Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 6 - Evidence, May 6, 2009
OTTAWA, Wednesday May 6, 2009
The Standing Senate Committee on Banking, Trade and Commerce met this day at
4:02 p.m. to study the present state of the domestic and international financial
Senator Michael A. Meighen (Chair) in the chair.
The Chair: We are pleased to welcome the Governor of the Bank of
Canada, Mr. Mark Carney, as well as the Senior Deputy Governor, Mr. Paul
Jenkins. Welcome, gentlemen.
This is Governor Carney's second visit to our committee. When he first
appeared last year, the governor highlighted the deteriorating economic and
financial situation in the United States, and its direct consequences on the
Canadian economy and the global economy.
He also talked to us about turmoil in global financial markets, and how they
would continue to impact the cost and availability of credit here in Canada, as
well as the consequences on the conduct of monetary policy in this country.
No one fully anticipated the breadth and depth of the downturn that we are
enduring and that is being endured worldwide. It is important to stress that the
Bank of Canada has acted within its mandate to help the Canadian economy through
this difficult period.
Normally, the Bank of Canada conducts monetary policy by adjusting the target
for the overnight interest rate, with changes in this rate often affecting
banks' prime lending rate as well as mortgage and bond rates. Over the last
year, the bank has used this tool to the fullest extent possible, lowering the
target for its overnight rate to an unprecedented low of 0.25 per cent.
The bank has also taken other actions. For example, the possibility of
quantitative easing and credit easing has been contemplated. Through these and
other actions, many would agree that the Bank of Canada has made a vital role in
bringing us through this difficult period. In fact, it appears that things are
improving in both credit markets and the Canadian economy.
I do not know whether Mr. Carney and Mr. Jenkins can take credit for it, but
Statistics Canada reports today a 23.5 per cent increase in building permits in
March over February and we see oil at $56 per barrel, which is its highest level
since December of last year. When I left my office, the TSX had broken through
the 10,000 point level.
We are eager to hear your views on the economic situation in Canada and
abroad, especially as they relate to access to credit for businesses and
households. This is a topic of considerable interest to members of the
On that note, I will quickly introduce the members of the committee. Present
are: Senator Joseph Day of New Brunswick, who is not a member of this committee,
but is an interested observer and chair of the Standing Senate Committee on
National Finance; Senator Mac Harb from Ontario; Senator Paul Massicotte from
Quebec; Senator Céline Hervieux-Payette from Quebec; Senator Wilfred Moore from
Nova Scotia; Senator Pierrette Ringuette from New Brunswick; Senator Irving
Gerstein from Ontario; Senator Stephen Greene from Nova Scotia; Senator Francis
Fox from Quebec; Senator Trevor Eyton from Ontario; Senator Donald Oliver from
Nova Scotia; and Senator Yoine Goldstein who, regrettably, is attending his
second to last meeting as Deputy Chair of the Standing Senate Committee on
Banking, Trade and Commerce. My apologies for saving you to the last, but I do
want to make special mention of your presence.
With that, Governor, I would ask you to make your statement. I am sure that
you and Mr. Jenkins will be open to our questions.
Mark J. Carney, Governor, Bank of Canada: Thank you, Mr. Chair and
distinguished members of the committee. Before Paul Jenkins and I begin to
answer your questions, allow me to take a moment to review some of the
highlights and the conclusions from my latest Monetary Policy Report
released on April 23.
In particular, I would like to outline for you some of the details from the
bank's framework for unconventional monetary policy, which was published as an
annex to the latest MPR.
These are difficult economic times, with the Canadian economy being buffeted
by an intense and synchronized global recession. In recent months, the global
recession has been exasperated by delays in implementing measures to restore
financial stability around the world.
G20 policy-makers are now responding to the global crisis with a renewed
commitment to concrete initiatives and comprehensive plans. Our base-case
projection is that these policies will be implemented in an effective and timely
manner, and their impact will reach full force next year. Discussions in
Washington at the end of April were consistent with that outlook.
As a result of the current global economic and financial situation, the bank
now projects that the Canadian recession will be deeper than we projected in the
January Monetary Policy Report Update. Our return to growth will be
delayed by one quarter, to the end of 2009, and our recovery will be somewhat
In short, the broad outlines of the Canadian outlook are the same as those in
January, but its profile has shifted. Canada's real GDP is projected to decline
by 3 per cent this year and growth is expected to resume in the autumn and
accelerate to 2.5 per cent in 2010, and 4.7 per cent in 2011.
Our outlook for inflation is broadly consistent with that in January. Total
inflation will temporarily fall below zero in 2009, but core and total CPI are
expected to return to the bank's 2 per cent inflation target in the third
quarter of 2011.
In that context, the bank lowered our policy interest rate by one quarter of
a percentage point on April 21 to one- quarter per cent or 25 basis points as
the chair mentioned. This is judged by the bank to be the effective lower bound
of the policy rate. Conditional on the outlook for inflation, the Bank of Canada
has committed to holding this rate at one-quarter per cent until the end of
June, 2010. I will elaborate on this conditional commitment in a moment.
In total, since December 2007, we have cut interest rates by 425 basis points
to their historic lows and their lowest possible levels. It is the bank's
judgment that this cumulative easing, together with the conditional commitment
to keep rates low for a considerable period, is the appropriate policy stance to
move the economy back to full production capacity and to achieve the 2 per
However, these are uncertain times and if additional stimulus were to become
necessary, the bank retains considerable flexibility in the conduct of monetary
policy at low interest rates. We have outlined in detail how we would use that
flexibility in conducting monetary policy at that effective lower bound in the
framework published in our recent Monetary Policy Report. In this
document, we describe the unconventional instruments that are available, the
principles that would govern use of these tools, should we decide to apply them,
and the exit strategies we would employ when these instruments were no longer
The three key instruments we have identified for conducting monetary policy
at the effective lower bound are: conditional statements about the future path
of policy interest rates; quantitative easing, which involves the creation of
central bank reserves to purchase financial assets; and credit easing, which
includes outright purchases of private sector assets. If required, these
instruments could be used separately or in tandem to improve financial
conditions in order to support aggregate demand and ultimately achieve the
As you are aware, the bank deployed the first instrument on April 21. As a
result of our conditional commitment to keep rates at 25 basis points through
the end of June 2010, interest rates across the maturity horizon of the
commitment fell. They also dropped relative to those in the U.S. across the
Let me reiterate that the bank's conditional commitment is not a guarantee
but, rather, it is conditional on the outlook for inflation. We will always set
our policy rate at a level consistent with achieving our 2 per cent inflation
target over the policy horizon. Similarly, if the bank were to deploy either
quantitative easing or credit easing, it would act in a deliberate fashion based
on the following principles: First, the focus of these operations would be to
improve overall financial conditions in order to support aggregate demand and
achieve the inflation target; Second, asset purchases would be concentrated in
maturity ranges in order to have the maximum impact on the economy; Third,
actions would be taken in as broad and neutral a manner as possible; Fourth, the
bank would act prudently, mitigating the risks to its balance sheet and managing
its ultimate exit from such strategies at an appropriately measured pace. If we
were to use these unconventional policy measures, the bank would closely a
number of indicators to assess their effectiveness. The most important thing
would be the effect of these measures on overall financing conditions faced by
households and businesses.
Other indicators would be used to judge the direct impact of a particular
instrument. For example, the effectiveness of conditional statements about the
future policy rate can be judged by their impact on longer-term interest rates.
As I mentioned a moment ago, we saw an almost immediate impact of our April 21
policy interest rate announcement. The effectiveness of quantitative easing
would be judged in the first instance by changes in the yield curve and more
generally by movements in broader financial conditions. The effectiveness of
credit easing would be judged by reductions in risky spreads and increased
Changes in credit terms and in the conditions faced by firms can also be
assessed by using the Bank of Canada's Business Outlook Survey and its Senior
Loan Officer Survey. In addition, the bank has constructed measures of borrowing
costs and an overall financial conditions index for the economy. In order to
enhance transparency, the bank now offers a comprehensive website that details
credit conditions in Canada. The link can be found on the top left side of the
Bank of Canada's home page.
The unwinding of the bank's various facilities and its acquisition of assets
— or the exit strategy if we were to pursue these policies — would be guided by
the Bank's assessment of conditions in credit markets and the inflation outlook.
A number of exit alternatives are available, including a natural runoff through
the maturing of assets, the refinancing of acquired assets and asset sales.
Finally, the framework describes how the bank would communicate its use of
unconventional policy measures. Press releases on each fixed announcement date
would remain focussed on the target overnight rate and on conditional statements
about the future direction of policy rates. The press release would also
indicate any intention to carry out purchase programs and the approximate size
of such purchases. The bank would explain the broad objectives of any purchases
and how they are to be financed. Detailed operational decisions would be
communicated in separate announcements.
