Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 16 - Evidence - April 25, 2012
OTTAWA, Wednesday, April 25, 2012
The Standing Senate Committee on Banking, Trade and Commerce met this day
at 4:15 p.m. to examine the present state of the domestic and international
Senator Irving Gerstein (Chair) in the chair.
The Chair: Honourable senators, it is a pleasure to call this
meeting of the Standing Senate Committee on Banking, Trade and Commerce to
order. We are very pleased today to have appearing before us Mr. Mark
Carney, Governor of the Bank of Canada, along with Mr. Tiff Macklem, Senior
As you know, Mr. Carney has ably served Canadians as the bank's governor
since February 1, 2008. During his time as governor, he has helped to guide
the Canadian economy through some very challenging times. On November 4,
2011, Mr. Carney took on additional responsibilities when he was named
Chairman of the Financial Stability Board.
Governor, I sense that your words reflect, to some degree, the reasons
for that appointment when you credited "the strong reputation of Canada's
financial system and the leading role that Canada has played in helping to
develop many of the most international reforms."
I might also add that, in my view, it is a great reflection on you
personally as Governor of the Bank of Canada. We look forward to your
comments in relation to your most recent Monetary Policy Report, as
well as any other matters you wish to bring to the committee's attention.
The floor is.
Mark J. Carney, Governor, Bank of Canada: Good afternoon, members.
Mr. Macklem and I are pleased to be with you this afternoon and we look
forward to the discussion of our April Monetary Policy Report and any
other matters you wish to raise. The profile for the global economy and
economic growth has improved since the bank released it s January
Monetary Policy Report.
Europe is expected to emerge slowly from recession in the second half of
2012, although the risks around this outlook remain high.
The profile for U.S. growth is slightly stronger. This reflects the
balance of somewhat improved labour markets, financial conditions and
confidence on the one hand, and emerging fiscal consolidation and ongoing
household deleveraging on the other.
Economic activity in emerging-market economies is expected to moderate to
a still robust pace over the projection horizon, supported by an easing of
Commodity prices are expected to remain elevated, owing to improved
global economic prospects, supply disruptions and geopolitical risks. In
particular, the international price of oil has risen further and is now
considerably higher than that received by Canadian producers. If sustained,
these oil price developments could dampen the improvement in economic
Overall, economic momentum in Canada is slightly firmer than the bank had
expected in January. The external headwinds facing Canada have abated
somewhat, with the U.S. recovery more resilient and financial conditions
more supportive than previously anticipated. As a result, business and
household confidence are improving faster than forecast.
The bank projects that private domestic demand will account for almost
all of Canada's economic growth over the projection horizon. Household
spending is expected to remain high relative to GDP as households add to
their debt burden, which remains the single biggest domestic risk. Business
investment is projected to remain robust, reflecting solid balance sheets,
very favourable credit conditions, continuing strong terms of trade and
heightened competitive pressures.
The contribution of government spending to growth is expected to be quite
modest over the projection horizon, in line with recent federal and
provincial budgets. The recovery in net exports is likely to remain weak in
light of modest external demand and ongoing competitiveness challenges,
including the persistent strength of the Canadian dollar.
The bank projects that the economy will grow by 2.4 per cent both this
year and next, before moderating to 2.2 per cent in 2014. The degree of
economic slack has been somewhat smaller than anticipated, and the economy
is now expected to return to full capacity in the first half of 2013.
As a result of this reduced slack and higher gasoline prices, the profile
for inflation is expected to be somewhat firmer. After moderating this
quarter, both total and core inflation are expected to be around 2 per cent
over the balance of the projection horizon, as the economy reaches its full
production potential. The growth of labour compensation remains moderate and
inflation expectations stay well anchored.
Despite recent improvements to the outlook for the global and Canadian
economies, risks regarding inflation in Canada remain elevated.
The three main upside risks to inflation in Canada relate to the
possibility of higher-than-expected oil prices, stronger-than-expected
growth in the U.S. economy and stronger momentum in Canadian household
The two main downside risks to inflation in Canada relate to a
reintensification of sovereign debt and banking concerns in Europe, and the
possibility that growth in Canadian household spending could be weaker than
Overall, the bank judges that the risks to the inflation outlook in
Canada are roughly balanced over the projection period.
Reflecting all of these factors, on April 17, the bank maintained the
target for the overnight rate at 1 per cent. In light of the reduced slack
in the economy and firmer underlying inflation, some modest withdrawal of
the present considerable monetary policy stimulus may become appropriate,
consistent with achieving the 2 per cent inflation target over the medium
term. The timing and the degree of any such withdrawal will be weighed
carefully against domestic and global economic developments.
With that, Mr. Macklem and I would be pleased to take your questions.
The Chair: Thank you very much, governor, for your opening
remarks. When you appeared before us last fall, you referred to the risks
surrounding Canadian household debt and the level that it was at. I note in
your remarks just now you again said that household spending is expected to
remain high level relative to GDP as households add to their debt burden,
which remains the biggest domestic risk.
I would gather that a large portion of household debt has occurred
through the extraction of household equity, which you cite in your report.
With the imposition of more stringent mortgage insurance rules and the banks
turning down more applications, could this be leading individuals to borrow
from sub-prime Canadian lenders and could this turn into somewhat of a
debacle as they had in the U.S. with the real estate market?
Mr. Carney: Thank you very much for the question, chair. As you
rightly note, and I emphasized in my remarks, we do see the evolution of
household debt as one of the biggest risks to the Canadian economy. May I
clarify that? These risks with respect to inflation are both on the upside
and the downside. There is a possibility that this process that we have
witnessed over the last several years continues at a faster pace than we
currently anticipate and is anticipated in this report and, as a consequence
of that, household spending is more vigorous. There is also the possibility
that, as a result, if there were a turn in the housing market, for example,
and house prices, then the consequence of that would be a sharper headwind
against the rate of consumer spending because of the scale of the household
debt burden. That is to put it into context.
As you rightly note, the government has, quite rightly in our opinion, on
three occasions tightened the mortgage insurance rules. This will contribute
to a more sound evolution of household debt and the stability of the
Canadian economy. In addition, I might add that the Superintendent of
Financial Institutions has issued for comment tighter underwriting
guidelines for home equity loans, which will also, in our opinion and
certainly in the opinion of OSFI, contribute to a more stable evolution of
household debt and therefore the Canadian economy.
As you suggest, any time there is tightening in one section of the
financial sector, there is the possibility that another portion of the
financial sector will fill the perceived need. The ability to do so is
somewhat constrained by a few factors. Most importantly, as you are aware,
any high ratio mortgage, any mortgage with a loan to value 80 per cent or
higher, requires mortgage insurance, and the terms of that mortgage
insurance are ultimately set either through CMHC or the private mortgage
insurers. There is a control exerted by the government, and so those terms
in the end apply to the sub- prime market.
Another point is that the tighter mortgage underwriting standards are not
just for the large banks. They apply across the regulated financial
institutions. Again, those standards include, very explicitly, consistent
with international norm, requirements for full documentation of incomes.
This "no doc" world that developed in the United States has not been
permitted in the past in Canada, and that aspect has been tightened. A
further range of other elements of improved standards are there as well. We
need to be vigilant across the system — the bank, the superintendent, the
Department of Finance — because the measures that have been taken and are
being put in place apply across the system.
Importantly, there is not the channel that was in the United States by
which mortgage aggregators — and I will use your terminology, "sub-prime
lenders" — were able to aggregate mortgages and then sell them through
asset-backed securities into the capital market, shifting the risk to the
capital markets, because in effect the vast majority of mortgage
securitization in Canada is done through the Canada Mortgage Bond Program or
what is called NHA MBS, both of which have to meet the standards of CMHC.
Those standards, as I referenced at the start, are determined by ultimately
CMHC, but the Government of Canada. Just to finish, the Minister of Finance,
appropriately, in our opinion, tightened those standards three times in the
past couple of years.
The Chair: I take it from that comment that the term "sub-prime
lender" in the United States and the use of the term in Canada is not
apples to apples?
Mr. Carney: It is not apples to apples. That is not to say that
there is not a small proportion of mortgage borrowers in Canada who have
below-threshold credit scores, by which I mean there are certain conforming
standards for mortgage insurance in Canada. However, those who do not meet
the standard and therefore cannot get mortgage insurance have to have higher
equity down on the mortgages they exert. That is the first point.
