Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 24 - Evidence
OTTAWA, Tuesday, March 18, 1997
The Standing Senate Committee on Banking, Trade and Commerce, met this day at 10:00 a.m. to give consideration to the state of the financial system in Canada.
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Senators, we are here today for the annual appearance before this committee of the Governor of the Bank of Canada, Gordon Thiessen. As many of you will recall, four years ago we started the tradition that in the months following the budget the governor appears before the committee to talk about macro-economic policy, to give his views on major economic trends and to respond to our questions.
Thank you very much for coming, Mr. Thiessen. As usual, you will begin with an opening statement, after which we will then turn to questions.
Mr. Gordon Thiessen, Governor, Bank of Canada: I would first like to introduce to you my two colleagues, Sheryl Kennedy and Charles Freedman. Both are deputy governors of the bank and members of the bank's governing council and, as such, share with me and the other deputy governors responsibility for the management of monetary policy and the bank's other activities.
This regular appearance before your committee, Mr. Chairman, following the release of the Bank of Canada's annual report, gives my colleagues and me an opportunity to present an account of our stewardship. As in previous years, I should like to focus particularly on monetary policy, but I will also say a few words about our other activities.
[Translation]
As you know, our monetary policy objective is to hold inflation in Canada within a target range of 1 to 3 per cent. Once again this past year, we met that objective. Looking through movements in the volatile elements of the Consumer Price Index, the trend of inflation remained in the bottom half of our range.
[English]
I know there are those who believe that the bank should set aside this focus on keeping inflation low and somehow redirect its actions to economic growth and employment. In fact, our inflation control targets provide the best assurance that monetary policy will contribute to long-run growth and will also act as an important economic stabilizer over shorter periods to help guide the economy to a path of full capacity use and high employment.
I will explain what I mean. A monetary policy that delivers low inflation provides more certainty about price movements and, therefore, a better climate for decision making by businesses and households. A low inflation environment also avoids inflationary booms and busts. It eliminates the distortions caused by the interaction of inflation in the tax system, and it prevents the misallocation of resources as people seek to profit from inflation or to protect themselves from inflation. All these benefits contribute to a more efficient, productive and growing economy over the long term.
[Translation]
Over shorter periods, a monetary policy that seeks to hold inflation within our target range will be helping the economy to operate close to its full potential. Such a policy approach also ensures that the Bank will not make persistent misjudgments about how rapidly the economy is capable of growing over time.
[English]
Inflation control targets have these advantages because the trend of inflation is the best indicator of how the economy has been performing relative to its potential. When excessive spending in the economy has been pressing against capacity limits, inflation will tend to rise. Similarly, a margin of unused capacity will put downward pressure on inflation. Inflation control targets are therefore useful in signalling the need for monetary policy action when the trend of inflation looks like it will go through the bottom or above the top of our range.
As we point out in our annual report, the economy has been going through a major but necessary transformation in both the public and private sectors in Canada. The magnitude of the adjustments taking place and their associated effect on consumer confidence have held back the expansion of economic activity.
[Translation]
In these circumstances, the performance of the Canadian economy over the past couple of years has been disappointing but not surprising. Persistent slack in the economy and downward pressure on inflation towards the bottom of our target range have called for an easing of monetary conditions.
Unfortunately, concerns about the budgetary positions of Canadian governments, interacting with the worries caused by the Mexican currency crisis and by the Quebec referendum, restricted the Bank's room for manoeuvre through much of 1995.
[English]
However, since November 1995, the bank has taken actions to ease monetary conditions substantially. As a result, short-term interest rates are at their lowest levels since the 1960s, and the improved budgetary positions of governments in Canada have contributed to declines in medium- and longer-term interest rates. Indeed, rates in Canada are below those in the United States out to maturities of 10 years.
Given the normal lags of 12 to 18 months, these lower interest rates are now having a considerable effect on the interest-sensitive expenditures in our economy. That is an effect which should continue through 1997 and into next year.