Press releases on fixed announcement dates and monetary policy reports would
continue to provide an ongoing assessment of the economy and the outlook for
inflation. Speeches and parliamentary appearances, such as this one, would
provide additional venues for reporting on the details of the bank's conduct of
monetary policy. As always, the bank reserves the right to announce policy
measures in periods between fixed announcement dates to address truly
We welcome the opportunity, following the conclusion of my remarks, to
discuss this framework and its potential role in achieving the bank's inflation
Allow me to conclude with a few words on the outlook for the Canadian
While there remains a high degree of uncertainty — particularly with the
Canadian economy dependence on forces beyond our borders — we remain confident
in the prospects of eventual economic recovery in Canada.
This recovery should be supported by the following factors: the gradual
rebound in external demand; the end of the stock adjustments in Canadian and
U.S. residential housing; the strength of Canadian household, business and bank
balance sheets; our relatively well-functioning financial system and the gradual
improvement in financial conditions in Canada; the past depreciation of the
Canadian dollar; stimulative fiscal policy measures; and the timeliness and
scale of the Bank's monetary policy response.
With that, Mr. Chair and community members, Mr. Jenkins and I would be
pleased to answer your questions.
The Chair: Mr. Carney, you indicated that if the Bank of Canada were
to pursue quantitative easing, it would act prudently in mitigating the risk to
its balance sheet and managing exit from such strategies at an measured pace.
Could you be more specific about the nature of these risks? Can you elaborate on
how they will be managed, other than what you said in your statement?
Is there a series of events that might precipitate the institution of
quantitative easing or is it simply an assessment of the situation across the
Mr. Carney: To recap on the definitions, pursuing quantitative easing
means the Bank would purchase assets financed by the creation of new central
bank reserves. Those assets could be government bonds or private securities such
as corporate bonds. In the instance of government bonds, there is no credit risk
to the Bank of Canada but there is market risk in the mark-to-market value of
those bonds. If there were a generalized rise in interest rates across the yield
curve, relative to the purchase price, there would be a mark-to-market valuation
loss on those securities. It would then become a question of whether the bank
realizes that loss or whether it holds the instrument to maturity. That would be
one risk to the balance sheet.
The other risk, which would be similar, is that you could have the interest
rate risk on the corporate security and that generalized rise in interest rates
and capital loss relative to the purchase price of the security. The other
associated risk with the corporate security would be credit risk that could be
borne by the Bank of Canada if there were a credit event associated with that
In order to mitigate that risk, the issue is prudent targeting of those
purchases. I will segue into the second part of your question because it is
relevant to this. Part of it would be prudent targeting of those purchases on
the portion of the yield curve that is appropriate for the economic
circumstance. We have to weigh that relative to the economic circumstance. In my
opening remarks, and it is detailed in the framework, I mentioned that there is
a possibility that we would hold the securities to maturity and they would
naturally roll off so that the point in time, mark-to-market loss gradually
pulls to par over the maturity of the security. It then unwinds over the
maturity of the security. In the case of corporate securities, it is inescapable
that some credit risk would be taken on. Depending on the size of the operation,
some of that credit risk could be realized.
The judgment would have to be the relative value of taking that exposure in
the context of a judgment about the challenges that we are faced in a corporate
financing market. This would be about a true failure in that market — not just
that we did not quite like the level of the corporate securities, but a true
market failure. This might be, for example, a big liquidity premium that had
developed because of tremendous strains in the financial market, and that the
risk- reward would be such that taking that operation would make sense.
It should be said that the bank has a strong balance sheet. In addition, the
bank has had considerable earning power over the years, with net earning which
are remitted to the federal government. I want to underscore that any credit-
easing operation that might be pursued, if it were pursued, would only be done
in close coordination with the government, given its fiscal aspects.
When could these operations be triggered? I would like to reiterate that our
current position that our overall stance and policy is sufficient — the
combination of where rates are and our conditional commitment. We do not
currently envision the need to provide additional stimulus through either
quantitative or credit easing.
What would trigger the potential need? It would be a negative shock — a
material, persistent, net negative shock to the economic outlook — that would
impact the outlook for inflation to the extent that we did not feel, given the
current degree of stimulus in the economy through policy and net in the economy,
that we would achieve our inflation target on a reasonable horizon. The bank
would then have to decide whether there was a need for additional stimulus. If
there were, then we would make the judgment at that point in time about where we
would get the biggest bang for our buck. We would want to see what would have
the biggest impact on overall financial conditions, whether it is quantitative
or credit-easing or a combination, and what would have the biggest impact on
overall financial conditions and, therefore, bring the outlook for inflation
back to target over a reasonable horizon.
To sum up on that question, which is an understandable hypothetical, it is
difficult to answer because, even as you referenced in your opening remarks,
financial markets move around. Where the stresses were two months ago is not
necessarily where the stresses are today. Therefore, the judgment must be taken
at that point in time in the future.
The Chair: Senator Goldstein would like to ask a supplementary.
Senator Goldstein: In dealing with quantitative easing, you suggested
in your remarks that if you were to engage in it, which you are not at the
moment, one of the criteria that you would be following, and I quote, is that
"actions would be taken in as broad and neutral a manner as possible.'' I do
not know what "neutral'' means in that context. Can you help me understand it?
Mr. Carney: Yes. Thank you for that question.
The best way to characterize this is to recall that in quantitative easing,
the key aspect is the creation of new central bank reserves to purchase assets.
It could be government or corporate. Let us concentrate on the corporate side
because that is where the neutrality principle applies. In this regard, the bank
would look to be absolutely neutral across industrial sectors and across
regions. There is no element of industrial policy whatsoever here. As I
referenced a moment ago, it must be a generalized market failure that we would
look to correct. We would then look to use mechanisms that ensured that we
applied the stimulus in a generalized way. We make a parenthetical reference in
the framework to the potential use of auctions.
I am not saying this is what we would do, but one could look at the approach
taken by the Bank of England which does auctions across all corporate securities
on a daily basis. There would naturally be concentration limits by sector, by
type of security, et cetera, so that there was not targeted stimulus to any
particular sector or part of the economy. The obvious reason for that is that we
deal with macro — that is, overall financial conditions. Those types of
decisions would clearly be the responsibility of the government.
Senator Hervieux-Payette: Thank you for meeting with us. I read your
report carefully, and I must confess that, like most Canadians probably, there
are certain things that are unclear to me. However, on page 18, I do understand
what you are saying about the cost and availability of business credit, and how
conditions have further deteriorated over the last three months.
When you, along with the Minister of Finance, decided to purchase
government-guaranteed mortgages directly from Canadian banks themselves, for an
amount as high as $200 billion, I presumed that, at the very least, this would
provide banks with liquidity to make loans to businesses. Yet, this is not what
we witnessed. Rather, there has been a tightening of credit.
Perhaps the banks that are performing better had behaved less badly on the
markets than our neighbours, but how can the government explain to Canadians,
who are practically shouldering an additional $200 billion in insured mortgages,
that no credit is available; and with no credit available, businesses cannot
expand nor grow wealth?
Mr. Carney: If I may refer to the report and the corresponding chart,
we can discuss this very important topic. Firstly, credit growth in Canada is
slowing, but there is growth of credit in Canada. On page 16 of the report,
chart 12 illustrates that growth of household credit is stronger than the
historical average. As for businesses, growth is declining, and this is normal
during a recession. This is one component of the demand for credit, as well as
the supply of credit.
The second point concerns credit rates. In table 2, at the top of the page,
we have provided key rates in Canada. These rates are posted and updated on our
Internet website each week. Key rates for businesses, and long-term corporate
bond rates, in the last column, remain at approximately the same levels as
before the start of the crisis. Risk premiums have increased considerably, but
overall, business rates remain the same. Other rates, such as mortgage rates,
With respect to variable mortgage rates in Canada, it is now possible to get
a variable mortgage rate of 3 per cent. This is the first and probably last time
that rate has been so low in our history.
Senator Hervieux-Payette: I hope so.
Mr. Carney: We are neutral. It is one of the bank's principles. We are
neutral on that issue. There is an effect, and there can be benefits in that
Senator Hervieux-Payette: Businesses are complaining. Most of my
colleagues, as well as myself, receive complaints from business people. Right
now, since you are now at 0.25 per cent, and banks are not improving the
possibility for business people to access credit, what can you do to guarantee
economic growth? Even if households are consuming, there is a rise in
unemployment. How are you going to achieve your highly impressive goal, of 2.5
per cent growth in 2010, and 4.7 per cent in 2011? To get there, there has to be
investment by someone, somewhere to generate wealth.
I assume that you probably carry out modeling and simulations on your
Mr. Carney: Quite a few.