The second point is with regard to the proportions here. As you may
recall, in the height of the sub-prime boom in the United States, the flow
of sub-prime mortgages reached 40 per cent of new underwritings in the
United States, almost 15 per cent of all the outstanding stock of mortgages
in the United States. In Canada, the total stock is measured in the low
single digits, so it is an entirely different structure than existed before
in the United States. We have to be vigilant to keep it that way, would be
the final message.
Senator Hervieux-Payette: Welcome, governor. You have worked very
hard to hammer out the Basel III rules. I wonder whether you are satisfied
with Canada's performance, and that of other players, as to the possibility
of following those rules.
My other question is a little more complicated, perhaps; what would you
suggest that our government and our business community do to increase
exports? Besides exporting natural resources, it seems to me that the
manufacturing side of things is experiencing enormous problems. I wonder if
our export model is working properly. Take Germany for example, already an
export champion. We have just announced our plans to cut back on embassy
staffing. I always relied on their support in matters of export for our
Canadian businessmen. But should we not have a joint government and a
chamber of commerce model as Germany does, to support our businesses in
selling to international markets and share the risks?
Mr. Carney: With respect to Basel III, it is difficult for a
central banker to ever say that he is satisfied. One aspect of our work is
saying that we are never satisfied. As for Canadian banks, first of all, the
quality of equities under Basel III is much higher than under Basel II. It
is like an equity of equities. That is good news. It is a much higher
standard; secondly, the deduction of assets has to be adjusted according to
the equity measures under Basel III with the quality of assets, that is
deferred taxes, for example, good will, service fees for mortgages in the
U.S., that is a third example, and minority investments would be a fourth
example. This basket is very small under Basel III. That is most important,
this increases the quality of the equity. There are two aspects of
satisfaction. Thirdly, the decision by OSFI in Canada, the Office of the
Superintendent of Financial Institutions, is that Canadian banks must
implement Basel III by the beginning of next year, not the end of 2013, but
2019, because for everyone, there is a transition period that begins in 2013
and ends in 2019. But in Canada, you must finish at the beginning, you must
finish at the beginning of 2013. The standard here in Canada is very high
compared with the rest of the world.
We are satisfied with respect to equity, which is an absolutely
fundamental aspect of Basel III. As for liquidity ratios and liquidity
measures, those remain a work in progress. The international community has
not quite decided upon those rules. The goal is determining the liquidity
ratio by the end of this year. So, we shall see.
As for increasing exports, the bank has researched that issue. It is
clear, yes, that we have competitiveness challenges, that is clear, and one
aspect of competitiveness is the persistent strength of the Canadian dollar,
but the problem mostly has to do with market structure and the direction
taken by Canadian exporters. Over 85 per cent of our exports go to advanced
countries with very weak growth rates, not only the United States, but also
Europe and Germany. The potential growth rate in Germany is 2.5 per cent,
but the emerging countries only represent 8 per cent of our exports, so we
must broaden our markets. That is absolutely clear. We need aggressive free
trade objectives, and we must create free trade agreements.
The question is bigger than just trade, obviously. It starts with that;
it starts with reinforcing the orientation of our exporters towards those
markets that do now and, in our opinion, will continue to represent the vast
bulk of export growth. We should remember that over 50 per cent of growth in
export demand since the crisis has been from the major emerging markets. We
think that will continue.
As you suggested in your question, it is not just about resources and it
is not as simple as just opening up trade deals with these countries,
although it is incredibly important. It also requires a reorientation of
thinking about what we can export. There are big opportunities for Canada
here, in our opinion. It does start with resources. It starts with the whole
gamut, though, of resources, which would include what we would term
"resource productivity," things that make more efficient use of resources,
building efficiency power, plant efficiency, and other aspects there. It
extends to the way global supply chains are changing.
We got used to a world where the supply chain was decomposed in a linear
fashion across economies, and each component of it was cited where the
comparative advantage was. The experience over the last five years of many
companies and supply chains has been that this is a risky strategy because
all it takes is one disruption along the chain that knocks out the end
product. We have seen this directly in the auto industry here in Canada,
first with the terrible events in Japan and the tsunami, but then the Thai
floods that took out key components, which had a knock-on effect, and some
of our GDP volatility was affected by rain in Thailand.
That experience has been replicated across a range of industries, and so
a tendency is starting to develop to have a more networked approach to
supply chains, which is good news for an advanced economy such as Canada's
because it means having elements of the supply chain, some redundancies
built in, which create opportunity, but also elements of the supply chain,
which are closer to the end consumer. Given the deepening of the links in
the North American economy, the perimeter work that has been done creates a
greater opportunity for Canadian firms that previously would have resulted
in outsourced supply chains.
Other opportunities extend across the range of digital commerce, where we
have true advantages. We are not unique in some of those advantages, but we
have comparative advantages ranging from manipulating big data, to mass
customization, to other opportunities.
I think, if I could sum up, that we have to first orient to the markets
where the big marginal demand is coming from. That does not mean abandoning
the United States, but it very much means diversifying. Then, it means
taking more of the value-added, as much of the value-added as possible, from
the resource complex. Finally, it requires recognizing how both digital
commerce and manufacturing is being reoriented around the world and
situating our businesses. These are decisions for businesses along that
chain. Certainly, government can play a role at the start of that process.
It can play a directional, information role within that process, but,
ultimately, it will be, as you know, for businesses to decide.
Senator Hervieux-Payette: Just give us a concrete example of the
sectors in which this new strategy would apply so that I can visualize. My
colleagues and I do not know, besides the automobile industry, which sectors
would benefit from this new approach. That would change the sequence.
Mr. Carney: The change in the —
Senator Hervieux-Payette: The linear approach.
Mr. Carney: Auto is a fantastic example of that. There is a range
of others. The communications hardware industry, for example, had been
reoriented a lot more towards a more linear approach. Again, there is an
element of networking that comes in there.
Basically, across consumer products, there are elements of this. Again,
it is about where we fit into that chain. In many cases, one wants to be
towards the end of the chain where the biggest value-added is in terms of
design, not end assembly but in terms of design. The start and the end of
the chain are where the largest amount of the value-added is, but there are
additional manufacturing and delivery opportunities, in our opinion, that
are created because of proximity to market. Proximity to the Canadian market
does not necessarily sell it, but proximity to a seamless North American
market does sell a Canadian advantage, as it did previously.
Obviously, we are not consultants and going to tell people exactly where
to go, but these are dynamics that are happening and that could create true
opportunity for Canadian business. I will leave it at that.
Senator Greene: I would like to ask a question that is of
interest, I think, to every Canadian, no matter where they live, who they
are, what they do for a living, or how old they are. That is the penny. In
your view, are there any inflationary impacts, or even deflationary impacts,
to what the government is doing in abandoning the penny? Are there any
impacts that may be measurable? If you could inform us, what have other
countries experienced when they have abandoned their lowest unit of
Mr. Carney: I almost feel we should ask the chair of the committee
This is an important issue, without question. We have all lived our
entire lives with the penny. The decision that this is the final year that
it will be produced comes, in our opinion, for sound reasons. I know the
question is about inflation, but the fully distributed cost of the penny is,
last time I checked, about 1.6 cents, perhaps even a little more given where
copper is. Given our view on copper prices and despite the expertise of the
Royal Canadian Mint and their ability to minimize the amount of actual
copper in a penny, it is hard to see how it would not cost more, for the
foreseeable future, to produce a penny than the penny was actually worth.
We do not bear reminding that the penny itself has lost more than 80 per
cent of its value since it first was introduced. I think we all see that —
the relative value of a penny — every time we go to any retail till and
leave them or pick them up. I do not know how many people pick them up. How
many people pick them up? I think that is the question here. We probably
should not take a poll around the table.
To get to the point, which is an important point, is it potentially
inflationary? We do not think the elimination of the penny will be
inflationary, and I will explain, for a minute, why that is the case.
Post elimination of the penny, the issue is obviously around rounding of
transaction costs. We are all familiar with things being at $1.99 or $2.99,
the seemingly attractive pricing that is used. Will retailers round up or
will they round down? The first point to make is that rounding, with respect
to coins, is only relevant for cash transactions. Online transactions or
electronic transactions can retain — and experience suggests that retailers
do retain — pricing in pennies. That is the first point, because you can
charge your credit card in pennies.
The second is that the rounding comes into play for the aggregate of your
purchases, not just the one purchase. If you make one purchase, obviously,
that is where the decision is, but it is the aggregate of the purchase. Of
course, it is the aggregate of the purchase post tax. The likelihood is
that, in most cases, it will either be retained at that level or, when you
get to point of sale and, after all of what I have said you still face the
roundup or round down decision, there are obvious rounding protocols that we
learned in school. If you are at five and above, you go up; below five, you
go down. The question is, will retailers follow through on this? Part of
that is a question of degree of competition, also provided by the purchaser.
