It recommended ways to make the
market and the financial institutions more resilient so as to restore public confidence in the functioning of the market
and of the financial institutions.
In this report, two recommendations specify that the central banks should be flexible enough in their operational
frameworks in terms of the possible frequency of operations and the maturity of available instruments as well as of the
range of available counterparties and guarantees — this is the most important point — to enable them to manage
extraordinary situations. We are not talking about extreme situations, but about extraordinary ones.
The current situation in Canada is extraordinary, but it is not extreme, because we do not have great powers to
manage extreme situations. Paradoxically, pursuant to the Bank of Canada Act, our actions are restricted when
extraordinary situations arise.
Senator Massicotte: Why is it important for Canadians to subsidize or indirectly help these banks? Is it not because
the banks are short of cash? The banks are not in a position to offer cash and this will be harmful to economic growth?
Mr. Carney: In the first place, this is not a subsidy. First, when we carry out internal pension operations such as the
ones we are now carrying out, we cut back on the bonds, which means that we give much less money than what the
bonds are worth. Second, how much does this operation cost? We could compare it to the sale of a product at an
auction. The price depends on competition.
This is really important for two reasons: First, the price is higher and second, we learn a great deal through this
process. What are the liquidity problems? In what sector of the market are they occurring? Is it on the Canadian
government's mortgage or bond market or is it on the cooperative bond market?
In several sectors of the market, the Bank of Canada cannot get this information, which is abnormal for a central
bank. The Bank of England, the American Federal Reserve, The European Central Bank, the Central Bank of
Australia, of Sweden, et cetera, in short, all the big central banks have this power, this ability.
Senator Massicotte: Do you intend to extend this power to institutions other than the Canadian banks, such as life
insurance companies or recent investment banks like those found in the United States? Will the Canadian banks be the
only ones that have to auction off their loans?
Mr. Carney: Actually, both possibilities exist. We are not limited to any counterpart of the Bank of Canada. Nor are
there any restrictions for that kind of operation.
Senator Massicotte: Will you begin facilitating the work of life insurance companies or investment banks that are
patterned on the American model? The big issue in the United States, as it was the case with Morgan Stanley, arose just
when the government, through the central bank, decided to come to the rescue of the investment banks. Citizens said
that if we want to help the market and get involved in this, we should perhaps change the regulations to make sure that
situations like these never arise again.
If we choose this path, should we change Canada's government structure? As we follow the Bank of Canada's
decisions, should we change the way in which we supervise financial institutions in Canada?
Mr. Carney: I would like to reassure Canadians. At this time, the interbank market is having problems, as we just
said. There are 40 base points on the very short-term markets. This will change the prices of mortgage loans and other
loans for Canadians and Canadian companies. This is the current situation, but it is not normal. We are limited in
what we can do. Nevertheless, we are doing better than some other parts of the world, but it is not normal. Canadians
are having to pay the cost of this.
Senator Massicotte: Should we change the governance of the Canadian financial markets to protect the interests of
Canada and Canadians?
Mr. Jenkins: In general, we have two kinds of facilities. First, we have shares on the market, where we do business
with chartered banks and other institutions such as Merrill Lynch. We operate on a daily basis. Second, there is our
role as a lender of last resort. The institutions benefiting from this facility must be members of the payment system. The
rules and the circumstances are different from those in the United States. In Canada, we can intervene quickly whereas
in the United States, the situation is different, because they have different kinds of institutions, but they certainly do
not have the same measures with regard to our facility as a lender of last resort.
Senator Massicotte: Do you think that the current governance is up to the task?
Some say that there are delays and that the financial markets are in trouble. Should we review our system of
Mr. Carney: The regulation system of the Canadian financial system is a very broad field that goes well beyond
ensuring cash flow. We could discuss this issue later, but perhaps not now.
Senator Ringuette: I am interested in the impact of the economy on Canadian consumers. In your preliminary
presentation, you said that you were anticipating a 2 per cent inflation rate.
Although I am certainly not an expert on these matters, I find you to be rather optimistic, given of the increase in
energy costs and food prices. This is a vicious circle because energy is essential to the manufacturing industry and the
price increase has a direct impact on our exports and Canada's competitiveness in the world.