Senator Hervieux-Payette: Another piece of data we do not have is
credit extended to individuals, as compared to businesses. I imagine that the
amounts are much higher for businesses than for individuals.
Mr. Carney: There are challenges. The terms imposed on businesses are
becoming more difficult. It is not the price, but the terms of credit that are
becoming more difficult, and this is something we noted in our survey. There are
examples in our report. With respect to efforts made by the banks, it must be
stated that Canadian banks are now providing credit to businesses; not
necessarily at a price businesses are satisfied with, but the situation in
Canada is considerably better than it is elsewhere. There really is not any
Paul Jenkins, Senior Deputy Governor, Bank of Canada: Very briefly, as
the governor mentioned, overall, rates of household and business credit growth
remains positive. Broken down into detail, loans made by chartered banks to
businesses are also positive. Relatively speaking, the problems are on capital
markets, commercial paper markets, for example.
Businesses that use these markets to raise capital are in a more difficult
situation. It is, however, true that with the economic slowdown, the rates of
household and business credit growth are less robust today.
As the governor mentioned, compared to the American situation, or the
European situation, things are very different here.
Senator Hervieux-Payette: I have one last question. I monitor the
market to see if more liquidity is being made available to businesses that need
it. Banks issue bonds quite regularly, and recently, have been doing so on very
reasonable terms from the investor's perspective, as well as compared to the
return on government bonds.
On the other hand, conditions are such that an investor can expect a return
of 4, 5, or 6 per cent, a business can anticipate a yield of 9, 10 or 12 per
cent, which means that the spreads are very wide. It is almost as though
businesses have just discovered the notion of risk assessment. It is true that
less equity is available. But in terms of debts, do you believe that our
businesses are so dangerously indebted that the banks must be as fearful?
Mr. Carney: No. Generally speaking, our businesses have strong balance
sheets. That is one of the advantages. I can assure you that we are tracking
credit availability to businesses and households in Canada very closely.
With respect to capital markets, because this is a very important point, we
are seeing a few encouraging signs. Right now, however, it is too early to be
totally reassured as to the smooth functioning of capital markets, particularly
of corporate bond markets.
Senator Greene: Thank you very much for coming. I have a two-part
question. You, of course, are responsible for monetary policy, but governments
are responsible for a fiscal policy, the federal government and all of the
provinces. Could you give a brief synopsis of the current pressures that you
need to influence and describe the relative merits of fiscal policy, which
essentially means Bill C-10, what the provinces are doing or not doing and how
monetary policy works with those budgets?
Mr. Carney: I will begin on that. It is a very important and timely
Let me begin by saying that the scale of the economic shock from outside our
borders, and the impact that has had on demand in Canada, requires a response
from both monetary and fiscal policy. I have talked at some length on the
monetary policy response. I would say that we have also seen a considerable
fiscal policy response in Canada between both levels of government, federal and
provincial, in recent months. The total of those responses is on the order of
what has been encouraged around the G20 table, so all the major economies of the
There was broad consensus that something on the order of 2 per cent of GDP,
of discretionary fiscal stimulus, would be provided. These are decisions as
opposed to the automatic stabilizers. Automatic stabilizers are very important,
but on top of that is discretionary action.
We have seen a considerable fiscal policy response in Canada. Canada
benefits, as you know, from the hard work of Canadians and of governments over
the course of the last 15 years or so to put our fiscal house in order. We have
considerable fiscal flexibility.
In times like this, one of the things that we stress, that bears remembering,
is that for both monetary policy and fiscal policy it is absolutely essential
that those policies retain their credibility or else measures become
self-defeating. We certainly believe monetary policy has credibility. Inflation
expectations in Canada and medium-term expectations remain well-anchored on 2
per cent. We have a range of options, if we need to, in order to achieve that
target, but we will only use them if we need to and only to the extent we need
Certainly if you look at a variety of measures of not just the statistics,
which are very impressive in terms of our relative debt burden, but also in
terms of market rating of government securities, Canada has tremendous fiscal
credibility and fiscal flexibility. That is one of the other things that stands
us in good stead at this difficult time.
Mr. Jenkins: Perhaps I will just add one other element on the fiscal
policy side. This picks up on the fact that stimulus is occurring globally,
which for Canada is quite important. Being an open economy we obviously have
these direct trade links with countries like the United States. As well, we have
to take into account the importance of commodity prices. When you think about
the stimulus that is being provided through fiscal policy, it is also important
to remember that this is being done internationally. Certainly that adds to the
overall stimulus in Canada that benefits because of those linkages to the rest
of the world.
Senator Harb: About 18 months ago, this committee went to the United
States and was looking at the market and the function of the market. We met with
a number of people involved with hedge funds. They told us that disaster is
looming because there is a lack of regulation. They used the terminology of the
herd — as one moves, everyone else follows. They told us then that when things
fall, it would be hard and everyone would hear it. Some members of the committee
will testify to that and our minutes would reflect it.
From everything we hear and see in Canada, our banks are in good shape
because we have good regulations. They are solid, well-managed and nearly the
only financial sector that did not receive any sort of government intervention.
That is good, but what we see more and more on the international scene is
governments nationalizing institutions, taking ownership of corporations, et
cetera. Are we looking at trouble down the road? When we discuss trade and
investment, international rules, WTO, et cetera, someone, at some point in time,
will say: The party is over here. There is a direct government subsidy for this
product and it is competing against my product.
You discussed the kind of stimulus necessary to return to a 2 per cent
inflation rate. Was there any discussion of the terms or underlying factors?
What sort of standards are we talking about? Do you have an emergency plan
dealing with how long you can continue to inject and own, et cetera? What is the
Also, is there anything we need to do as a government or as a committee? Do
we have to make a recommendation for more regulations?
One of the things they told us in the United States is that there was no
regulation in the financial sector. Hedge funds collapsed and that is why they
have the problem.
Mr. Carney: Senator, you raised a number of very important points. Let
me break them into two, if I may. First is the issue of what I would almost say
market "reciprocality'' — the hedge fund collapse and credit trades. Second,
fiscal packages related to banks, financial systems support and the
international dimension to that.
First, on market "reciprocality,'' I have a couple of additional points to
the ones you made. One of the surprises of this crisis is that basically it was
not caused by hedge funds. Two and a half years ago, a number of people would
have said one of the weaker links in the system is the unregulated hedge fund
industry and these dynamics will be pro- cyclical. In reality, the crisis was
generated first from faulty assets and structured products. However, it was
amplified through the core of the system and, to some extent, through hedge
fund-like activities and proprietary trading and positioning at large, complex
financial institutions around the world. It was not the hedge fund multiplier.
Among the casualties of this crisis have been a number of very important
funding markets necessary both for corporate finance, which goes back to the
capital market question we discussed earlier, and well-functioning international
banks. The Bank of Canada is very focused on the need to build what we call
sustainable continuous markets. These core markets — including the repo market
for corporate securities, government bonds, interest rate derivative markets and
commercial paper markets — need to be open 24/7 for our system to function well.
What we saw internationally, though not as much in Canada, was that at times
of real stress, just before the fall of Bear Stearns and Lehman Brothers, was
that these markets shut down. In shutting down, they caused tremendous damage to
otherwise healthy institutions. This was not to those institutions, per se, but
to otherwise healthy institutions.
Fast-forward to today. How will people conduct their business knowing that it
is still possible those markets could shut down at a future point of stress? We
think that is unacceptable. It is unnecessary. It is an issue of market
infrastructure. It can be addressed and we are working diligently on this issue
to find solutions for Canada. Canada did not experience this dynamic, but part
of the reason we did not experience this is because these markets were not as
important as they were elsewhere.
For a well-functioning financial system, you need not only well-capitalized
and well-run banks, you need resilient markets that have the right
infrastructure. You need both legs to have the advantage. Canada can have both
legs. We clearly have one of them. We should build the other and then we will
really be a world leader. That is our view.
The second point relates to fiscal packages, which is important. It is less
about the 2 per cent fiscal stimulus raised by Senator Greene's question, which
is conventional fiscal policy — infrastructure, tax measures, et cetera. It is
the contingent fiscal policy that has been pursued following the crisis of
September 2008. A number of countries, and eventually all major countries,
effectively provided contingent guarantees to their financial systems.
Canadian banks have the option, although they have not used it, to borrow on
the market with a Government of Canada guarantee. They would pay a fee for that
if they did it. In the United States, the banks have the option and they use it
all the time for obvious reasons. It is the same situation in the U.K. There is
a need to pull back these guarantees to get the system back on its feet and
fully functioning, which is your reference.