As you may be aware, New Zealand and Australia have eliminated the one
cent and the two cent and, in New Zealand's case, the nickel. The experience
has been that retailers do follow rounding rules. They round down when they
should round down, and they round up when they should. That symmetry in
rounding, when it has to happen, ensures that there is not an inflationary
On top of all that is the consideration that we are talking about a
penny. The order of magnitude here — the travel in the rounding — is quite
small. As a proportion of the actual Consumer Price Index, these are modest
effects. I am not trivializing them, but the experience has been that
retailers in other comparable jurisdictions round symmetrically. It happens
in only a small number of cases because it is only in cash transactions, so
it is relatively small. Also, the order of magnitude of the issue is quite
small relative to the cost of a basket of goods.
Finally, it is a one-time effect. I do not want to trivialize and say
that, if there were a deviation, it would not merit scrutiny, but in the end
we do not see that it is inflationary. If it is of interest to the
committee, we did some work on this in the past, in preparation, I think,
for testimony to another committee that looked into this, led by you, Mr.
Chair. I would be happy to provide that written testimony if that is of
In effect, what I said — well, I hope what I said — is that I believe
that to be the case.
Senator Massicotte: The long answer is, no.
Mr. Carney: The long answer is, no; but it is not a hunch. It is a
considered long answer. We have looked at it, and there is rationale as to
why that would be the case.
The Chair: Senator Greene asked a great question. I would like to
confirm to the Banking Committee that the Governor's testimony today is
totally consistent, almost word for word, for what he said before the
Finance Committee over a year and a half ago. I thank you.
Senator Harb: Mr. Carney and Mr. Macklem, thank you for your
presentation. In one of your paragraphs, you talked about the fact that the
bank projects that private domestic demand will account for almost all of
Canada's economic growth over the projection horizon. Are you putting all of
your eggs in one basket?
Mr. Carney: Let me clarify what is included in private domestic
demand. It is the sum of household consumption, housing investment and
business investment. Let us look at what is not included? It is government.
It is not a surprise given the fiscal restraint, appropriate in our view, at
federal and provincial levels, that there is a modest and negligible
contribution of government. It is not a big negative contribution but modest
to negligible contribution from governments. Where there is a challenge,
which goes to the previous question, is on the net export side where there
is not much of a contribution from net exports; and that reflects two
things: first, the challenges we have in developing new export markets and
competitiveness; and second, very strong imports. Part of those imports is
good news, i.e. the imports of machinery and equipment, which are up fairly
strongly. That is consistent with what we project, which is fairly strong to
quite robust business investment over the projection horizon. That is part
of private domestic demand.
The other two components of private domestic demand bear scrutiny:
consumption, investment in housing, and the extent to which those are funded
by household income versus household income plus additional debt. We see a
modest further increase in household debt, and we are alert to that and we
can discuss it. However, it is happening at a less rapid pace than we had
seen previously and, given the improvement in labour markets, with a greater
consistency between household spending and household income. That is saying
the same thing a different way.
We are not putting all our eggs in one basket — the collective "we." In
this environment, given the global weakness and particularly the weakness in
the United States that we have seen over the last several years, it has been
inevitable that if the Canadian economy is to grow, there will be a heavy
reliance on domestic demand, which has happened. Part of the reason to
ensure that that does not proceed to excess has been to ensure that these
measures taken by the government and OSFI have been put in place in a timely
Senator Harb: Two reports, the retail report and the Conference
Board report, both came out with some pretty gloomy figures. The retail
indicators were down and the consumer confidence in April fell. In fact,
according to the Conference Board, it has gone lower than it was two years
Yet, we see a lot of people in the community talking about the importance
of raising interest rates. Given what we are seeing with consumer
confidence, I do not understand how we can expect the consumer to fuel
economic growth when we tell them that we will increase their borrowing
costs. It strikes me as diabolical. We have to make up our minds about what
we want. You want to keep your eye on inflation, which is great, governor.
Mr. Carney: It is my mandate.
Senator Harb: However, at the same time, you want the consumer to
spend. The consumer is saying, "As long as you are trying to hit me with a
two-by-four, I will not spend." We saw this situation recently around the
same time when governments in the United States and Canada were talking
about increasing interest rates. It froze the whole market. I had a
developer in Ottawa who told me to tell you, governor, so you can tell the
Minister of Finance that it is great to tighten up but, he could not sell a
condo if everything came to a stop as soon as the Minister of Finance talked
about strengthening the borrowing, et cetera.
Mr. Carney: Certainly, I have to respond to that. First, the
decisions around interest rates in Canada, certainly the overnight rate in
Canada, are the decisions of the Governor-in-Council and the Bank of Canada.
They are not the decisions of the Minister of Finance. The Minister of
Finance has to take many decisions but that is not one. Second, the
decisions that Mr. Macklem, four deputy governors and I take by consensus
around monetary policy are grounded in meeting the 2 per cent inflation
target. We renewed that agreement with the Government of Canada at the end
of this past year. It is 2 per cent total Consumer Price Index inflation. We
will do what is necessary to achieve that for a whole host of reasons, which
we can discuss in greater detail if it is of interest.
Monetary policy is exceptionally accommodative in Canada and has been for
some time. We have a well functioning financial system. I would not
characterize the observation of the bank that in the environment of reduced
economic slack and slightly firmer underlying inflation, the possibility
that it may become necessary that some of the considerable monetary policy
stimulus in Canada may need to be withdrawn consistent with achieving the
inflation target. I would not characterize that as hitting the consumer with
a two-by-four. I would suggest to your developer friend that if the possible
withdrawal of some considerable monetary policy stimulus in Canada, under
the context that the global risks and domestic risks will be taken into
context and that we would proceed with caution — all those caveats and
orders of magnitude — means that his condominiums are not sellable, then
perhaps his condominiums are not sellable — full stop. Things are so fragile
there, but I would say that that is not the experience in the rest of the
country in the condominium market. In fact, in a number of condominium
markets in Canada, we see signs of extreme strength, which factors into some
of our thinking.
The Chair: Senator Harb, I assume you were asking that on the
basis of one of your constituents that you will have to appeal to at some
Senator L. Smith: Governor, I watch the late news every night
before I go to bed. Of course, the first things I see are oil prices and the
Canadian dollar and the fluctuations. People have labelled our dollar as a
"petro dollar" or "oil dollar." In your release, you stated that it is
far too simplistic to talk about the Canadian dollar as a commodity currency
let alone a currency that moves consistently with one commodity. It is a
much more diverse, complex economy than that. Could you give us some
background? The vast majority of folks, who may not be that well-informed,
may think that the dollar is related to the movement of oil. What other
elements affect the movement of our dollar?
Mr. Carney: It is an important question. Let me say at the outset
that it is a bit of a mug's game at any time to try to explain. People
always try to explain momentary fluctuations in the values of currencies.
The fact of the matter is that in many cases they do not actually know or
they do not precisely know. There is a variety of factors. Since all
currencies are relative prices, the value of the Canadian dollar versus the
United States dollar is influenced by factors in Canada; it is influenced
by, at any given time, factors in the United States but also, as you know,
global risk aversion, factors in Europe, other flows, et cetera. However, I
know your question is to step back from those momentary fluctuations and
address the broader, more fundamental determinants of exchange rates.
The value our currency is certainly influenced by our terms of trade and
the value for exports relative to the cost of our imports. We certainly
export commodities. At present, about 45 per cent by value of our exports —
so less than half, but a significant proportion — are commodities, a broad
range of commodities, which includes oil, obviously, but a range of base
metals and agricultural products, importantly, as well. We find that both
the prices of energy commodities — some of which are strong, such as oil,
and some of which are very weak, such as natural gas — where there is a
structural change in that market, the price of energy commodities and of
non-energy commodities, base metals — I will give forestry as an example —
are important determinants over time of the level of the currency.
In addition, there are factors that include the relative fiscal health of
the country. In a period when we had real fiscal challenges in the late
1980s, early 1990s, up to the mid-1990s, that was a factor that affected the
value of the currency negatively. Experience tells you that once a country
gets into that situation, it takes a long time to lose the risk premium that
has been put on the currency and the asset.
I think we can all recall a predecessor of mine and the then Minister of
Finance having to go to New York and make the case, if you will, for
investment in Canada and the value of the currency, at a time when all the
fundamentals fully supported that case. This was not marketing; it was
talking about reality. However, exchange rate markets sometimes react with a
lag, which creates challenges and can affect the conduct of monetary policy
and other policies in the country.