I would like you to reassure us that the 2 per cent rate will keep Canada in second standing, even in light of the fact
that further increases to energy and food cost are expected.
I am thinking about Canadians who live on fixed incomes and those earning minimum wage. For those people, it is
a matter of survival.
Mr. Carney: I can certainly reassure you by saying that the inflation rate is very important for the Bank of Canada.
It represents everything.
To begin, let us review the facts. The current situation in Canada is practically unparalleled in the world. The
inflation rate for food products for this past year was 2.5 per cent. Why is it so low? There are probably three main
First, there is an excess supply of meat in North America. Second, there is the impact of the appreciation of the
Canadian dollar, which has had an effect on the price of meat, seafood, fruit and vegetables, all imported goods. Third,
there is heightened competition between food retailers. Those are the three factors that help mitigate the food inflation
rate in Canada.
We have observed a sharp increase in the price of wheat, rice and other consumer products. Those products
represent only one component of future prices.
Take for example any type of grain. The value of basic commodities in a cereal box sold in the U.S. accounts for
only 1 per cent. Therefore, there is a significant portion of value that is derived from merchandise and distribution.
I can assure you that the Bank of Canada intends to reach the target inflation rate of 2 p. 100 for all food products.
Currently, the total inflation rate in Canada is 1.5 per cent.
Senator Ringuette: I appreciate your comments and optimism regarding the Bank of Canada's objectives. It is what I
was hoping for. Has the Bank of Canada evaluated the cost of energy and its impact on both exports and the domestic
consumption of energy?
Mr. Jenkins: Absolutely. The Bank specifically analyses the fluctuations in energy prices. First, with respect to the
growth rate of the CPI, the report sets out the difference between the Bank's outlook on total CPI and core CPI, which
excludes the price of energy for the very purposes of assessing its impact.
There are also effects on the economy in more general terms, as concerns increases in the price of basic products.
This not only affects energy prices, but non-energy products as well.
Senator Gustafson: Given the fact that food prices have remained low — and Canada has a great advantage there —
for machinery coming from the United States, particularly John Deere, we cannot buy a new combine or a new tractor
unless we order it. The price has gone up 15 per cent or 20 per cent on these machines. At the same time, the
automobile industry plummets. What is the rationale?
Mr. Carney: That point is an interesting and relevant one. I will generalize. What we see in global commodity
markets, whether energy, base metals or farm products, is that there has been a long period, given current prices, of
underinvestment. That underinvestment extends to there not being enough engineers or enough experienced people
who want to go into farming, for example, and there is not enough capital equipment.
In all these markets, there is a rush for exactly those needs. Engineers are in incredible short supply and capital
equipment is in short supply. The prices are increasing sharply, reflecting a global effort to invest. In North America,
both the farming and the agricultural industries are well aware of global prices. These industries are looking to invest
and things are in short supply, such as drilling rigs. That is what is happening with commodity demand.
The Chair: In response to Senator Ringuette's observations, you talked in your brief about the emergence of excess
supply in our economy to keep inflation below 2 per cent. From where is that excess supply coming?
Mr. Carney: At present, we view the economy as being in excess demand. That level of excess demand has come
down as the rate of growth has slowed in our economy. Over the course of this year, we expect the economy to move
into excess supply as growth slows.
I recall also in my opening statement and in the report that our projection for growth in Canada for 2008 is 1.4 per
cent. That projection involves two conflicting forces, which was partly referred to by my colleague: strong domestic
demand, in part driven by strong commodity prices but still high employment; and a slowing export sector that exhibits
a strong trade drag on our economy. The combination of those forces is slowing growth and will create some of this
excess supply to which you refer.
The Chair: Does that come close to that evil word ``stagflation''?
Mr. Carney: Not at all. For absolute clarity, first, we are starting from a position where inflation is 1.5 per cent. We
have made adjustments to that figure because, in our judgment, certain factors are one-off. GST reduction is clearly
one-off and the auto impact that we talked about earlier is one-off. It is a judgement; it could spread. Those one-off
factors bring the trend toward 2 per cent. We expect excess supply to emerge, as we discussed. That situation is
something to which we are responding by providing monetary stimulus to help the economy. That stimulus, plus U.S.
recovery and other factors such as the normalization conditions in financial markets, will help to bring the economy
back into balance into 2010 and bring the inflation rate there.