[Translation]
The prospects are good for reducing much of the present slack in our economy over the course of 1997 and 1998 and for a substantial improvement in the employment situation.
[English]
Finally, I would also like to draw your attention to the discussion in the annual report of our other activities. Major changes have been taking place in all areas of the Bank of Canada. We have found more efficient ways of carrying out our business, including new partnerships with the private sector. When all the changes in the bank are fully in place next year, they are expected to result in savings amounting to 20 per cent of operating expenses.
Let me also point out changes taking place in the Bank of Canada's presence across Canada. We are establishing two new representative offices in regions of the country and upgrading existing ones to improve communications between the bank and Canadians in every part of the country.
The Chairman: My questions relate to some comments made by your counterpart, the Chairman of the Federal Reserve System in the United States. At least twice that I can recall in the last little while he has warned about, and I believe his words were, the "excessive exuberance" of American equity markets. Do you think it is appropriate or part of the mandate of governors of central banks to even worry about what is happening in the stock market? Would you care to comment on whether there is excessive exuberance in the Canadian market or some other kind of exuberance in the Canadian market at the present time?
Mr. Thiessen: Mr. Chairman, I think the term used was "irrational exuberance".
I do not think it is the job of the central bank to make judgments about whether the markets are excessively exuberant or irrationally exuberant. What Chairman Greenspan is concerned about is a repeat of what happened in 1994, an event that occurred just before my first visit before you when, indeed, the Americans raised interest rates by one-quarter of 1 per cent. There was an incredibly strong reaction in the financial markets, particularly in the bond market. That reverberated around the world and ended up having an excessive response to what was a gentle attempt to slow things down in the United States.
I think Chairman Greenspan is now worried that in the stock market there are expectations about the future which are incredibly optimistic and may not include in them the possibility of an increase in interest rates in the U.S. I think it was more of that kind of warning as opposed to an attempt to cause the stock market to move to a different level.
The Chairman: You did such a thorough job in explaining that I cannot help but conclude that you have probably gone through much the same thinking yourself and have reached the same conclusion. Are you concerned about what is happening in Canadian markets in that you think the same degree of optimism exists among people investing in Canadian markets, or have Canadian markets also not reflected upon or taken into account the potential of a change in interest rates?
Mr. Thiessen: The situation in the two countries is very different. The Americans have been operating essentially at full capacity for two or three years now. We still have yet to reach full capacity utilization in this country. I think that makes quite a difference. That means that there is an outlook in Canada for more expansion. In those circumstances, increases in the stock market of the sort we have had seem to be quite consistent with that.
However, I would not like to leave you with the impression that we at the central bank can make precise calculations about what is an appropriate stock market level because, of course, we cannot.
Senator Angus: Mr. Chairman, I wish to welcome the Governor and his colleagues. It is great having you here again. We look forward to this post-budget appearance before the Senate banking committee.
It is interesting that you pointed out, I think very correctly, the difference between conditions in the U.S. and Canada because we tend to be so influenced by what happens there. We have been reading a lot about these Humphrey-Hawkins hearings that Mr. Greenspan and his predecessors have every year in the U.S., first before the Senate banking committee, and then a week or so later at the House of Representatives budget committee. Recently, of course, there has been a lot of publicity about what went on there. The chairman was saying to me that perhaps your appearances here will become the Kirby-Angus hearings. I do not know if you know the background of the Humphrey-Hawkins hearings. Perhaps you could explain it.
Mr. Thiessen: The Humphrey-Hawkins bill goes back to Senator Hubert Humphrey. This was an attempt to get the central bank to lay out its objectives for the year. That was the period when the U.S. Federal Reserve was using monetary aggregates to define their intermediate objectives for monetary policy. The idea was that the Fed should come before Congress twice a year to explain how it was doing with respect to the targets it had set a year ago and, indeed, to set new ones for the year ahead. The problem is that, subsequently, the Federal Reserve has stopped making use of those monetary aggregates because they turned out not to be as reliable as all that, but the Humphrey-Hawkins bill lingers on.