We recognize that. Having the strongest financial system, it is easiest for
us. The guarantees are not being used and we can pull back. However, one wants
to orchestrate something in a coordinated fashion, not a "beggar thy
It also has to be coordinated at the right time. We are still in a difficult
position in the financial sector. There are important decisions to be taken in
the coming weeks in the U.S., the U.K. and in continental Europe with regard to
their banks. Now is not necessarily the time to be withdrawing from these. Next
year, when Canada is chair of the G8, you can see a potential role as an honest
broker to manage some of these issues. We will wait and see.
It is like earlier questions where it will have to be judged on the
circumstance. However, your point is absolutely right. It does need to be
coordinated. As you were suggesting, Canada could play a role because we have
not relied on these instruments and we can be more objective.
Senator Harb: I have one small supplementary question.
The committee is currently looking at credit cards charges. Some of the
credit card companies have issued their financial statements. They are doing
very well, which is good. We are taxing them, which is great.
Do you expect any fallout in terms of consumers who have borrowed money? They
may have borrowed money during the crisis and may not have come out of the
pipeline. We may not have seen some of the defaults from the consumer end.
Mr. Carney: That is not a small question; it is a big one. You have a
lot of questions before the committee if this is a small one. We know the
committee has been engaged in this issue, as have others on the Hill. As you are
aware, this is not an issue for the majority of credit card holders in that
approximately 75 per cent pay off their balances each month.
We have continued to see household debt growing above historic averages. That
has principally been both mortgage and line of credit debt. Credit card debt has
been static through this period. That does not mean there have not been
individuals shifting that way, but as a whole, we have not seen that.
Obviously, personal bankruptcies have notched up. It is a difficult period.
Although we see growth towards the end of the year and into 2010, the employment
situation will deteriorate further before it improves. That will put strain on
some households, without question.
Mr. Jenkins: We track very closely developments around the household
sector balance sheet. We monitor the trends in credit growth and debt service
costs and how they play into the ability of the household sector to finance
their liabilities. In the bank's other key publication, our Financial System
Review, we do stress tests of the financial system generally. Certainly, we
watch the household sector closely for all the reasons that you suggest.
Senator Gerstein: Mr. Carney, at page 9 the April Monetary Policy
Report listed a number of factors that should support an anticipated
economic recovery. Could you tell us what the essential preconditions are for an
Mr. Carney: Thank you for the question because it is important to make
this point. First and foremost, the big precondition is stabilization of the
global financial system. That was a precondition for our forecast in January. In
the end, we were disappointed with the pace of progress on that.
What is necessary for stabilizing the global financial system,
notwithstanding the encouraging recent performance in a variety of global
financial markets? There is a need to fix and stabilize the banking systems more
strongly in the United States, the U.K., Germany and Continental Europe and in
general. We are pleased that there are now comprehensive plans to do so in those
key countries. The issue is implementation. An important step will be taken
tomorrow with the announcement of the U.S. stress test results. The next stage
of that implementation in the United States will be the asset sales from some of
these core institutions into a series of vehicles that have been set up by the
U.S. Treasury and the Federal Reserve.
Both legs need to be in place. There must be transparency to know where the
capital deficits are in a credible way. There must also be the provision of
capital, and as a backstop, government capital will be provided. Apparently not
all the banks will need this capital but the banks in question will have time to
raise capital on their own. As well, a separation of the assets is required so
that you have well-functioning banks focused on the future and not working out
the past, as you are familiar with.
That is the most important precondition. It is also important in the context
of stabilizing global financial system that continued steady progress be made on
the G20 agenda to create the new financial architecture. We at the bank were
extremely pleased with the results of the April leaders' meeting, and a number
of key decisions have been taken. If I may grossly simplify, I would say that we
have moved from 30,000 feet of principles to 5,000 feet of objectives.
Unfortunately, there is still a great deal of work ahead but the process is
keeping those who need to do the work focused on it. Provided we continue to
make progress, it will help to provide the necessary confidences.
Senator Gerstein: May I take from those comments that, from a domestic
perspective, it is your view that the necessary elements of the recovery are in
Mr. Carney: We certainly need to remain vigilant because there is a
tremendous amount of uncertainty, and there will be additional shocks and
setbacks. I would not want to leave the impression that we are on autopilot.
That said, considerable stimulus is in place. Always, there are delays in the
impact of monetary and fiscal stimulus and it is our view that it will be felt
increasingly over the course of this year and with full force in 2010.
Similarly, the international fiscal stimulus packages to which Mr. Jenkins
referred will hit in 2010 through commodities through the trade channel. We have
been transparent in terms of what we think our stimulus should be and its
limits. Our base case scenario remains consistent. Given the strengths of the
economy, provided we do not have these negative shocks and steady progress
continues on stabilizing the global financial system, we expect growth to return
at the end of this year and to accelerate going into 2010.
Senator Massicotte: Firstly, I would like to take this opportunity to
congratulate you. Two weeks ago, you decided to bring the central bank's
overnight rate to 0.25 per cent, and you committed to keeping it at this level
for a period of 12 to 13 months. I am convinced that this will bring stability
and make an important contribution to our economic growth. It was courageous. In
the history of the Bank of Canada, this has never been done. Therefore, in my
own name and on behalf of all Canadians, congratulations, gentlemen.
The goal of this Monetary Policy Report, as well as the goal of
today's meeting, is to better understand the risks. The French version of this
report is made up of 32 pages; the English version is 28 pages. Everyone is
trying to understand it.
You predict that in the fourth quarter, there will be economic growth. You
project 2.5 per cent next year, and 4.7 per cent in 2011. And yet, in this very
report, you talk about quantitative easing. Average readers in Quebec, like
myself, are trying to understand the risk. What is your level of certainty over
these growth rates of 2.5 per cent and 4.7 per cent? Would there not have to be
a decline in growth to resort to quantitative easing?
One goes through each of these pages, tries to understand, and really, one is
looking to know what the probability for economic growth is. You are Canada's
experts, you enjoy the greatest credibility, and you are the most well versed in
this area. Are you very confident that 2.5 per cent will be reached next year?
Are you just confident? Are you 90 per cent sure? Are you 10 per cent sure? What
level of comfort can you give us?
Readers try to gauge the level of confidence by reading the 32 pages of the
French version. I do not know if we can be confident, very confident or not very
confident at all. What is your opinion?
A very short answer will suffice.
Mr. Carney: As usual, that is a difficult question. This is our
outlook, our base scenario. This is the most probable economic situation from
now to the end of 2010. However, it is obvious that there is a wide range of
uncertainty. We have just discussed the challenges concerning stabilization of
the global financial system.
There are also downside risks with respect to the range of global imbalances,
those famous global imbalances. At the same time, there are risks to the upside.
It is possible that consumers and businesses will regain confidence more quickly
than expected. It is even possible that global recovery be stronger than
But of course, there are risks. Near the end of this report, on page 28,
there is a definition of the risks. For the first time, the Bank of Canada
published a projection for core and total CPI inflation. If one is bearish, one
can expect the inflation rate to be lower than expected; if one is bullish, it
will be higher.
I have the impression that you are much more confident than you let on. When
you say you are 51 per cent sure, I assume that you are much confident than
Mr. Carney: There are a few points here. But ultimately, our mandate
is to achieve the target inflation rate, and we have options. If there is a
negative shock, we would use one of the options, for example quantitative
easing, or credit easing to achieve the inflation rate target.
Senator Massicotte: I will not insist, because I do not think I will
get an answer. Looking at all of the available measures, quantitative easing
serves to provide liquidity to the banking system. If I recall correctly, you,
along with the Minister of Finance, stated four to six months ago that Canadian
banks were not doing their fair share. They were not doing enough to inject
liquidity in the market. Despite your comments, Canadian banks replied that
their lending rates lending were on the rise, and in quantitative terms, had
increased by 9 per cent.
There is always a risk. You can inject liquidity into the market, but it is
never certain that this liquidity will be passed on to borrowers. If I
understand correctly, Japan tried the same thing, but it did not work because
banks held on to the capital for their own needs. How do you manage this risk
and how can we be sure that even if you provide liquidity, the banks will indeed
do their part and make sure that it is passed along to the Canadian market?
Mr. Carney: If I understood correctly, your question is twofold. With
respect to the situation in Japan, during the 1990s, their policy was indeed to
target the central bank's liabilities, in other words, create new liquidity for
the Central Bank of Japan. Here, our framework is to improve financial
conditions through the creation of new liquidity by the Central Bank of Canada.
We would be targeting assets, and not liabilities. In a way, that approach is
entirely different, as compared to conducting monetary "policy at the effective
Mr. Jenkins: With respect to the framework presented in the monetary
policy report, the goal of these measures, if indeed these measures are
necessary, is to improve financial conditions in Canada's overall economy and to
increase the rate of real growth within the economy; that is what we are
focusing on. In Japan, the situation that prevailed in the 1990s was very
different. The approach we would use under our framework is different in that it
would increase credit levels and improve the functioning of financial markets.