``Stagflation'' is a slowing economy and sharply rising inflation. We have inflation below our target. We have reason
to expect a continuation of that situation, so policy is adjusted accordingly.
The Chair: That is reassuring.
Senator Eyton: Welcome, governor and deputy governor. Your reputation as a hockey player may help you in the
turbulent times to which the chair referred.
I want to pick up on the question of asset-backed commercial paper. You indicated that the bank can now accept
that kind of paper. The question is: Are you now accepting that paper? In what approximate volumes are you
accepting it? How do you value that paper? What is the process of valuation?
Mr. Carney: Those are excellent questions. We have laid out the criteria for the paper that we will accept. There
must be disclosure. It is contained in a single document that is provided for us. There cannot be synthetic assets. Think
of collateralized debt obligation, CDO, squared-type assets or CDO assets which were at the heart of the nonbank
asset-backed model. There are a variety of other requirements. For example, there must be two ratings on the program.
The program must also have a global style liquidity line, which is an automatic liquidity draw, if the market were to go
away. We require a variety of factors.
Senator Eyton: That is essentially on demand?
Mr. Carney: On demand, yes. Virtually all these factors did not exist in the nonbank market, which is where we had
the problems with the Montreal accord. We require all those criteria. Banks are working towards those standards.
They have not yet met those standards so we are not yet accepting any asset-backed paper. We will accept asset-backed
paper prospectively, but we have not accepted it thus far. The banks are in the process of rating things, working on this
disclosure document, and so on.
I underline that the bank-sponsored asset-backed commercial model, by and large but not exclusively, involves
credit-card receivables, auto-loan receivables and more traditional assets; if you will, real assets, but not synthetic
assets. The banks are going through a process of ensuring that a specific program meets our standards before we will
accept it. We will apply a substantial haircut discount, if you will, to that paper before we accept it.
Senator Eyton: How close are you to having that program in place?
Mr. Carney: We have the program in place and the banks must work on it. We will continue to meet with the banks.
It will take some time for them to meet the criteria fully, but, at the end of this process we will have an asset that we are
comfortable taking, namely, real transparent assets that meet the standards and assets that we understand.
We do not take something that we do not understand. We cannot make a judgment on that. Too many people have
made that mistake. The Bank of Canada does not make that mistake, ever. When we have that transparency, then we
will take them, but it will take some time. In the end, in a small way, or maybe in a larger way, this approach will
contribute to the development of this market, which is an important market. It matters to lower overall borrowing
rates in the sectors that I mentioned, for example credit cards.
Senator Eyton: When all of that qualifies, it will be treated on par with the other kinds of securities that are
Mr. Carney: No, the haircut on it is higher than the others. It is higher than Canada mortgage bonds or provincial
bonds that we also take. It is more akin to bank BA types of rates, which are at least 10 per cent. I will give you the
precise figure in a moment; I will look it up after I hear subsequent questions.
Senator Eyton: My next question concerns your overnight rates. Obviously, your spending rate is an important part
of your arsenal. From reading and comment, it seems that our chartered banks are more reluctant now to follow the
lead, for example, in the reductions you talked about earlier. There have been significant reductions in the last few
months and the banks have followed them, but the banks have been increasing reluctant to do so, particularly at a time
when their own financing costs are rising.
In The Globe and Mail of April 21, the chartered banks wanted you to find a way to bring down other rates instead
of lowering your target overnight rates. What are they talking about? What other weapons do you have in your
arsenal? How effective can they be?
Mr. Carney: That is an excellent question. Mr. Chair, with your permission, I will read a short statement that relates
to this issue of the relationship between our overnight rate and other rates in the financial sectors. The senator has
raised a topical issue. My colleagues can distribute this statement to the clerk after the meeting.
The Chair: By all means, governor; we would be pleased if you did.
Mr. Carney: Mr. Chair, the sharp movement and wide swings in interest rate spreads that we have witnessed since
the onset of the recent market turbulence have prompted many analysts, including the senator, to question whether
monetary policy remains effective in controlling inflation. The short answer is yes. I would like to take a few minutes to
explain why this is the case.