Nonetheless, it is still a good idea for central banks to appear before Parliament and Congress on a regular basis to explain what they are up to and why. I think that my colleagues in the Fed are perfectly happy with that arrangement.
Senator Angus: To explain, Governor, the sorts of considerations you examine and the guidelines you employ to set monetary policy in Canada, is it fair for us to conclude that in your appearances here you are quite comfortable to give a state of play in terms of how you view our economy and how you are establishing monetary policy?
Mr. Thiessen: Absolutely.
Senator Angus: We certainly appreciate that. In that regard, it might be useful at the outset to explain a further difference which I believe exists between Canada and the U.S. central banking systems. Although it is probably well known by most people who have had first year university economics courses, it tends to get lost in the shuffle. We hear, for example, Mr. Greenspan saying, "We are completely independent of Congress," whereas we read that you have weekly meetings with Mr. Paul Martin, or whoever the Minister of Finance of the day is. Could you explain that difference and how our system of central banking is slightly different?
Mr. Thiessen: Certainly.
The American political system is different in that there is a separation of powers between Congress and the administration. The Fed is a rather somewhat separate institution. It is a creature of Congress because it has been established by an act of Parliament. Therefore, it has an obligation to report regularly to Congress.
I must say that the head of the Federal Reserve also sees the Secretary of the Treasury on a regular basis. The difference is that their legislation does not call for that formally, whereas the Bank of Canada Act calls formally for regular consultation between the Minister of Finance and the Governor of the Bank of Canada.
The only real differences have to do with the fact that they do not have a parliamentary system. They have a system where the administration is separate from Parliament. More than that, I do not think there are large differences.
Senator Angus: That is comforting and interesting to note. Would it be fair to conclude that, in your view, the position of the Bank of Canada is, for all intents and purposes, just as independent of our Parliament as the Fed is of the U.S. political system?
Mr. Thiessen: They are very comparable. One of the differences in our case is that the Minister of Finance has a directive power with respect to the Bank of Canada which does not exist in the United States. The minister can use that power in the event that, after consultation with the bank, there is a fundamental difference of view and neither side feels able to compromise. In those circumstances, the minister has the ultimate responsibility. He can therefore issue a directive causing the bank to change its policy. Very formal conditions are laid down: it must be explicit; it must be for a time period; and he must lay it down in Parliament.
Senator Angus: As with the Coyne affair.
Mr. Thiessen: It came out of the Coyne affair. It is after the Coyne affair. The amendment to the Bank of Canada Act in 1967, in which this change was made to the Bank of Canada Act, set out clearly the relative responsibilities of the bank and the Minister of Finance.
Senator Angus: Thank you for that, governor.
In your annual report which you issued earlier this week and which I have read with great interest, as have my colleagues, you refer to this agreement with the federal government or the Minister of Finance in terms of the band of 1 to 3 per cent inflation. You have told us this morning that you are pleased with the way that is going and that we are in the lower half of the band.
I read somewhere -- it might have been in your report -- that the agreement the bank has with the ministry of finance will expire next year and that there will be a new agreement as to targeted inflation rates. Would such a thing prevail in the U.S., or is this uniquely Canadian?
Mr. Thiessen: This particular arrangement is uniquely Canadian, but it is not unlike the situation in New Zealand. The difference is that in New Zealand there is a legislative requirement that the minister and the governor agree on a target and that such an agreement must be reached at the beginning of the term of a governor, whether re-appointed or a new governor. That agreement has implications. If the central bank does not meet the targets, then the board of the central bank has an obligation to speak to the minister about what should be the result. One potential result is that a new governor should be found.
Senator Angus: That is interesting.