The Chair: Senator Eyton has a quick, short supplementary.
Senator Eyton: It concerns targeted interest rates. We know what they
are and it is your prime tool for monetary policy. We seem to be doing well on
that score now. This is picking up on the notion of the Japanese experience. We
have heard lots about inflation but we have not heard anything at all about
stagflation and the prospect that that could occur. I put that in the context of
a two-year stimulus package where we bet the house on a program within a finite
period of time that we think will provide the answers.
Might stagflation occur after the two-year stimulus period? If that were so,
what would we do about it? We would have conducted an aggressive program that
may not have delivered all that we hoped it would.
Mr. Carney: It is our job to ensure that the "flation'' bit of the
stagflation does not occur. We would absolutely underline that we feel we have
the tools necessary to achieve the inflation target from below, if you will. As
we discussed earlier, we do see total CPI inflation dipping down this year but
then coming back to the target by the third quarter of 2011. We have the tools
both to bring it back and to keep it there or to prevent it from running away
when we use those tools.
For the inflation bit, I would reiterate our intent to achieve our inflation
target and our ability to achieve our inflation target.
The issue, though, if I may generalize your question a bit, is that there
needs to be a hand-off from a public sector stimulus that is trying to fill in a
gap in both consumption and investment in the country and our net export
position and contribution from net exports that is a result of the crisis. There
does need to be that hand-off. Part of that hand- off will come through the
recovery of our export markets, which we need to see. To be absolutely clear in
terms of our projection, we do not see U.S. growth rocketing out of this
recession. We see quite timid U.S. growth in 2010 and 2011. We do not see global
growth coming back to the levels of earlier this decade. That will have
However, we do see that balance sheets on the corporate side are in good
shape, and also are solid on the household side. There should be that ability
for the hand-off, but we have to manage policy collectively in a credible
fashion so that people have the confidence to pick up the reins. We do need to
see continued progress elsewhere. If external demand is weaker, growth in Canada
will be weaker, but the inflation side we will focus on.
Senator Oliver: My question follows that of Senator Eyton. It is about
inflation in the medium term. I guess I am talking about the third quarter of
Your statement is clear. Today you told us that we will always set our policy
rate at a level consistent with achieving our 2 per cent inflation target over a
policy horizon, and the bank has promised to hold the overnight rate at a
quarter of 1 per cent until June 2010. As we move out of recession, energy
prices are expected to rise. The return of consumer confidence will create
additional demand for goods and services at a time when inventories will be
very, very low and run down. You are expecting exceptional growth, as you have
told us, of 4.7 per cent. Should we be concerned that as we move into the second
half of 2010, there is a risk that interest rates will have to rise, and perhaps
rise significantly, to keep inflation within the target of the 1 to 3 per cent
range? If you start raising interest rates, will that put any constraint on
businesses who want to invest and expand their businesses?
Mr. Carney: Thank you, senator, for your question.
The first point to recognize is that the Canadian economy has experienced a
big shock. Including in this quarter and the next quarter and even with the rate
of growth we are seeing in the fourth quarter, that has opened up an output gap,
a difference between the potential of the economy and where it is actually
operating, that will be considerable — not unprecedented at all, but
considerable. It will take some time. In fact, it will take, in our estimation,
until the third quarter of 2011 before that gap is closed, even with those
strong rates of growth.
Senator Oliver: Then, in the third quarter of 2011, will you have to
start raising interest rates?
Mr. Carney: Certainly we have given a tremendous amount of
transparency. Normally we would come in and reluctantly tell you what our last
decision was. We would tell you that, but we would not give you the transparency
that we have given and I am loath to extend beyond it. At some point, interest
rates will be higher than they are today, but that is at some point in the
Senator Oliver: Will there be a restraint in growth once you start
raising the rates for those people who want to start increasing their
inventories again and expanding their plants and wanting to borrow money to do
Mr. Carney: We will ensure that financial conditions are consistent
with sustainable growth, not inflationary growth, growth that is consistent with
the 2 per cent inflation target. There is a variety of other factors, whether it
is return of some measure of confidence, whether it is further improvements in
the financial conditions in the country, or other aspects of demand.
I would like to make one other point, though, if I could, because it is
important on this. One of the risks in a situation like this, in our view, is
that the view of the potential growth of the economy is not kept up to date.
Therefore, as a central bank, one could get caught thinking that there is
greater capacity and a greater output gap than there is in fact. That is why we
took a hard look at what we believe the current rate of potential growth is in
Canada. In this report, we outline this in one of the technical boxes.
Basically, given the scale of the restructuring that is going on, in
particular in our manufacturing sector, and given our outlook for investment
this year and next, we believe that productivity growth will be considerably
lower than previously thought. Therefore the rate of potential is lower in this
year, next and 2011. In fact, the starting point level potential of the economy
is lower as well.
The sum of that is that the gap is smaller than it otherwise would be. That
is important. That provides the discipline in terms of the management of policy
going forward, obviously to ensure we achieve our target and not miss it.
The last point I will make on that is that we normally update our view on
potential once a year, in October. Given the scale of what has gone on and the
importance of this, we did update it again in this report and we will review
those findings in October so that people and the committee will have our best
view of the speed limit, if you will, of the Canadian economy.
Senator Moore: Thank you, witnesses, for being here.
How many people work at the Bank of Canada?
Mr. Carney: There are 1,200 people working there.
Senator Moore: Last June we were dealing with Bill C-50, which
received Royal Assent on June 18. That bill gave the Bank of Canada huge
additional powers to buy and sell from any or to any person, securities and any
other financial instruments that comply with the policy established by the
governor under subsection 18(1), and if the governor is of the opinion that
there is a severe and unusual stress on a financial market or the financial
system by himself, to or from any person, any securities and any other financial
instruments to the extent determined necessary by the governor. Then, in the
next section, you were to establish a policy that is to be published in the
Before I get into the policy as published on July 26, and what happened here,
I want to ask about this: you were asked to appear before the Standing Senate
Committee on National Finance and you declined, which I found extraordinary
given the powers you were asking for.
Can you tell us about that?
Mr. Carney: I do not recall the specific circumstances of the request.
Senator Moore: I know that you were asked and given three dates to
appear and you did not appear. You did not send Mr. Jenkins, who we know, and
you did not send any of the other 1,200 people. This was an historic granting of
power to the bank.
When we go to the policy that you had published on July 26, I was surprised
when I read it. It does not just apply to you being able to purchase instruments
in Canada. It gives you the authority to do purchasing beyond Government of
Canada savings bonds and treasury bills, including any security issued by the
Government of Canada; by the U.S. government; by organized member states of the
Organisation for Economic Co-operation and Development; Canadian corporate and
municipal bonds, including Canadian dollar bonds issued by foreign entities;
Canadian dollar bankers' acceptance with a term maturity of 365 days; promissory
notes that with a term of 365; commercial paper, including asset-backed
commercial paper not exceeding 365; and Canadian dollar-term asset-backed
It is all in your discretion and you are to give notice. It does not say how
much notice you have to give. At the bottom, in small print, it states: "This
power has been in the act since 2001.'' That is the second part permitting you
to do transactions outside of Canada. If it has been in the act since 2001, I do
not know why it was repeated in this act. Has it ever been used?
Mr. Carney: Yes. I would like to respond.
First, under what is now 18(g)(ii) of the act, which was formally 18(g.1)
of the act, enacted in 2001, the bank had the power to do exactly what you said,
including purchase of equities, I would add. The requirement was and still is —
Senator Moore: This does not permit equities.
Mr. Carney: Section 18(g)(ii) does, if you read it. The
governor had to declare the severe and unusual financial stress in the economy.
That declaration would be disclosed at the appropriate time; potentially after
the fact, potentially before the fact. That was originally put in following the
experience of Japan where there was a need in Japan for that kind of thing.
Now, coming to the changes that went through Bill C-50. The purpose of those
was to modernize the options for the bank in the provision of liquidity to the
financial system. Historically there had been a very specific listing of the
type of securities against which the bank could purchase sale. Some of those are
no longer operative in the Canadian market and the more relevant securities that
are operative, Asset Based Commercial Paper, for example, and other aspects of
foreign treasury bonds and government bonds, were not listed. These were
included in the new amendments to the act and then the bank has published a
Your question is: Have we used the policy?
Senator Moore: That is one question, yes.
Mr. Carney: When Lehman Brothers hit, AIG went down, and a series of
U.S. banking institutions went down. When liquidity froze in the global money
markets and capital markets, the bank used the policy to provide liquidity to
the Canadian financial system and ensure that Canadian households and businesses
continue to have access to liquidity. You can see from the charts they continued
to have access to liquidity, to credit, throughout this crisis. We did that on a
collateralized basis. We provided liquidity to the banks.
Senator Moore: Do you mean to Canadian banks?