With regard to the prices of our exports relative to our imports and the
sustainability of the fiscal position, in recent years, quite reasonably,
the relative health of financial systems has become an element that has
influenced, in our opinion, and not surprisingly, because one of the lessons
of the crisis has been that if you have a poorer financial system, it
quickly becomes a fiscal problem. We see that very much so, unfortunately,
in a number of European countries. That is an element as well.
In the end, the relative productivities will also be an important
determinant. You heard me in my comments a number of times mention
"relative." It is all relative. It is a relative price; it depends how we
do relative to others. There is a variety of factors that influence the
value of the Canadian currency.
Our view on the currency, as we sit here today, is that the persistent
strength of the dollar does create a headwind for the Canadian economy. It
creates a competitiveness challenge for exporters. That is one of the
factors we take into account in the setting of monetary policy, the impact
of the currency on the export complex, and therefore on activity in Canada,
and therefore inflation. We always look at it, in the end, through the prism
of the influence on inflation.
We caution those who are sometimes tempted to make the very simple
petro-currency argument to think that if there is an adjustment in the level
of activity in the energy sector across Canada, there would be a material
adjustment in the level of the currency. That is too simplistic, because
there is a variety of other factors, globally and domestically, that
To go back to the deputy chair's question: In our opinion, what is not a
wise strategy for our exporters, or for the country on behalf of their
exporters, is to rely on a weak currency. That is a hope, not a strategy,
and it is a misplaced hope, in our view.
Senator Massicotte: Thank you, governor, Mr. Macklem, for being
with us today. It is always useful and informative.
Let me go back to the issue Senator Hervieux-Payette raised about the
exporters. A heavy exporter will tell you it is difficult now, in terms of
our high Canadian dollar relative to our major trading partners, to be
competitive and derive adequate profit. Your answer to that was that they
have to change the markets, with which we agree. They have to be more
diversified and competitive. They have to invest and become more efficient.
However, even recent history has shown us that many countries have not
gotten there. Norway suffered immensely 20 years ago. Self-interest alone
may not get us there. It should be in a country's interest to do so, but
sometimes they do not get there.
What is the probability that we could be emptying out our industrial base
in Canada, given that a large part of our export is the commodity market and
natural resources, and they seem to be competitive with the high Canadian
dollar? Second, if that risk is significant, should we be doing more
structurally, in a government sense, to ensure we remain competitive and
incite those companies to change their markets or process to be more
Mr. Carney: With respect to the first question, our viewpoint is
that it is important for all of us — whether at a central bank, the
government, the Senate, Parliament, and particularly businesses — to take a
medium-term view of what are the major dynamics in global markets.
Our view, for which we have provided backup — there is always a
possibility we do not have it exactly right, but it is a well-researched,
firmly held view — is that our major historic market, the U.S., is not the
market it once was. That does not mean the U.S. is in terminal decline, by
any stretch of the imagination, but it does mean that given the forces
there, we expect the United States to grow more than the 2 or 2.5 range for
some time, as opposed to a much stronger rate of growth that there was
previously. I can provide a graphic description of this, but we do not think
the U.S. will get back to the path of GDP that it was previously on prior to
One of the consequences of that level adjustment in the path of U.S. GDP
is that, given demand for Canadian exports and the historic elasticity,
Canadian exports are about $30 billion lower per annum than they would
otherwise have been at this stage in the cycle. It is a material difference.
Part of my point is that we have to be eyes wide open about where these
dynamics are. The first is that the U.S. is not what we were used to and
unlikely to return to that in the near term.
Second, we expect commodity prices to remain relatively elevated because
of the transformation of emerging markets. We discussed that.
Third, the transformation of emerging markets creates huge markets for
our businesses if we want to take advantage of them.
Fourth, Canadian business as a whole is not as productive as it could be.
Across the economy, the productivity of our businesses is still in the low
seventies relative to the United States, and the United States is not the
most productive economy in the world. There is a lot of catch-up that can be
done here through investment.
Those four factors, or those four realities — and realities are likely to
persist — for us provide the context to these types of discussions. Yes, it
starts, importantly — and I do not want to trivialize how difficult it is —
opening up new markets, striking these trade deals, whether it is with
Colombia or a trans-Pacific partnership, potentially, or even with the
European Union, and building new markets. These are complex and
time-consuming efforts, but they are well worth it, in our opinion.
To get to your industrial structure question and the "hollowing out" of
our industrial sector, there will be adjustment for our businesses, without
question. There is adjustment going on. One of the strengths of the Canadian
economy has historically been that there is flexibility in the economy, so
people move to different sectors if they are stronger. People shut down
businesses in areas they are weaker and reallocate the capital to stronger
bits of the economy. Canada is one of the easiest places in the world to
open a business, and to close a business as well. You need both of those
elements, and that is a good thing. It is a good thing and necessary.
Provided those decisions are being taken with a clear-eyed view of where
the world is headed, we will be better off. We have to remember that, even
with the losses of jobs in manufacturing that we have seen over the course
of the last decade as this adjustment has gone on, and particularly since
the crisis began, there has been net job creation in the country, and 80 per
cent of those jobs have been created in the private sector. The vast
majority of those jobs, of all the jobs, have been in industries that pay
above average wage, wages higher, in fact, than in manufacturing. An
adjustment is going on that is headed in the right direction.
To get to the last bit of your question, which is kind of the crux, this
is all about keeping flexibility and trying to ensure that there is a shared
understanding at least of the broader forces in the economy. In a small way,
we can contribute to that, but government can as well. The question becomes,
what can government actually do? That is a broad gamut of policies that
range from, in our view, competitive tax structures to appropriate
investment in infrastructure. The multipliers on infrastructure,
particularly border and port-oriented infrastructure, are tremendous. There
is not just developing new markets in terms of the structure of trade deals
and investment deals, which are very important because that brings a
reciprocity in opportunity, but also in joint marketing and seeking out and
identifying opportunities. There is an information role there. We have
targeted and sustained research, a policy that has been pursued by
successive governments in this country, increasingly concentrated in areas
of excellence, which include the energy complex to medical research through
to certain aspects of information technology. Again, that should help to
enhance the productivity of our industrial base and lead to markets of the
There are other things that can be done, but government has the
purchasing power of government, at both the federal and provincial level,
and being a demanding buyer for Canadian suppliers. It is not just
purchasing to keep businesses going but actually using the demand and
specifications of demand in order to help drive productivity that ultimately
leads to Canadian businesses that are competitive internationally.
Senator Massicotte: The way I read the answer, you basically cited
four circumstances, which means there is a significant threat of hollowing
out, but the last part of your answer is you think the circumstances and the
flexibility and liquidity of change are such that you think those jobs will
be replaced by other good-paying jobs, either service sector or other
sector. You seem to be saying government has done a lot, could do a little
bit more, but we are probably not bad. In others, there is obviously a
significant hollowing out, but it looks like we are replacing it with
equally good jobs, so a low risk of a major hollowing out.
Mr. Carney: It depends on your definition. I would be a little more
careful in summing up. What has happened has worked very well.
Senator Massicotte: So far, so good.
Mr. Carney: So far, so good, but the forces I cited at the start
will persist for some time, and therefore adjustment will persist for some
time. In that environment, given the scale of the change, it pays, as in all
things, to be vigilant and to ensure that, yes, the Canadian economy
continues to be as flexible as it has been. Are there other barriers to
flexibility that should be adjusted? One can think of some. I do not want to
volunteer them, necessarily, because many of them are sensitive. However,
that should be consistently looked at. Are we making the right, large-scale
infrastructure investments and facilitating them, including helping exports?
We should focus on that. Are the research dollars we are spending and
encouraging through the tax system in other ways but also direct primary
research going to the right things?
As we have said, government has put in place many of the elements.
Governments have done a lot over the course of the last couple of decades.
Federally and provincially, successive governments have done a lot to
improve the environment for enhancing productivity. That does not mean that
it is ever finished, and the challenge is the adjustment is still going to
be quite considerable, in our view. Again, just to finish, 85 per cent of
our exports go to slow-growth economies.
Senator Massicotte: Our currency is competitive relative to the
emerging markets, the new markets. We complained about a high currency
always to the United States, but I thought it was roughly high compared to
most other countries, given the reputation.