Continuing with the U.S.-Canadian comparison for a moment, I was interested to note that a commentator or analyst with the Wall Street Journal borrowed a line from our former Prime Minister, Mr. Trudeau, when he said that when Allan Greenspan sneezes, the U.S. economy gets a cold. Of course, we saw what happened after the December 5 statement, which I gather was watered down a bit during the Humphrey-Hawkins hearings. The Canadian quote was something to the effect that our neighbour, the U.S., is like an elephant and that we are a mouse. When the elephant sneezes, the mouse gets a cold.
At the present time, there seems to be, as you said, a substantial nearing of capacity of the U.S. economy. There seem to be some warnings, at least from the Fed, that there may be a modest increase -- perhaps 25 basis points in the short-term interest rates. You have always cautioned us not to ask you what the rates will be; however, in terms of market forces influencing your monetary policy, is there something useful you could tell us in that regard?
Mr. Thiessen: Certainly, Senator Angus, the U.S. is very important to us. It is by far our largest trading partner. Approximately 80 per cent of our trade is with them. However, we are also completely open with respect to the financial market in Canada and the financial market in the United States. Flows of funds between those two markets occur without any interference at all. Events in the United States do have a important impact on Canada. If, for example, the U.S. economy looks as if it is expanding even more rapidly, that will have implications for Canadian exports to the United States. If U.S. interest rates go up, that will have implications for interest rates in Canada and, indeed, interest rates around the world because financial markets really are international.
That does not mean we cannot have an independent monetary policy or that we cannot have a policy oriented to the situation in Canada. However, you cannot have interest rates in Canada which are absolutely not influenced at all by international rates, which is true everywhere.
Senator Angus: Pursuing this line of questioning, it is quite striking to note that the U.S. short-term rate has only been increased once since January of 1996 when it went from 5 per cent to 5.25 per cent. In roughly the same period, going back to perhaps June of 1995, there have been 19 changes in the short-term interest rates in Canada. That is an amazing difference. It points to the difference in our economies and our approach to monetary policy and the need for constant jiggering in this country. Perhaps you could elaborate.
Mr. Thiessen: No doubt there is a big difference between our economies. Theirs is a large economy, an economy which is much less influenced by what goes on in the rest of the world than are we. We are a smaller economy and one which is, by necessity, more open to the rest of the world.
However, there is also a big difference in terms of the starting position. The Americans started this recent period with less of an inflationary boom at the end of the 1980s, a more shallow recession subsequently, and a fiscal situation which, while it was not ideal, tended to be not as difficult as the one here. Debt-to-GDP ratios never got as high. All in all, the things that led to much volatility and influenced situations in Canada did not exist at all to the same extent in the United States. That explains most of these differences between Canada and the U.S. over the last several years.
Senator Angus: That led to as many as 19 changes.
Mr. Thiessen: I would remind you that at the end of 1994 and the beginning of 1995 and right after the Mexican currency crisis, there was a re-examination around the world of the situation of countries with a high debt problem where fiscal deficits did not seem to be under complete control. During the period between that Mexican currency crisis in December of 1994 and the federal budget of 1995, there was much concern about the situation in Canada, but it was not uniquely a Canadian situation. You see remarkable parallels in places such as Sweden, for example, which had similar problems. Italy and Australia had similar problems as well. You had sharp increases in interest rates and subsequently a substantial reversal of all of that.
Senator Kolber: Welcome, Mr. Governor, and your colleagues.
My first question has to do with the mutual fund industry. Historically, people of my generation, the older types, grew up feeling somehow that government would look after us. The Old Age Pension would always be there, and interest rates were such that, if we saved, we could put money on deposit and somehow muddle our way through. The baby boomers today have grave doubts that this scenario will unfold for them. People do not deposit money with banks like they used to, which of course is changing the entire banking industry. We have had, in the last several years, an unbelievable amount of money come into the mutual fund business. If there is a rise in interest rates, as surely there will be at some point, there will be a market correction. There is no great mystery to that. I do not think people will be badly mauled financially, but I do think they will be badly mauled psychologically. If Canadians are feeling poor and they stop spending, we could be in for a great deal of trouble. I am not presaging a great doom and gloom.