The Bank of Canada's policy objective, as we have discussed, is 2 per cent inflation for total consumer price
inflation. The tool we use to achieve our policy objective is the overnight rate, as referenced. That is, the rate at which
major financial institutions borrow and lend funds for one day or ``overnight'' among themselves. We set a target for
the overnight rate. It is currently 3 per cent. We adjusted it last week. We can achieve that target through our ability to
use our balance sheet to supply overnight funds.
When the Bank of Canada changes its target for the overnight rate, as we did last week, it sets in motion a complex
change of consequences that first influences prices in financial markets, and then affects spending, production,
employment and, ultimately, inflation. The words economists use for this chain is ``the transmission mechanism.'' My
focus here is on the first link in that chain.
With a change in the overnight rate, other interest rates along the maturity spectrum tend to change. Intuitively, this
makes sense. If the cost to borrow money for a one-day period becomes cheaper or more expensive, depending on what
we do, and this change is expected to persist, the cost to borrow money for a 30-day period, 90-day period or one-year
period, et cetera, should also change. In addition, administered interest rates such as the prime lending rate, and the
prices of many other financial assets, including the value of the Canadian dollar and equity prices, are affected.
Thus, all else being equal, a change in the overnight rate that is intended to persist will influence the overall level of
short- to long-term interest rates and the prices of many other financial assets. But typically, all else is not equal, and
the situation we face today, with a fundamental re-pricing of risk taking place, is a good example.
Interest rates on various financial obligations include a risk premium that reflects the creditworthiness of borrowers
and the degree of liquidity of the financial instrument. Corporate bonds, whether issued by financial or non-financial
firms, carry a rate of interest that incorporates both these considerations. Lending institutions, such as banks, set their
lending rates on the basis of their cost of funds and the creditworthiness of their customers. The reference of Senator
Fox to London Interbank Offered Rate, LIBOR, is relevant here.
Risk premiums, or credit spreads, as they are often called, are market-determined. Any widening or narrowing of
risk premiums is not something that monetary policy can influence. However, monetary policy can, and does, take into
account these movements in risk premium by influencing the overall level of interest rates through changes in the target
for the overnight rate of interest.
I will give you an example using the circumstances we face today. Because of heightened uncertainty in global
financial markets and widening risk premiums, the cost of raising funds has increased for Canadian banks. These
higher costs are being passed on to corporate and household borrowers. Less creditworthy borrowers also face higher
credit risk premiums in the rates at which they can borrow from banks, but this does not necessarily mean that the
absolute cost of borrowing for corporate and household borrowings has risen.
The reason is that the Bank of Canada can factor in these movements in risk premium, or credit spreads, when
setting the target for the overnight interest rate at a level that is judged to be appropriate for achieving our 2 per cent
target. Such a judgment led the bank to lower its overnight target by 150 basis points since last December.
In summary, Mr. Chair, the key point I am trying to convey is the difference between interest rate spreads and the
absolute level of interest rates. The former is determined in competitive financial markets; the latter is what monetary
policy can and does effectively influence, and recent developments have not altered that fact.
The Chair: Governor, that is extremely topical and interesting and appears to be somewhat of a response to the
recent headline entitled ``the Governor's dilemma.''
I hope, governor, you might give us a couple of extra minutes past one o'clock in view of this statement. I have
senators who have good questions.
Senator Dawson: It is my turn to congratulate you. Your predecessor was a governor of great quality, he was an
excellent communicator. I see today that you fill his shoes very well.
Good communications is important on an issue.
I share the view of my colleague, and am slightly more pessimistic than you are to the extent that I believe interest
rates have hit their lowest levels and that the relative appreciation of the Canadian dollar versus its U.S. counterpart —
which in effect saves money on food products — will not be recurrent. Savings have been made in the last two years,
but at this moment in time, we have reached a stage where we will no longer benefiting from this differential. That
being said, I will point out to you that like my colleague, I am not an expert.
My first question is about regionalism. Twenty-five years ago, when Senator Fox and I first arrived here, the interest
rate was 16 per cent; there was inflation in certain provinces, including Ontario, and there was even stagflation, or
something similar, in Quebec. Today the inflation rate is about 3.5 per cent in Alberta, Saskatchewan, and other
provinces and is about 1 per cent in Ontario. You must apply a monetary policy that cannot be tailored individually to
the regions. Twenty-five or thirty years ago, the Deputy Minister of Employment and Immigration set up employment
programs adapted to regional needs as a way of compensating for these disparities. Those types of tools do not seem to
be used today. How do you take into consideration the gap between provinces that have high inflation rates and those
that do not?