Mr. Carney: It depends. One measures the movements in the currency
based on your trade-weighted basket against whom you actually trade. If you
reorient towards countries that, with some likelihood, you will see their
currencies appreciate over time relative to the United States and to all
advanced economies. It is a reasonable expectation that, in the fullness of
time, the Chinese currency will appreciate against all advanced economies,
given the scale of the adjustment going on there. That is not a short-term
prediction, but on the horizon that we are talking, that is reasonable. The
more we are oriented from an export perspective towards China and Indonesia
and other countries like that, the more those adjustments work in our
favour. That bears keeping in mind.
Tiff Macklem, Senior Deputy Governor, Bank of Canada: I would add
just one small point, and it is completely implicit in everything the
governor said. The phrase "hollowing out" is often associated with Dutch
disease, and Dutch disease is about a situation where you have a discovery
or a big run-up in prices that is very temporary, so then you get this big
shift of factors of production for a temporary gain, and then you have to
What we are talking about here is much more a sustained situation. For
the reasons the governor has already cited, our view is yes, there will be
volatility in commodity prices, and you can bet that, but there are good
reasons to believe that commodity prices will be relatively elevated for a
sustained period of time when you see the kind of growth coming out of
emerging markets. This is not just energy. Energy is part of it, but it is
base metals. It is food. They are moving up the protein chain. Against that
environment, having resources is a good thing, and that is a real benefit to
our economy. The question is how you make the most of that benefit, and the
governor's comments were really all in that context.
Senator Oliver: Welcome, governor and Mr. Macklem. It is nice to
have you. I was very encouraged by the profile you gave of economic growth
for the future, and I think that is very encouraging for Canadians. I hope
that it lasts.
I have two separate and totally unrelated questions. The first relates to
the G20 meeting in Washington over the weekend. Our Minister of Finance
raised some concern about the IMF and the way that it was dealing with the
European debt crisis. He used the word "troika." He asked why the IMF is
dealing with the European Union and the European Central Bank. Surely it is
the job of the IMF to take the lead on these things. Could you explain to us
what is behind our Minister of Finance's concerns? Is this a serious
question for Canada? If so, in what way? If it is, what could be done about
it? That is my first question.
The second question relates to your opening comment today. You said
something about Canadian growth that I was encouraged by, but you said the
profile for U.S. growth is slightly stronger. In your paper, you said the
things that were in that profile upon which you based that positive
conclusion. You said the balance has improved in labour markets, financial
conditions and confidence on the one hand, and emerging fiscal consolidation
and ongoing household deleveraging on the other. Nowhere in that did you say
anything about American housing and the housing crisis that has formed so
much a part of the American economy since 2008, the number of banks that
have had to assume mortgages and homes and so on, and the fact, most of all,
that the trades are not working there. The housing starts are not there, so
carpenters and plumbers and others are not working. I would have thought
that would still be holding down the economy. Can you explain why I am so
wrong on that?
Mr. Carney: You are not wrong in that. I will deal with that first
and come back to the G20 and the IMF.
Again, when we use the language that the U.S. is slightly stronger, it is
slightly stronger than we had anticipated in January. It is slightly a
relative thing, so we have seen some signs of some modest improvement in
labour markets in the United States. We had anticipated that there would be
greater confidence, due to financial effects from the European crisis, in
United States. That has not transpired. I will come back to Europe in a
second, but, given developments, we think that is less likely to transpire
to as great an extent as we had thought in January. That helps support the
outlook for the United States.
With respect to the housing market, yes, it continues to be extremely
challenged in the United States. I think we are familiar with the broad
scale of the drops in prices and the big overhang of homes that have been
foreclosed and that will be foreclosed as that process is going to
reaccelerate as some of the legal problems have been increasingly sorted
out. Unfortunately for the individuals, that process is going to
reaccelerate, so there will be a greater overhang.
By way of context, U.S. household formation in the recent past, up until
the last few years, has been about 1.6 million households a year. That is
the natural household demand; that is new people, new immigrants, children
leaving home, marriages splitting up, people having a second home, or things
running at that rate. The peak of U.S. housing starts reached 2.1 million
and then went to a trough of around 500,000 most recently. The scale of this
is phenomenal and has had a big effect directly on the rate of U.S. growth.
It is in around the 600s now — mid-600s — as there has been an increase, in
part, in rental units that have been started more unusually, and we have the
actual chart. On page 10, we have a chart that shows the scale of the
Again, just in the order of magnitude, housing, as a whole investment,
was about 6 per cent of GDP pre-crisis. It dropped down to about 2.1 or 2.2
per cent of GDP most recently. The importance of the sector for GDP has been
cut by two thirds by that metric. It can bounce along at a low level, and
that is unfortunate for the individuals involved and those in the trades and
other things. Even if it gets a little worse, it does not hold back actual
GDP as much as it does from the higher level down. That is just the
arithmetic, the reality of it.
All that said, given the dynamics we are seeing now, partly on the rental
side, partly with new permits, partly with some marginal easing of some of
the financial terms, some of the measures that governments have taken, we
expect that there will be a modest — I underscore modest — improvement in
housing between now and the end of the projection period, so that housing is
not net detracting from GDP growth. It is not so incredible that we felt
compelled to mention it as one of our reasons for what is going on in the
United States. That is the full answer to your question or as full an answer
as you are going to get to your question.
In terms of the G20 and the IMF, the minister's comments, and the
Government of Canada's position — I underscore that these are decisions of
the Government of Canada — the way lending to Europe has developed has been
quite unusual. I mean, there is no comparison to the situation in Europe
vis-à-vis the IMF because normally if an emerging market — a developing
country — needs the IMF, it goes to the IMF itself and negotiates a series
of conditions for a new loan from the IMF. Then, the IMF board looks at that
and votes thumbs up or thumbs down, and, if there is a majority, the program
goes forward. In those discussions, it is the government of the country, the
central bank, and any other relevant authorities that agree to the
conditions of the program and actually sign the letter. As governor of the
central bank, quite often you are required to sign the conditional letter
before the funds are released, and then you are measured against how well
you met those.
What happened with Greece is that because it was part of the monetary
union, the European authorities actually put up a tremendous amount of money
for Greece. Then they decided that there would be value in having the IMF
alongside, partly for their expertise, additional conditionality, oversight,
and other things, but also for extra money. A convention was developed
whereby European authorities provided two thirds of the money and the IMF
provided a third. Programs were decided, negotiated, and agreed, between
Greece, Ireland, and Portugal, and the Troika, the European Commission
particularly, remembering that the European Commission was the vehicle to
provide the money and that member states of the European Union have
obligations to the European Commission. The European Commission and the IMF
had these reponsibilities. The IMF still had its historic thumbs up/thumbs
down voting at the board, and Canada participated in those votes. I believe
that what the Minister of Finance was drawing attention to — I will put it
in my words — was that it is not clear that this system is suitable going
forward. When it was a relatively isolated case with Greece, Ireland, and
Portugal — relatively small economies — that may have been appropriate, and
that was the arrangement that was struck. To be absolutely clear, a new
program is not contemplated or being negotiated. However, as a contingency,
if there were to be a new program with a larger European economy, would it
not be more appropriate if the IMF's relationship with that economy were as
it historically has been, where it is solely the IMF setting the conditions?
I will finish by saying that this issue found some sympathy in
Washington. What was agreed at the G20 was not precisely what I just
outlined but that any new IMF lending — it is in the G20 communiqué — will
be subject to strict IMF conditionality. That really goes to the heart of
it. We want to ensure that any lending is subject to the standards of the
IMF and the conditionality associated with that because that is what will
maximize, in our opinion, the probability of success of any of these
Senator Oliver: If Italy were another European country to have a
problem, would it not be in the IMF's interests to try to have the European
communities come up with the two thirds and the IMF one third in any
potential bailout for Italy?
Mr. Carney: The European authorities, to their credit, have set
aside and made commitments to provide considerable funds, if necessary, to
additional programs within Europe. This year, it reaches to 700 billion
euro. Next year it will be about 500 billion euro, but there is some
flexibility to those numbers. To their credit, the stronger European
governments have made those commitments. I think the expectation would be
that those commitments would be drawn on first before the IMF were involved.
Yes, it is in everyone's interest, and the European authorities — European
governments — have put their money where their mouths are, if you will, on
this by putting those commitments and agreements in place earlier this year.
What you are saying should logically happen. I should underscore the
other point. On the additional resources for the IMF, it was the strong
feeling of those who put money in that they are for the general use of the
IMF and not targeted for one continent.
Senator Moore: When you talk about the projection horizon, what
time period is that?
Mr. Carney: It is 2014 — the years we actually go out to.
Senator Moore: Is that the end of December?
Mr. Carney: Yes.