Do you have the same concerns as I have articulated? If so, do you have any suggestions about what, if anything, could be done about this?
Mr. Thiessen: I do not know that my concerns are as strong as the ones you have expressed. There is no doubt that when you have a sharp change in the savings habits of many ordinary Canadians, there may be some surprises down the track. I would accept that. However, we have already had some ups and downs in markets since the beginning of that movement of funds into the mutual fund industry. Already there has been some unhappiness at various times of people who found that the stock market was not somehow a non-risky road to riches.
There is a major structural change going on in our economy. For much of the last 20 years, we had a situation of relatively high inflation. That meant that savers were always at risk. They were never sure what would happen, whether they would get back the funds they had saved with the value intact. Many savers ended up in the banking system with very short-term deposits because they were concerned that, if interest rates went up, they would get behind. During the 1970s and 1980s, a disproportionate amount of savings ended up in that kind of form.
Now there is some readjustment to that where more money is going into the equity market. That is indeed very important. It is terribly important that Canadians become a source of equity financing for Canadian firms. There has been a traditional lack of that over the last 20 years with those high interest rates.
Through that period, there was also a strong incentive for companies not to issue equity but to lever themselves up as high as they possibly could because one could deduct any borrowings with those high interest rates pushed up by inflation. We had two influences going in the other direction. Now it seems that is reversing.
I do rather hope that in the mutual fund industry there will be more of a realization than there has been in the recent past about savers who want to take risk and savers who do not want to take risk. I hope there will be more of a sense of which funds are minimal risk funds and which are not. It is not clear to me that that has come through as neatly as it should have. There has been more emphasis on high rates of return rather than on stability in rates of return.
Senator Kolber: Is this partly as a result of you having done your job too well? Today, treasury bills only earn you 2 per cent interest. People do not really have any alternative. They just cannot live on that return, especially pensioners.
Mr. Thiessen: It is true that interest rates are currently very low. The Canadian economy has yet to return to full capacity use. In that sort of period, you would expect interest rates to be remarkably low.
However, I must say, I still believe that most people are hugely better off now than they were during a period of high inflation and high interest rates. That was a very volatile period. It was hard to plan. I made reference to distortions in my opening statement, and many people lost sight of the fact that our tax system taxed the interest rate, which included not only the real return but also the compensation for inflation. Frequently, they were hugely worse off after tax at those high interest rates than they are now.
Senator Kolber: Last time you were here, I tried this question and I met with total failure. You say in your opening statement that the bank's room to manoeuvre through much of 1995 was restricted by a series of events. One was the possibility of a Quebec referendum. The last time I asked, you did not want to comment on it at all, but here it is in your opening statement. Is there something you wish to say now that you did not want to say last time?
Mr. Thiessen: It is after the fact, senator. Yes, there is no doubt that through a good part of 1995, because of the sorts of uncertainties that the referendum campaign was causing in financial markets, our room to manoeuvre was limited. You will notice that the major easing in monetary conditions started at the end of October and went through for the subsequent year.
Senator Kolber: Again I will meet with failure but I must try.
If you are the guardian of the financial well-being of our country -- may I phrase it that way -- and if the possibility of our country separating would create financial chaos in the view of most people including me, then why does the Bank of Canada not say something about that and perhaps show us a few numbers?
Mr. Thiessen: As I explained to you last time, senator, it is really impossible for the central bank to do that. It is very difficult for us to comment on events which may or may not occur and the possible implications. Indeed, I think it is inappropriate. It is very difficult indeed for the central bank to comment on political events, even though they have economic implications. I am afraid that my answer is still the same: No, I would not wish to comment on that.
Senator Kolber: I heartily disagree with you and I will try again next year.