The Chair: Provinces or regions?
Senator Dawson: Either provinces or regions. Last, I would like to know the effect of the two-time cut of 1 per cent
to the GST on inflation.
Mr. Carney: First, Senator Dawson, thank you for your compliment. I will begin by answering your last question
first. The impact of the GST cut is approximately 0.5 per cent. Its effect is ongoing over the span of one year and
disappears afterwards. Of course, consumers benefit, but the cut does not have an impact on the underlying inflation
trend. That is important.
Now, managing monetary policy for regions is a very significant matter. Of course, we manage monetary policy and
have a national monetary policy. This is the only way to manage monetary policy for a country.
At present, the manufacturing sector is probably suffering the most among all of the sectors, and it is concentrated
mostly in central Canada. Central Canada represents 60 per cent of our economy, and is very important in the
management of monetary policy. It is certain that there is an impact.
The third point I want to raise relates back to a subject that you have discussed extensively, the importance of
building flexibility into our economy. I know that my colleague appeared before you some time ago to specifically
discuss the importance of the Canadian economic union. This is crucially important if we are to be able to make
adjustments in situations such as those that you have just described.
The Chair: Are you vying to become the next Governor of the Bank of Canada, Senator Dawson?
Senator Dawson: I am not a good enough communicator!
Senator Goldstein: Thank you for being here and for being as open and forthright as you traditionally are. We look
forward to your visits. They are always worth our while. They are always informative. We walk away from them
enriched. You have continued that tradition, Mr. Carney, and, of course, Mr. Jenkins, with great brio, and we look
forward to a calm career on your part.
Mr. Carney: I join you in that.
Senator Goldstein: I have two brief questions, one a macro-question and one a micro-question.
As a result of the bailout in the United States of Bear Stearns and other equivalent bailouts, at least one major one
in the United Kingdom, and some indirect bailouts, I must say, in Canada, an increasing volume of concern has been
expressed by opinion-making organs such as The New York Times, the Washington Post, the Los Angeles Times and
others, both in their editorials and their op-ed pages, about their concern that the availability of these bailouts, far for
being salutary for the economy, will encourage risk-taking by institutions that should not take those kinds of risks.
What is your take on that concern, which has been expressed virtually unanimously by the non-financial press?
Mr. Carney: You raise a serious question, but an appropriate one.
I will start by being clear in terms of the Bank of Canada's role in a situation where a financial institution in Canada
finds itself with severe problems of liquidity but not insolvency. There the role, as referenced earlier, of the bank is to
supply, potentially, as lender of last resort, under our emergency lending facility.
We do that on the advice of the Superintendent of Financial Institutions that the institution is insolvent, not on the
basis that the institution needs money. The institution is insolvent. These judgments are difficult, but the banking
regulator is the appropriate one to make those judgments, and that is how the system works in Canada.
I want to go to the core of the question because it is important. The issue is, from my perspective, one of moral
hazard that you refer to and whether these measures encourage excessive risk-taking behaviour down the road.
The extent to which they encourage excessive risk-taking depends on what happens to the shareholders and the
senior management of those institutions, who have taken a risk in the hope of an asymmetric payoff. They benefit from
the upside, and they are protected on the downside, if you will. There is high value, if a situation were to come about —
it does not matter where it would happen in the world — in ensuring that the shareholders and the senior management
bear the full consequences of their actions. The judgement must be that they are the first loss around their actions. The
provision of any stabilization from a public authority is not a transfer or a limiting of the losses of those individuals.
Senator Goldstein: That answer is reassuring, although it seems to me it imposes some kind of responsibility on the
Canadian public to hold its financial institutions more accountable than it has in the past, in the sense of, you spoke of
shareholder reaction, trying to elicit shareholder reaction from that perspective. We will listen to that indirect advice
My second question deals with the asset-backed commercial paper and the freeze-up. We talk about it as the sub-
prime problem, but it is not only sub-prime, as you pointed out correctly. It extends as far as securitization mechanics,
for instance, drug payments for licensing. They are securitized and then marketed.