Senator Moore: I want to ask you a question at the outset that
deals with the end of your remarks. You said that in light of the reduced
lag in the economy and firmer underlying inflation, some modest withdrawal
of the present considerable monetary policy stimulus may become appropriate.
What is the monetary policy stimulus? Is that the overnight rates? I do
not understand what these words mean: "some modest withdrawal of the
present considerable monetary policy stimulus." Please explain.
Mr. Carney: It is a poem, senator.
Senator Moore: I know; but you do not look like Leonard Cohen to
me. Who wrote that?
Mr. Carney: Poets come in many guises. It is a poem written by a
committee, with their full agreement.
Clearly, the principal tool of monetary policy in Canada is the overnight
interest rate, which is at exceptionally low levels, not the lowest level.
It was as low as it could effectively be when it got down to 25 basis
points. It has been at 1 per cent for a period of time. A well functioning
financial system, as we have in Canada, provides considerable monetary
policy stimulus in this country, as is appropriate, given the headwinds that
the economy is facing both from external demand and from the persistent
strength of the Canadian dollar.
Senator Moore: The monetary policy stimulus is the overnight rate.
Mr. Carney: Yes.
Senator Moore: At the outset you said that Europe is expected to
emerge slowly from recession. I see that the U.K. is presumed to be in
recession, having a second quarter retraction. I do not know what that means
and the speculation of problems in Spain and Italy that Senator Oliver was
I want to talk about another item you mentioned repeatedly. You talked
about commodity prices remaining elevated owing to improved global economic
prospects, supply disruptions and geopolitical risk. In particular, if
sustained, oil price developments could dampen the improvement in economic
momentum. You mentioned the three upside risks, one being higher than
expected oil prices. I guess in Canada we are dealing with the West Texas
price of $103.33 per barrel and the Brent price is $117.83 per barrel. The
consultants who were involved in this industry talk about the building of
the Keystone Pipeline from Cushing, Oklahoma, to the Gulf of Mexico. They
say that when that happens, there will be a release of the glut of oil in
the mid-continent and oil will be priced in world terms of the Brent index,
which is $18 more per barrel than we are paying now. If that happens, what
will it do to your numbers because we are such an oil-reliant economy? I
want to ask you about the speculation part of this pricing but if it
happens, it would have a significant impact on our numbers and what you see
happening. I do not know when this pipeline will be finished, but they have
the approval to do it to the Gulf coast. Do you want to answer that first,
Mr. Carney: Yes. Thanks for the question. The first thing to
recognize is that at page 13, we give the spot oil price at the time of the
setting of the forecast and the futures prices. These are the prices in the
market not ones forecast by the bank. They are the futures prices between
Brent and WTI. We use those future prices mechanically in our projections.
It is as good an estimate of the future price of oil as anything. You see
that some of this convergence between Brent and WTI is built into the future
expectations of the price of oil. Not to over interpret, it is a bit messy
because of the number of lines but there is a convergence of the blue and
the red. With the Brent price coming off, one would posit of some of these
supply disruptions and the geopolitical risks in the Middle East, in
particular Iran, and the firmness of WTI in relative terms representing to
some extent an expectation that some of this glut at Cushing will come off.
There are some short-term fixes for that glut, such as the announced
reversal of the Seaway pipeline owned by Enbridge. That being put in place
is one of the factors that could help to reduce the glut.
There is another point, which we outline in a box on pages 16 and 17. It
is a relatively unusual situation. I draw your attention to the bottom of
page 16 and that chart with the red and the blue. The sum of the red and the
blue is the net differential between the Brent price, which you cited at
$118 today, and the prices received by Western Canadian producers, not
Eastern Canadian, of oil. The so-called Western Canada Select is one grade
of Western Canadian production. You see on the chart that in recent months
the differential has become quite large. It has come off that historic low
but it reached a historic low — a very wide amount. You roughly had Brent at
$120, a very high international price of oil as we referred to, while WCS
was getting $80. Our producers are getting $80 per barrel, the international
price is $120 per barrel and WTI is somewhere in the middle.
Senator Moore: It is closer to the Brent price, is it not?
Mr. Carney: It was $103 at the time we did it, but it is a little
closer. Relevant here for the purposes of projection is that the price of
gas in Central and Eastern Canada is effectively influenced by a blend of
WTI and Brent prices. Western Canadian oil is a shift of volume out to
central and eastern Canadian refineries. In some cases, they are not set to
take that crude. We are buying in oil that is higher priced relative to what
we are producing.
There is a gas price impact, which obviously has an effect on consumption
and we are not getting as much for our Western Canadian exports. The net of
those two effects, which we mention in the report, is marginally negative at
this time for the Canadian economy, which is very unusual. Normally, higher
oil prices cause adjustments and it is a net positive for the Canadian
economy because higher profits for the producer outweigh the impact on
consumers through various redistributive mechanisms, spillover effects on
investment and other upstream firms in Canada. Given the scale of the
differential, it is marginally net negative, so our forecast reflects that.
We also have to remember that the expectation both for structural reasons
and because of where we think the market thinks the international price will
go, is that this effect will dissipate and actually reverse over the course
of the projection horizon. That is a complete answer to what we are seeing
on the oil price side.
Senator Moore: Getting to the bottom line, do you think that we
will be paying at the Brent index price but that there will be a convergence
and will basically be structural but not meaningful in terms of impact to
Mr. Carney: We have to be careful when we say "we." It depends
on whether you are in Central and Eastern Canada or Western Canada. It is a
complicated energy infrastructure where we export some oil and we import
some gasoline, so there are different mixes there. It is only when the scale
of these differentials gets really large that that matters. For the
forecast, we expect that the Brent price will come down. That is what the
market expects. That is where we are bringing it in.
Senator Moore: If they get Iran fixed and some other things, then
that may happen.
Mr. Carney: The global market adjusts, and the net backs, the WGI
price relative to Brent, that narrows. The bigger question, which is a
structural question, is that discount of Western Canadian select relative to
WTI. It is not a surprise. The reason there is so much focus on energy
infrastructure and oil pipelines, whether it is the one you referenced,
whether it is pipelines out to the Canadian coast, whether it is potentially
even a pipeline across the country, or all of the above, is in part because
of issues such as this and the future of growth and supply of oil production
in Western Canada. At the moment, it is a negative. It is an opportunity.
There is found money, if you will, in just closing that differential and
having a more seamless market.
To the core of your question, in central and eastern Canada we are paying
not Western Canadian prices but world prices because of the structure of the
market. You cannot get the oil from there to here in a way that can be
refined so that we can enjoy gas prices that people out west enjoy.
The Chair: Can I put you down for round two?
Senator Moore: Yes.
The Chair: Senator Massicotte has a quick supplementary on this
Senator Massicotte: It will not be a supplementary. It will be a
real question, but I presume I can still ask it. Thank you.
Let me jump to the consumer debt. You talked a lot about it. You made
reference to it yesterday in the House of Commons. You are making a speech
on it I think tomorrow. The Minister of Finance has talked quite a bit about
it. Everyone quotes numbers about the amount of debt. In fact, you quoted
examples about house prices relative to income. Every ratio seems to be
high. You did comment that the rate of growth of consumer debt is slowing
down, 4 per cent from 10, but I always wonder and I am not sure we are
comparing apples to apples. The last ten years, interest rates came way down
because we all got the religion about monetary policy and low inflation. How
about servicing? If we look at total net service relative to income, it has
gone up, but has it gone up as much as all other factors —
The Chair: That is round two; quick answer.
Mr. Carney: The quick answer is that servicing is around historic
averages at current interest rates, but once interest rates are more level,
the level of vulnerable Canadian households will be quite high. We provided
the simulation of that. The risk is that that proportion of vulnerable
households continues to grow. In an environment of more normal interest
rates, quite a high number of Canadian households are paying more than 40
per cent of income on debt service, which is difficult.
Senator Buth: It is a pleasure to meet you both here today. I come
from the ag sector, which luckily has done very well in Canada through these
tough economic times, due in part to high commodity prices and demand but
also due in part to the adoption of innovation. I am interested in exploring
the whole innovation agenda with you. While Canada has been a world leader
in post-secondary research, outpacing other G7 countries in terms of higher
education investment, we continue to lag behind our peer countries in terms
of innovation performance, including private sector investment in R & D and
also that really important portion where we go from innovation to
commercialization in products and processes. A significant portion of the
most recent federal budget was devoted to improving the innovation agenda in
Canada. Can you talk about the importance of the innovation agenda in Canada
and that government support and where we should be heading?