Mr. Carney: Yes, to Canadian banks, and we took back those securities
you listed as a belt and suspenders.
Senator Moore: Other than the mortgages, governor?
Mr. Carney: Yes, absolutely. We detail this as well. I reference this
credit site on our website. You can go there and all the facilities are listed
and the composition of our balance sheet is listed as well and we detail what
securities we have taken back. That is all disclosed. We use those securities as
protection for our balance sheet because we are effectively making a loan to a
bank so that they can continue to operate.
Senator Moore: When you said "facilities,'' did you mean securities?
Mr. Carney: Yes.
Senator Moore: Was that in addition to $200 million in mortgages that
you bought from Canadian chartered banks?
Mr. Carney: The Bank of Canada has not purchased any mortgages. That
is on the account of the Government of Canada, and the figure is considerably
less than that. That is the insured mortgage purchase program of the Government
of Canada. Our balance sheet is approximately $75 billion. I would add, if I
may, that the bank's ability to pursue quantitative or credit easing — the
purchase of securities for the purpose of improving financial conditions to
ensure that Canadian households and businesses have access to the appropriate
credit — to achieve the inflation target, would be under section 18(g)(i)
of the Bank of Canada Act and would not require the declaration, whether delayed
or not, of severe and unusual financial circumstances in the country.
Senator Moore: Is that covered in the second part?
Mr. Carney: That is covered under the Bank of Canada Act of 2001. The
provisions of that act are consistent with the powers of the Federal Reserve,
the Bank of England, the European Central Bank, the Bank of Japan the
Reichsbank, the Swiss National Bank and all other major central banks.
Senator Moore: It would have been educational and instructive if you
had come to us and told us and the Canadian Public about that last June.
Would the Bank of Canada buy toxic assets, as Henry Paulson, former Secretary
of the Treasury, did in the United States?
Mr. Carney: We have about $26 billion outstanding in liquidity
facilities. They are lent against high quality, investment grade securities.
They are not purchases but they are lending on a collateralized basis against
those securities. Toxic assets would not qualify. No, is the short answer for
Senator Moore: You would not buy.
Mr. Carney: If ever we were to pursue credit easing, we would do it in
as neutral a fashion as possible. Toxic assets tend to be concentrated. They are
toxic because they are a specific sector or a specific type of security. That is
why we have a neutrality principle apart from the prudence principle, which
appropriately protects our balance sheet and would obviate the purchase of toxic
assets. Both neutrality and prudence would mitigate against such purchases if we
were ever to pursue credit easing, which is an open question.
Senator Eyton: I want to talk about constant business loans. We know
that the bank's rate is at an historic low and that you have made a commitment
that it will stay in place for a long time. Banks in general followed the trend
but not quite, so their spread increased a little. However, the banks have
suggested that their cost of borrowing has risen and, therefore, it has been
difficult for them to follow completely the trend set by the Bank of Canada's
In addition, there is a reluctance on the part of Canadian and international
banks to make interbank loans. The cost of borrowing money to fund their
operations and the lack of interbank loans has made it more difficult for them
to respond as you might wish.
Have recent initiatives and developments helped the cost of borrowing to
banks to stabilize? Is the rate coming down? Similarly, with interbank loans,
are they happening in greater frequency?
Mr. Carney: Thank you for that question. Those are important issues
that we have been grappling with since the crisis broke out in July 2007. There
were tremendous strains first in the interbank market and then more broadly in
the longer-term funding markets. I am pleased to report that in both cases, the
cost of funding has improved considerably for banks. Chart 11 at page 15 in the
English version of the Monetary Policy Report indicates funding costs for
Canadian banks swapped on a floating bases. You can see both the shorter term
levels, which are below 1 per cent, consistent with the moves down in the Bank's
rate; and the longer term, five-year debt spreads. Canadian bank funding costs
have started to fall quite sharply, as one would expect. We have seen that
response. Canadian banks have not resorted to using government guarantees. There
has been a partial reliance on the Insured Mortgage Purchase Program, which has
helped their funding costs and has been an important element.
In the interbank market, we have seen tremendous progress over the course of
the last several months. Canada has consistently had the lowest spread in the
interbank market relative to where the expected overnight interest rate would
be. Our spreads have fallen down as low as 20-25 basis points, and to compare,
the U.S. spreads have begun to come down to 75-80 basis points after being up
well above 100. European and U.K. spreads are slightly higher than in the U.S.
We have consistently outperformed. We are almost back to levels that preceded
the start of the crisis, not just the Lehman series of bankruptcies. We are
approaching what might be the new normal.
Why have we performed well? Part of it has been the strength of our
institutions, without question.
To be honest, during the strains, including from October and to the last
exchange, it has been the liquidity facilities provided by the Bank of Canada
and made possible under section 18(g)(i) of the Bank of Canada Act. The
combination of the two has brought things back. The ability of banks to fund on
a quite liquid basis is one of the encouraging signs in financial markets.
With the chair's leave, I wish to make another point. We did one other thing
on April 21 that is related to this. We have been providing liquidity through
facilities with the $26 billion for a one to three month horizon. We have seen
this improvement but, given the time it will take to stabilize the global
financial situation, it will be the work of this year and into next year. There
will be a continued need to provide a measure of Bank of Canada liquidity for
this calendar year.
In recognition of that and in order to reinforce our conditional commitment
to keep our overnight rate at 25 basis points, we will roll over some of these
1-month and 3-month facilities to 6-month and 12-month maturities. We run an
auction so that banks have to compete for this money, but we will have a floor
of 25 basis points and a cap of 50 basis points. It shows that we are putting
our money where our mouth is. We lend on a collateralized basis out to 12 months
at a rate consistent with where we expect the overnight rate to be. That has
helped the market as well.
Senator Eyton: I was in New York on Monday where a wise man was trying
to describe the American government programs to me. One is TARP, the Troubled
Asset Relief Program, which essentially builds the balance sheets of the banks
and insurance companies. The second is a Public-Private Investment Program,
PPIP. That is one where, in effect, they buy legacy assets for both loans and
securities on very favourable terms.
The third is Term Asset-Backed Securities Loan Facility, TALF, which is only
starting now. It is the same as the intermediate PPIPs, except these are for new
securities and loans.
The ground they cover touches on your quantitative easing and credit easing.
That is essentially the same ground. What worried me as a Canadian as I was
listening to it, is the immense amount of money involved. The programs together
currently aggregate approximately $3 trillion.
I would like your comment on what I would call dislocation or challenges
within the marketplace given the size of the loan and the proximity of the U.S.
Canada and the U.S. are fundamentally one market in many ways, even including
our financial institutions. I looked at the aggregation of those facilities and
wondered what can be the effects in Canada. They have to be significant. How do
you deal with it?
Mr. Carney: First, as we obviously all know, is Canada's size relative
to the U.S. We have to look at the size of their economy and the usual 10-times
factor comes into play.
Second is the relative importance of the non-bank financial sector in the
U.S. historically, which magnifies the scale of what is being done there. As
this committee would know, this sector is much more important in the U.S. than
it is either historically or currently in Canada. That is the sector that has
been the hardest hit. As a result, particularly with the TALF, there is a focus
on the securities aspect of what are now known as toxic assets. The scale is
immense and it is a broken market.
They are trying to provide both a measure of credit easing — to use our
terminology — by reactivating that market with a mixture of private and public
capital. That is not an issue that pertains to Canada because we did not have
large structured product markets. We had one, which was the non-bank
asset-backed commercial paper. That has now been restructured and addressed.
Senator Eyton: What about Canadian investment going south into these
Mr. Carney: We are not aware at this stage of investments, nor would
we ever look to interfere with those investments. It is not our role.
It is in the interests of Canada in the global economy that these facilities
work and that these markets are restructured, turned out or restarted. The PPIP,
which you referenced, is the way of moving legacy loans and toxic loans off the
balance sheet. That is part of the precondition we discussed earlier and we need
to see the progress there.
Senator Eyton: Therefore, we are okay.
Mr. Carney: In this regard, we will benefit from successful execution
of these facilities. We are not exposed directly to these facilities. We are
only exposed to the implications of them either being well run or not well run.
Senator Ringuette: One of the questions I have is in regard to the
credit market. You referred earlier to $75 billion of insured mortgages out of a
potential $200 billion that the federal government has identified. I have been
told that the interest rate on the government funds lent to provide liquidity to
our banking system was 1.7 per cent. Can you verify this?
Mr. Carney: I am not the best person to give you the precise interest
rate, but the floor on the interest rate for the facility is related to the rate
paid on Canada mortgage bonds issued by CMHC. For the committee's purposes, in
very general terms, these spreads change, but it is 75 basis points — three
quarters of one per cent — above the rate at which the Government of Canada
There are two aspects to the way the rate is set. The clearing rate in these
facilities is set through auction. So the rate I mentioned is the floor, and
that is as low as it can be. Banks have to bid. Therefore, the actual clearing
rate is higher than the floor, not much often, but it is higher than the actual
The point is that the government already has the risk on these mortgages.