The banks are working through their write-downs and write-offs. The basic question is whether they are yet marking
to market or whether they are slowly writing off and writing down and to what extent we can expect a continued set of
write-offs and write-downs from our financial institutions, which have, obviously, a significant effect on the economy.
How much is left to go, in a nutshell?
Mr. Carney: It is a difficult question, which I am not sure I will attempt to answer. For the core of it, I refer back to
the importance of adequate disclosure and the steps that have been taken through the financial stability forum to
create an appropriate template for that disclosure. As that is followed through, more will be discovered. It is also,
obviously, a product of the evolution of the real economy, in terms of both downside and upside to these underlying
For the third point, which is important for people to keep in mind, I refer to a speech I gave in Toronto, which goes
through some of these issues. In the absence of the core markets for a number of these securities, firms have been
marketing them with reference to derivative markets, which are often thinly traded, and could have overshot, to some
extent, one could argue, during the force of the recent turbulence. It is up to investors to make those judgments,
whether they think some of these marks may have been too extreme, and there may be some upside — their judgment
— but also within those judgments has to be the evolution of the economy and a level of comfort with the quality and
the breadth of disclosure of the institution, so there are not other things to come.
Senator Goldstein: On another occasion, perhaps, we will have occasion to talk about the extent to which we can
realistically expect investors to make those kinds of judgments in the absence of high degrees of sophistication, which
not all investors have. That discussion is for another day, however.
Mr. Carney: The only point I make about that subject, though, is if they cannot make the judgment, they should not
own the security.
Senator Goldstein: That is true. Some people out there are making the judgments, who may not be in a position to
make those judgments adequately and accurately, and they are affecting the rest of the economy. We will talk about
that subject another time.
The Chair: Bill C-50 is making its way through Parliament, which grants special new powers to you with respect to
buying or selling, excluding equities, for the purpose of your monetary policy or promoting the stability of the financial
system. Can you explain why this bill is important?
Mr. Carney: First and foremost, this change is important, but it is a practical change we are looking for. We have an
ability to act against a wide range of collateral in the overnight market, and we have an ability to act against the full
range of financial securities, including equities, in the case that the governor would declare severe and unusual stress.
Those powers exist today. We have not used the latter power. We are using the former power. In the middle —
referring to the exchange with Senator Massicotte — the extraordinary circumstance we are working through right
now, somewhat paradoxically, we are more constrained, and I suggest that to some extent that is a product of history.
A clear list was set out that restricts our ability to conduct what are called ``term repo operations,'' purchase and resale
operations. We can lend, as Mr. Jenkins referenced, against a huge range of collateral at the bank rate.
This point is slightly technical, but we can lend treasuries out and take in a wide range of corporate bonds, asset-
backed securities and other issues today. We cannot conduct auctions for those same securities. Why would we want to
conduct auctions? We would want to do them because we will obtain a better price. Moreover, we obtain real
information. In a situation like this one, where there are liquidity strains in the market and we are trying to determine
where they are and we are trying to target liquidity, that information is incredibly valuable.
We ran an auction today. We can act against Government of Canada securities and provincially guaranteed
securities, but we cannot act against the full range of corporate bonds, which we can do with all these other
instruments. The request is to broaden it.
The European Central Bank, the Bank of England, the Reserve Bank of Australia, the Riksbank in Sweden and the
Federal Reserve all have this power. Furthermore, a core recommendation of the FSF report is that central banks are
able to act against a wide range of collateral with a wide range of counter parties. We see this bill as modernizing the
act and providing a principle-based framework, our ability to work against this collateral.
If it is ultimately the decision of the House and the Senate, and this bill receives Royal Assent, we will publish a
policy, publish it in the Canada Gazette and put it into effect.
The Chair: I wanted you to have an opportunity to explain that bill. The question has come up by some who think,
perhaps, that the way you are dealing under the present regime might exceed authority which, of course, as you have
explained, is not the case. The present regime is cumbersome and less up to date.
I thank all senators for their excellent preparation and questions. More important, Governor Carney and Deputy
Governor Jenkins, thank you for your wonderful answers. We have had a terrific discussion. We wish you both
Godspeed and come back soon.