Mr. Macklem: I will say a few words on that, but I will not
comment on the specific government measures. You are right that, in some
parts, in terms of public support to innovation, we do very well. We have a
very high proportion of people with higher education. Where do we not seem
to be doing as well? Private expending on R & D is low. Given the size of
our economy, given where our position is, we will probably never be at
German or U.S. levels, but we certainly would like to see it higher.
The other element where we seem to have trouble is getting as much actual
productivity, what we call multifactor productivity, out of the innovations
we do put in place. When you combine labour and capital, and the capital
embodies new technology, how you organize yourselves and how you make best
use of that capital determines how much productivity you get out.
There are a few places, when you break it down, where we seem to be low.
It is the private investment in innovation and R & D. It is also that even
with what we have invested in, we are not getting as much bang for the buck,
would be the bottom line. We would probably have to work on both those
In terms of the broader productivity, there are also some, I would say,
fairly astonishing facts. If you look at how much capital American workers
have to work with compared to Canadian workers, and it is a little hard to
compare those directly because there are different appreciation rates, et
cetera, but roughly speaking, Canadian workers have half as much capital to
work with as American workers. Not surprisingly, they are less productive.
We are seeing stronger investment, but that cannot be a one-quarter,
one-year boom. That needs to be a sustained period of strong investment. We
have a long way to go. This speaks to the competitiveness issue. Any agenda
is probably not going to be about working only on one thing. There are a few
things to work on. If you only work on one thing, you will get limited
returns, but there are a few dimensions to work on, and I have outlined a
few of them.
Senator Buth: How do you start stimulating that private R & D
Mr. Macklem: I think that might be a good issue for this committee
to take up. You really need to break it down at a very granular level. I do
not think that the sort of macro answer that we could give would shed a lot
of light on that.
Senator Buth: Is there anything in comparison between Canada,
Germany and the U.S. that is fundamentally different that we do not get,
other than size?
Mr. Macklem: This is admittedly anecdotal, and I do not have a
scientific research paper to back this up, but in speaking with industry
here and in other countries, one example is that there does seem to be a
fairly effective industry in Germany where experts come in and help
companies put in place new machinery and figure out how to optimize it. It
is not like how to bolt it to the floor. It is how to change your production
process to take maximum advantage of your new technology. They have experts
to come in and help firms do that.
Just to make this more concrete, the quintessential, historical example
was the discovery of electricity. Electricity was discovered, and all the
steam-powered production was converted to electricity.
One of the puzzles is that there was very little productivity payoff.
Then, Henry Ford comes along and invents the production line, steam plants
were built vertically, electrification allowed you to build along a flat
plain and completely changed the production process. It was when they
realized that you could change the process completely with electrification
in a way that you could not with steam that they got the big productivity
payoff, not when they first discovered electricity. That is a sort of thing
I have in mind.
Mr. Carney: I agree entirely. To give you a couple of macro
answers, one of the historical relationships between innovation and
productivity investment has been the degree of competition. There are
differences of course because competition can be provided internationally
and domestically. Domestic competition is particularly effective in terms of
spurring people to do things that they might otherwise put off until
tomorrow. It is a sensitive subject, to the extent that there are
industries, which I will not name, where for a variety of structural reasons
there is less competition than there would be otherwise. Not surprisingly,
their productivity performance tends to be lower.
From a general perspective, if there is not domestic competition, why
not? What is the net productivity impact? The second macro thing goes toward
part of the roles of the bank. In this environment, one thing we are
concerned about from time to time, given global volatility, is that our
industries and businesses will hesitate to invest because of concerns that
there could be another experience such as we all lived through in 2007 and
2008 and, in particular, 2008 and early 2009, where global financial systems
seized up and there was a dramatic adjustment to demand.
We saw in that period a sharp fall in the rate of Canadian investment. In
fact, there was a much sharper fall in the rate in Canada than there was in
the United States. One of the responsibilities of the bank working with OSFI
and the government is to ensure that our financial system remains open and
functioning. There is no point in having a financial system if it is not
there in bad times as well as in good times. We try to convey this to our
industry. Maybe it was more relevant in the fall last year when there were
more acute problems in Europe, which were not welcome developments and could
get worse. However, the Canadian system can withstand this and will continue
to function and will ensure that all types of Canadian business can continue
to access capital at appropriate rates.
In order to allow them to plan for the medium term and ensure that they
can do so, that medium term is oriented more to other economies than to
those that are experiencing the biggest difficulties at present.
Senator Ringuette: Mr. Carney, I have a basic question: What is
the amount of your reserve and how does it compare to 10 years ago?
Mr. Carney: Do you mean the foreign exchange reserves?
Senator Ringuette: Yes.
Mr. Carney: The foreign exchange reserves of the Government of
Canada are not held on the balance sheet of the Bank of Canada. The level of
the exchange fund account is $60 billion. It depends partly on valuation
effects with the currencies that are held, but it is $60 billion. Ten years
ago, it would have been in the order of half of that, about $30 billion.
There has been a conscious plan over the course of the last about five years
to build up the level of reserves in a prudent manner. This is part of the
overall liquidity plan of the Government of Canada. It has slowly been built
up and that is where it stands at present.
Senator Ringuette: Would that $60 billion be made up of bonds or
strictly foreign currency?
Mr. Carney: It is held in the different major currencies and it is
invested in bonds. I should be clear that they are very high quality bonds,
which might be your next question.
Senator Ringuette: It is my next question. Do we have any bonds
from Greece, Portugal, Ireland, Italy or Spain?
Mr. Carney: Actually, we do not disclose the composition of the
reserves — the specific securities in which they are invested.
Senator Ringuette: Just say, yes or no. You do not have to
Mr. Carney: There is a strict investment policy, and there is an
annual attestation of the consistency of the investments in the reserves to
that investment policy signed off by the Minister of Finance. These are the
Government of Canada's reserves, not the Bank of Canada's reserves. We
manage them on their behalf. As Mr. Macklem said, they are invested in
high-quality securities, and that policy has been followed.
Senator Ringuette: Since my colleagues were all talking at the
same time when I asked my question and you were replying, I did not get the
Mr. Carney: I am not at liberty to disclose the precise
composition. I will not confirm or deny the specific securities in which the
country's reserves are held.
Senator Ringuette: The amount has doubled over the last five
Mr. Carney: The reserves have doubled. They have been built up.
Not to confuse the matter, the reserves are match funded. The government
earns a small positive profit on the reserves on an annual basis and has
continued to do so during the crisis. The cost of funding those reserves is
less than the return on the reserves.
Senator Hervieux-Payette: Does your board know?
Mr. Carney: No.
Senator Hervieux-Payette: The board does not know either.
The Chair: The question has been answered.
Mr. Carney: This does not belong to the Bank of Canada. We invest
as agent on behalf of the government.
Senator Ringuette: My second question is about household debt in
Canada. You have highlighted that sector for the last 18 months, at least,
in every statement that I have read from you. It does make the household and
Canadians very vulnerable; I agree with you. However, most of these debts
are not in home equity or mortgage. They are mostly intangible or
unnecessary goods on unsecured lines of credit and/or credit cards, which
range between 18 per cent and 30 per cent in interest rates, while your
overnight rate has been between 0.5 per cent and 1 per cent over the last
On the one hand, you and the Minister of Finance complain about the
household debt level while at the same time, your overnight rate has been at
its lowest in the last four decades. There seems to be a lot of talk about
this issue but not a lot of action.
Governor, what action should the government be taking to help these
households reduce their household debt?
The Chair: Is that not a question to ask of the Minister of
Senator Ringuette: Also when he comes, but we do not see him
Mr. Carney: It is an important issue. We will provide these
figures to the committee, but it is important to get the orders of magnitude
right. The actual proportion of household debt that is represented by credit
card and other unsecured lines of credit is relatively small relative to
mortgage and secured household debt. We will provide the figures to the
It is an issue for some Canadians, and, in fact, it goes to your point,
which is about low income and the more vulnerable Canadians, those with debt
service ratios that are high relative to their income. That was Senator
Massicotte's question, so it is very relevant there.
To put this in some context, we have a responsibility at the bank. The
Minister of Finance shares that responsibility. We have a direct
responsibility to provide an objective assessment of developments in the
Canadian economy — actual perspective — and the risks around those
You may be bored hearing about the issue. I do not think you are.
Senator Ringuette: I am not bored.
Mr. Carney: Others may be, but it is our responsibility to be
transparent about what we see as major risks for the economy and what can be
done about them. We set interest rates for the entire Canadian economy. We
set them neither for a particular region nor for a particular subset of
Canadians. We are aware of the impact of interest rates. We certainly take
an interest in the impact of interest rates on regions — and the differences
in strength of regions — and on subsets of Canadians, Canadians who may
struggle with household debt. We follow this closely. We have done a lot of
very detailed analysis about the risks that these individuals face if they
take on additional debt or, for the debt that they have, if and when
interest rates rise.