They are guaranteed by the government. The government borrows at its rate and
lends at a rate above it. Therefore, there is a spread between the two without
taking risk that accrues to the fisc.
Senator Ringuette: I am beginning to be fairly well informed in
regards to credit cards, but it is not the same situation in regard to world
credit, so please correct me.
I am assuming that there is only "X'' amount of money in the global credit
pool. If the Government of Canada acquires $200 billion, plus another $12
billion for the asset car lease situation, that removes liquidity from somewhere
because the Government of Canada has no reserve. The Bank of Canada has a
reserve, but the Government of Canada has no reserve. They have to borrow this
Mr. Carney: First, I will leave it to the committee to verify, but I
do not think the sum is $200 billion.
Senator Ringuette: That is the number they have identified. However,
they are currently at $75 billion, plus $12 billion.
Mr. Carney: Second, the mechanics here are that these are assets. They
are mortgages currently on the balance sheets of banks.
Senator Ringuette: I understand all that. I am asking you about the
Mr. Carney: Those assets are financed by the balance sheets of the
Senator Ringuette: Okay.
Mr. Carney: Selling them back to the government frees lending capacity
for the banks, which has been helpful.
Senator Ringuette: Yes.
Mr. Carney: Then, the Government of Canada has an asset and a
liability on a net basis that offset —
Senator Ringuette: What I am asking you is where does the Government
of Canada get the money?
Mr. Carney: The government borrowing program has increased over the
course of this year. It borrows money from the markets as it does normally.
Senator Ringuette: That is what I am saying. The government borrows
the money from the global credit market. If the Government of Canada borrows
money from the global credit market, it removes available liquidity from that
market. There is only "X'' amount of dollars in the market.
Senator Massicotte: It is just a bigger credit card.
Senator Ringuette: That is right.
If the Government of Canada borrowed, let us say, $75 billion plus the $12
billion of asset car lease, that is $87 billion, plus the billions in deficit,
that is, let us say, a round figure of $100 billion at 1.7 per cent interest.
The banks in Canada can purchase in the same liquidity market, credit market, at
1 per cent. So what kind of deal did we really bring about for our financial
banking institutions because we are paying 0.7 per cent more? We have removed
early access to liquidity for our banking institutions.
Mr. Carney: The cut and thrust of it is that the banks are paying the
government the 0.75 plus through the auction, net. The banks do not have to
borrow that money in the market.
Senator Ringuette: No, the government does.
Mr. Carney: The government is a more efficient borrower net than the
banks. The government is a bigger volume issuer, that is why it borrows through
the banks. No bank in Canada ever will borrow through the Government of Canada.
The government is charging, at no risk to itself, three quarters of a percentage
point or more depending on the results of the auction.
That is a function of the way we have set up our mortgage market, because the
government, through CMHC, as you know, provides this net. The government is
taking advantage of the structure of the Canadian mortgage market to provide
this and to make a net. From a private bank perspective, that is financing they
do not have to do that they used to have to do. They are paying for that. From a
government perspective, it does not take on net debt; it does not take on net
Senator Ringuette: In reality there is 0.7 per cent more that must be
paid in the market.
Mr. Carney: It is up to the government to decide what to do with it,
but it is three quarters of a per cent plus on a large number. That is money the
government spends and that Parliament approves.
Mr. Jenkins: When thinking about it from a global perspective, one of
the elements we have been dealing with since this crisis unfolded has been what
we call the deleveraging process. This is the reverse of what got us into this
difficulty with all the leveraging that was taking place. Through this
deleveraging process people were falling back into, for example, bank lines of
An economy-wide issue was that we wanted to keep credit growing. One of the
ways would be to provide more scope for financial institutions in Canada, and in
this case the banks, to provide credit to households. Through the government
buying these particular mortgages from the banks. that then gives the banks the
capacity to actually go out and make more loans to Canadians.
There is that global overlay that is particularly important here. It is not
so much using up liquidity. I would say it is more freeing up liquidity to
ensure that money that is available is actually being used to create credit.
The Chair: Do you have one more short question, Senator Ringuette?
Senator Ringuette: Yes, I do.
The Chair: I have four more questioners.
Senator Ringuette: In relation to China's statement in the last few
weeks regarding the U.S. dollar and maybe looking for another means of measuring
global finances, what would the impact be on the U.S. economy and indirectly on
our economy if that happens?
Mr. Carney: One of the challenges going forward will be sustainable
rebalancing of the global economy. We referenced at the start that one of the
risks to our forecast is not achieving that over the forecast horizon. Even
more, that there certainly is no reversal of that process over the horizon, or
any material reverse. That will require a mix of demand management policies,
structural policies, in the major economies including the United States and
I think these economies recognize that. There is a role for exchange rates to
play in that adjustment, but there is not necessarily a role for change of
exchange rate regime to play in that adjustment.
The paper by the Governor of the Bank of China is interesting, but it should
be reflected on over a very long period of time.
Senator Ringuette: In other words, you do not want to answer.
Mr. Carney: It should be reflected on over a very long period of time,
and I certainly do not believe that it is a proposal that is relevant to our
Senator Fox: I must say I admire the way you use language. I used to
answer questions in the House of Commons but I do not think I have ever done as
well as you. I know you do not want to be on the front page of some of the
economic papers tomorrow.
Mr. Carney: We will see the headlines tomorrow. That is very kind,
senator, but you never know.
Senator Fox: I will put my questions right out. I do not hear the word
"deflation'' anymore, yet a few months ago there was some concern about that.
Is that something we can take off the worry board at the moment?
Second, you say that the recovery should be supported by certain factors, one
being the past depreciation of the Canadian dollar. We see oil going back up a
little bit. Today it was $56. U.S. debt is climbing a great deal. If we come out
of the recession, commodity prices are likely to go up with an effect on the
Canadian dollar. What policy instruments do we have left to keep the Canadian
dollar at an interesting level for exports once we have interest rates as low as
we have them now? We cannot use that anymore, I assume.
The third point, and I know Mr. Jenkins dealt with it somewhat, you say the
recovery should be supported by the strength of Canadian households. I get a bit
worried about that part of it anyhow. I look at Canadian households and see a
higher level of unemployment than we have had in the past. I see many people who
have lost a lot of money in their RRSPs and I see a real concern about the
continued existence of pension plans. How secure is that pillar of the recovery?
Those would be my three questions.
Mr. Carney: We will try to be quick. I could give you no answer on the
currency. How is that? It will save time. That is only in the interests of time.
Deflation: We do view the prospect of deflation as remote in Canada;
deflation being a sustained and broad fall in prices. We do expect, though, that
total CPI will go negative during this quarter and in the third quarter. We
expect the core CPI to go to the bottom of the band, and then both to move back.
Maybe it is off the radar screen, if you will but, to reiterate, we care as much
about sustained rate of inflation below the target as we do above. That is why
we are taking the actions that we are to ensure that we get back to the target
in a reasonable period of time.
That is also one of the reasons why we are managing policy over this horizon
as aggressively as we are given the scale of some of these forces.
With respect to the currency, very briefly, a flexible exchange rate is an
important part of our framework. It has served this country very well. We do
watch it closely and it is relevant to the outlook for inflation in Canada if
there are persistent moves in the currency that lead to an overall tightening. I
view you as having four questions. I will answer the third and give the fourth,
on consumers, to Mr. Jenkins.
You suggested we had run out of instruments. I know you know this, senator,
but we retain instruments, and that is why we wanted to publish this report and
the framework. Quite frankly, our preferred course was to publish it in advance
of going to the House of Commons and Senate committees so we could have the
discussion around it. Just to make it absolutely clear, the bank retains
important instruments that we could use them to achieve the inflation target if
it were necessary.
Mr. Jenkins: Very briefly on your last question, senator, in our base
case projection, household consumption is beginning to pick up as we go through
2010 and into 2011. As I mentioned earlier, we are watching very closely
developments of the household sector balance sheet. We really did go into this
difficult period in a much stronger position than virtually any other
jurisdiction. Yes, we have had reductions of household sector wealth, but as we
move forward with the policy stimulus that is in place, domestically as well as
internationally, gaining traction as we go forward, we see employment picking up
and, with that, consumption being a contributing factor to the outlook.
Senator Goldstein: Some months ago The Economist reflected a
concern of some economists that commercial financing, predominantly in the real
estate field, may be somewhat endangered because a large proportion of real
estate mortgages are coming due toward the end of 2009 and beginning of 2010,
and there may not be an appetite by lenders to refinance, and there may be no
other areas of refinancing.
More recently, a newsletter to which I subscribe from the United States
reflected the same concern. Do you have a concern about that, and is that a
concern for Canada?
Mr. Carney: Thank you for the question. The financing environment for
commercial real estate globally in the United States is extremely difficult,
without question. Part of that obviously reflects the economic outlook. Part of
it also reflects severe strains in the commercial mortgage backed securities
market and generalized problems in structured markets. It is a very difficult
financing environment in the United States.
Although not quite to the same degree, it is a very difficult financing
environment in Canada. It is a concern and we are watching it closely for its
impact on the economy and the economic outlook. We have met on this issue with a
number of the key players, not only on the financial side but also on the
developer side in the construction industry, as recently as this week.
Senator Day: I would like to ask for two points of clarification and
then one question on which you may or may not be able to help us.
The first point of clarification is on monetary policy and low interest
rates. You talked about quantitative easing, which involves the creation of
central bank reserves. We will all be asked to vote on Main Estimates in the
next few weeks. Will we see in those Main Estimates the creation of central bank
reserves, or is that done in another manner?
Mr. Carney: No.
Senator Day: How do you do it if it is not in the Main Estimates?
Mr. Carney: It shows up on our balance sheet, which is published on a
weekly basis on our website. I reference the one-stop shopping for all these
issues at the top left-hand corner of our website. There is a click-through to
our balance sheet, and it would show up there.
As I said in my opening remarks, if we were to pursue such a strategy, the
Bank of Canada's governing council's intent would be to announce it in advance
at a regularly scheduled fixed action date, the days we make our policy
decisions, and to detail it. So it would be detailed at that point in advance of
the action happening. You could track it through the weekly balance sheet.
Senator Day: That is helpful.
The second point for clarification is in relation to the amendments to the
Bank of Canada Act made in June of last year under the Budget Implementation
Act. You said in your response to Senator Moore that other jurisdictions have
similar powers. Were those amendments that you had been seeking for some time,
and the budget implementation was a convenient place to bring them in, or were
you seeking them specifically to deal with the anticipated downturn in the
Mr. Carney: It was not the anticipated downturn in the economy. It was
a confluence in that elements of the Bank of Canada Act were out of date, and we
did have fewer powers to provide the type of liquidity facilities and other
actions that we thought could be necessary — and in fact turned out to be
necessary — if the crisis were to persist. I do not speak for the government,
obviously, but it had a package of measures related to financial systems
stability. This was an element of it, and the natural place for it was in the
budget bill, but that is their decision.
For us, it was modernization, which is something we wanted for a while, but
it was put in sharp relief by what was happening in global markets. We would
have had to use the nuclear option, if you will, of declaring a national
emergency in central banking terms with wide powers as opposed to something more
direct and laid out through a policy framework.
Senator Day: It is difficult for us, when we get a budget
implementation bill, to deal with all the diverse aspects. Our difficulty was
that we really did not understand the effects of this, where it was coming from
and what the initiative for it was.
My final question is about Bill C-10. There are amendments to the Bank Act at
page 258 of Bill C-10. Clause 275 of the bill adds section 973.2 (1) to the act.
We have passed this, but it would be nice to know just what it means.
The section reads: "On the recommendation of the Minister, the Governor in
Council may, by order, provide that any provision of this act'' — the Bank Act —
"or regulations shall not apply to a bank, to Her Majesty in right of Canada or
an agent or agency of Her Majesty or to any other person otherwise subject to
the provisions of the Bank Act.''
Are you able to help us with that?
Mr. Carney: I would love to be the Governor-in-Council, but I am not,
nor am I the Minister of Finance, so I cannot help you at all.
Senator Day: You are not familiar with this? I think the basis for it
is to allow the Government of Canada to take money from the Consolidated Revenue
Fund to invest in banks.
Mr. Carney: I am not familiar with the specifics of the provision.
Senator Massicotte: In Canada we have been very lucky with what is
happening in our structure, but other countries in the world have not been. The
United States is questioning how they should regulate and govern, and how they
should ensure sound systems.
Last week you responded to the same question in the House of Commons Standing
Committee on Finance. You said that, irrespective of the fact that we have had
better times, we should learn from the experiences of other countries and
possibly look at changes in how we regulate our own industry. Austria takes a
prudency role and the Bank of Canada has a different role. How should we change
our system in order to minimize unpleasant surprises in the future?
Mr. Carney: Consistent with the agreement of the G20 leaders in April
and the recommendations of ministers and central bank governors a few weeks
earlier, I would say that one of the most important things is that all
regulators, in the broadest sense, must take into account the implications of
their actions for financial system stability, that is, they must think about the
system as a whole as well as their core responsibility.
There is a series of issues, and we would be happy, with more time, to
discuss them in more detail. They run across accounting, bank capital, pensions,
mortgage regulation, and margin arrangements in financial markets that can have
unfortunate amplifier effects and ultimately be destabilizing to the system. The
first thing is that there is that associated responsibility for the system.
Second, there must be a mechanism to coordinate and express views on the system
so that those decisions can be informed.
The Bank of Canada does not bear those responsibilities but we have a general
responsibility to consider financial stability under the preamble to the Bank of
Canada Act. We view ourselves at this time as having an advocacy role in
identifying problems and making them known to committees such as this and to
Canadians more broadly. We intend to continue to develop this role.
It is difficult at times, because when the institution has identified and
advised of problems, the advice has not always been followed. In some cases, the
problems have been identified repeatedly. In one instance, the only serious
capital market problem we had in this crisis had been identified by the bank
some years in advance. In the end, the bank had to play a central role, along
with the government, to sort out the mess, even though we had no direct
responsibility for it.
Senator Moore: Mr. Carney, could you clarify what I think you said,
that with a prudent and balanced approach, you might buy toxic or questionable
Mr. Carney: Given that "neutral'' means "broad'' and "toxic'' means
"narrow''; and that "prudence'' means "safety'' and "toxic'' means risky, it
is highly unlikely, given our principles, that we would purchase these assets.
The only caveat I tried to give is that "toxic'' is an incredibly elastic
Senator Moore: I am concerned about the moral hazard of such an action
with the inequity of a bad decision being rewarded when there is money involved.
Mr. Carney: That is an extremely important and fair point and
something to always consider in any of these activities. It comes down to
concentration in sectors. If certain institutions or sectors are rewarded for
bad decisions, it is counterproductive to the overall objective. Quite frankly,
it would not be necessary to achieve the overall goal of improving financial
conditions in order to achieve the inflation target.
I can assure senators that moral hazard is a term that probably is used more
frequently in the Bank of Canada than virtually anywhere else in the country. It
is of tremendous concern for us. We are thinking long and hard about the post
crisis design of the financial system and our activities and how to minimize
that because people know what has been done in extremis. How do you
rebuild the system?
Senator Moore: Do not let them take advantage of you.
Mr. Carney: We are thinking very hard about that.
Senator Moore: Both you and Ben Bernanke, Chairman of the Federal
Reserve, talked about the importance of stabilizing the U.S. banking system. I
believe you said that the Bank of Canada expected upturns conditional on the
U.S. and the U.K. stabilizing their systems. This is critical for Canada but you
did not mention that as one of the factors that would support a Canadian
recovery. How critical is it? Is it key to your planning?
Mr. Carney: It is an absolutely critical precondition for recovery in
Canada and globally. That precondition is spelled out clearly. It was in our
decision and published in the monetary policy report.
Senator Moore: Yes. I wondered why you did not mention it today.
Mr. Carney: Certainly, it has not become less important. While we take
some confidence in the scale of the plans and the will of the U.S.
Administration and other administrations around the world, execution is
everything. These plans must be implemented. They are being implemented but they
are complicated, so it will take some time.
A significant shortfall will have an impact on activity and inflation in
Canada, and the Bank of Canada will react appropriately.
The Chair: To what extent was the economic crisis aggravated by the
linkage of banks and investment houses? Would your job be made easier if they
Mr. Carney: The crisis was magnified and transmitted by problems at
certain large, complex financial institutions, which were both banks and
investment houses. They were poorly run institutions, in hindsight, and were
dramatically over leveraged.
The Canadian experience has shown that if you have well-run institutions with
appropriate leverage, banks and investment houses can be linked. Going back to
Senator Massicotte's point, lessons can be learned from the failures elsewhere.
We need to appropriate those lessons in further risk-proofing our system.
The Chair: Thank you, Mr. Carney and Mr. Jenkins. As always, it has
been enlightening and informative. We appreciate that you have renewed and
maintained the tradition of coming before the Standing Senate Committee on
Banking, Trade and Commerce. We wish you well in your work; it is vitally
important for Canadians. The Bank of Canada is to be applauded for its efforts.
Mr. Carney: Thank you very much, senator. We look forward to coming