We have been very public and vocal because it is important that people
put their affairs in order so that they can withstand the inevitable.
What can the government or, broadly speaking, the public sector do about
the issue, aside from draw attention to it? First, draw attention to it.
Second, remind individuals and institutions that lend to individuals that
current circumstances are exceptional and will not persist for ever.
Ultimately, individuals and institutions have responsibilities for their
actions, first and foremost, and they need to take those responsibilities
Third, the measures that we talked about at the start, in answer to the
Chair's question, that the superintendent has taken to increase the capital
of the banks, to tighten the underwriting standards of the banks, and to
ensure that the standards they should have are being followed, which is a
net tightening of the terms of debt to households, including to those that
are most vulnerable, are being done to help ensure that the system is
functioning properly. It provides a degree of protection for this issue so
that it does not get worse. Fourth, there are the measures that the
Government of Canada has taken, on three separate occasions, to tighten the
terms around mortgage insurance — shortening the amortization, increasing
the amount of down payments, increasing the qualifying interest rate, and
increasing credit scores. Those in the public sector — the government, the
Bank of Canada, the Superintendent of Finance, and CMHC, continue to monitor
the situation very closely. If there are other actions that could be taken
and that are necessary, I am very confident that they will be taken by the
appropriate authorities, and they will have an effect.
I would note that what we have seen, in part because of all of the
measures that have been taken and, in part, because of prudence of
Canadians, is that the pace of the accumulation of household debt has slowed
quite markedly over the 18 months in which we have had this dialogue and
action taken. It is now around 4 per cent, according to the most recent
figures. We are watching it closely. Other measures may be taken, as
appropriate, at the appropriate time.
Senator Ringuette: The nice thing about the Senate is its
institutional memory. I remember, in regard to the mortgage issues that you
have just said the government has tightened, that it did so after opening it
up in the first few years it was in government. They were just taking the
household mortgage issue and bringing it back to where it was supposed to be
in order for Canadians to be okay.
My third question is in regard to my concerns about our natural resources
not being converted into added value in Canada. We can look at either the
energy sector or the mining sector. My concern also involves the fact that
the ownership is an issue for the second and third tier transformation of
those resources. It is not happening in Canada, and Canadians, as a whole,
are not benefiting, to the nth degree, from those natural resources.
Mr. Carney: First, to your final comment, it is important that the
terms of mortgage insurance are at a sustainable, long-term equilibrium and
that any adjustment to them is done in the context of the overall economic
situation and the current situation for various vulnerable households. Those
are trade-offs that have to be made by the appropriate authorities.
With respect to natural resources, yes, to the extent to which the
Canadian economy can capture more of the value- added from our strength in
natural resources, that is to our benefit. I would note that, particularly
in highly capital intensive operations such as oil sands development, there
are important spin-off benefits across the country.
Senator Ringuette: There could be more.
Mr. Carney: There can be more. That again goes to a question of
context. There should be a reasonable expectation of opportunity in the
development of major resources in the energy sector and beyond that, in the
Quebec northern plan, in the Labrador trough, in the ring of fire here in
Ontario, in B.C, et cetera. All of these opportunities present upstream
opportunities as well for our capital goods manufacturers in Ontario and
elsewhere. One in 12 of the suppliers for the oil sands is resident in
Ontario. We can do more; you are absolutely right. The prospect of us doing
more would be aided by the recognition that what is happening will persist
for some time. This development will and should persist for some time, and
it is important to take full advantage, as you suggest.
Senator Stratton: Thank you. It has been refreshing to have you
here. I have sat through, I think, three of your type over the years, and
you are the most succinct and clear that I have yet heard; that is quite a
compliment. I appreciate it very much.
Germany is slowing down. China is slowing down. Britain is now in its
second recession since 2008. You get these worrying signs that are
persisting. You now have other countries, such as Italy, starting to vibrate
a little bit with respect to their economies. Yet, you are showing a
remarkable confidence in where Canada is going. I am with you; I believe
that because I think there is a growing confidence amongst Canadians
themselves, but I am betting against you that I do not think rates will
increase this year, not with an election in the U.S. I appreciate that
The question I have, and it is a very simple one, is that the labour
markets are really starting to concern me. I was talking to one of our
senators from Newfoundland; they are building a bridge in St. John's. They
had to stop construction halfway through because they cannot find the
labour. Unemployment rates in Newfoundland are at 12 per cent, but they
still cannot find the labour.
In Manitoba, my province, there is a shortage of skilled labour in the
construction industry, whereby they just simply cannot do the work. I think
it is having an impact on our economy to a fairly significant degree. Can
you help enlighten me? This appears to be a growing concern. Is that
something to be concerned about? Is it something that we can resolve through
policy? What is your take?
Mr. Carney: There are pockets of tightness in the labour market,
without question — the Prairies and Newfoundland. One of the things that is
a strength of the economy has been the flexibility of the labour market and
the willingness of Canadians to move for jobs, recognizing that it is
difficult. I think a third of the interprovincial migration has gone into
Newfoundland and Alberta, even though they are about an eighth of the
Canadian population. There has been sizeable movement. In fact, one of the
things that happened is that dynamic of transition from Newfoundland to
Alberta because of the scale of activity in Newfoundland has slowed and can
be expected to slow.
All of that is in the context of a labour market as a whole. All our
labour market indicators suggest that there still is some considerable slack
in the labour market. I give you two, and they are detailed in the report.
Involuntary part-time workers are about 28 per cent, up from 22 per cent
prior to the recession. That is fairly sizeable and persistent. These are
people who want to work full time but still are working part time. The
unemployment rate has come down, importantly, but not as much as it could.
We need that flexibility in the economy, because there are these
differential opportunities. We look at measures of wage growth and wage
pressure in the private sector. They are very muted. Unit labour costs,
according to the most recent figures, are negative, so we are getting
productivity growth outstripping wage growth, which is good for Canadian
competitiveness after a long period where it was going the other way.
Across the economy as a whole, there is still noticeable slack in the
labour market, so there is additional progress that can be made. We think
that will gradually dissipate, consistent with our forecast. That is the
comfort I can give you. There is no question that there are pockets. We do
see differences in the Prairies, and you mentioned Manitoba, Saskatchewan
and Alberta particularly, where things have tightened up considerably in the
last 12 months, not surprisingly given the underlying performance there.
Senator Maltais: Governor, I am pleased to meet you. We often hear
about you. I come from northern Quebec. There is major development in the
north of Quebec because of its minerals.
Mr. Carney: Precisely.
Senator Maltais: We are seeing unprecedented investment in the
North. My colleague mentioned labour shortages — we have the same problem.
And yet, Quebec has a reasonable unemployment rate, under 8 per cent. We
practically recruit workers in high school. Could that delay things?
Could mining in northern Quebec be profitable for all of Canada? Would it
be possible to mobilize workers in areas where the unemployment rates are
higher? These are fairly good salaries after all. We are talking about
$100,000 for a day labourer, which is considerable.
As you know, elections are taking place in France. You must be watching
them, like everyone else. If the socialists get elected, they are talking
about withdrawing from the euro zone. Would that have an influence on our
reserves and on the Canadian dollar, or would they become another Greece?
Mr. Carney: We shall have to discuss those issues after this
hearing is adjourned.
First of all, with respect to Quebec's northern plan, I completely agree
with the perspective of greatly increased activity over there very soon,
given the considerable opportunities provided by the mining sector and the
investments in hydroelectricity and in transportation infrastructure. So it
is a good plan and a great opportunity for Quebec and for Canada, as you
In Quebec, in Newfoundland, in Alberta, in Saskatchewan, in all of the
provinces, there is a shortage of skilled labour, and we will need time to
train new workers. We must begin immediately. Senator Stratton asked me
whether there were government initiatives. In fact, we do want to encourage
training. At the provincial level, both trades and education must be
Finally, it would be better to increase the flexibility of the labour
market as soon as possible here in Canada. Certain programs are still
preventing flexibility, that is to say the free movement of the workforce
here in Canada. It is up to the government and up to you to make those
decisions. That aspect must be considered.
Senator Maltais: And what about France?
Mr. Carney: Long live France! I cannot comment about France. We
The Chair: That is a great way to end. Governor, deputy governor,
it is always a pleasure. On behalf of all members of the committee, we
greatly appreciate your time today. Thank you very much.