The Chairman: Governor Thiessen, I appreciated your response to Senator Kolber on the mutual fund question because some of the issues you addressed are exactly the reasons why this committee is about to embark on the first major study in this country on the governance of institutional investors, both mutual funds and public and private sector pension funds. Our reasons for doing the study, among a whole range of reasons, include exactly the issues you just raised.
[Translation]
Senator Hervieux-Payette: Governor Thiessen, you mentioned in your report that consumers will eventually regain confidence in our economy. For a certain number of years, interest rates have been declining considerably. While normally, those who are indebted should have more money in their pockets now that they are paying lower interest rates instead of the 10, 12 or 15 per cent rates they used to pay, it seems that we are not yet seeing additional consumer spendings. In spite of the reduction in interest rates, I am not seeing any significant improvement in the retail business sector. Are there any areas of Canada where things are getting better? Is it only strictly in Quebec or is all over Canada that people are so much indebted? You suggest that consumers are going to come back to their spending habits, but on what basis can you say that? We expected that any significant decrease in interest rates would lead to better days. Yet, consumers do not seem to spend more than before. I fell as if we were at some kind of a deadlock.
Mr. Thiessen: Looking at the two last quarters, the third and the fourth quarters of 1996, some changes are appearing, car and home purchases seem to be rising. The number of housing starts have increased considerably. On the retail side, sales of appliances have increased substantially, and this is only a beginning. In that regard, it is quite interesting to look at interest-sensitive consumer goods, where indeed we can already note a real upwards trend in sales, and that is in response to low interest rates.
It certainly is what we are expecting. As it is mentioned in our annual report, that is only a beginning. Normally, there is a lag of 12 to 18 months between a reduction of interest rates and a change in consumers habits. A further increase in consumer goods sales is still expected in 1997 and probably throughout next year too.
Looking at the latest figures available, we can see an increase of 6.2 per cent in February for home and car sales, an increase of 9 per cent for durable goods excluding cars during the last quarter and an increase of 9 per cent for home starts in February. Those are positive signs, I guess.
Senator Hervieux-Payette: My second question is about unemployment rate versus inflation. I was going to tell you that if I was to give you good marks, you would receive an A-plus for inflation, and maybe a B for the unemployment rate. We always told our constituents that when interest rates are low, the dollar is stabilized and the inflation is controlled, the economy automatically improves and the unemployment rate goes down. But, when we see our American neighbours keeping their unemployment rate at a lot more enviable level than ours in Canada, and particularly ours in Quebec which is now at 12 per cent, I realize why consumers' confidence is not now very high.
Even though we are lagging behind our American neighbours, you mention on page 3 of your brief that the prospects are good for a substantial improvement in the employment situation in 1997 and 1998. Are there any sectors, in the area of capital goods or reinvestments, where we might expect to see some new jobs? Do you think that the government could intervene in that area to stimulate job creation on an ad hoc basis? In your opinion, what solutions should be put in place to overcome that very serious uneasiness?
Mr. Thiessen: You have to remind that the Canadian economy is undergoing a major transformation, a really huge transformation. That's why both private and public sectors had to be reorganized. Those adjustments led to personnel downsizing in some areas, and caused uncertainties and a lack of confidence in our economy.
As it was said in our annual report, we think that period is about to be behind us and that we are at a stage where the positive impact of that transformation is being felt. Because of that, we think that we are now going to see some improvement in the employment situation. But the employment sector always shows signs of recovery more slowly than the pace of growth in the economy. Even though our economic expansion is expected to by stronger in 1997 than last year, it will take some time before the number of jobs available rises.
It is sad, but that's life. I believe that things are changing. If you look at the private sector, for example, in 1996, some 220,000 new jobs were created. We can see some improvements in the private sector presently, and more are expected for next year.
Senator Hervieux-Payette: You said at the end of your presentation that you have established a number of regional offices and that you intend to increase your activities in that area. You are already maintaining a presence in schools and universities. Personally, I find your presence quite sober in Quebec, despite Mr. Garneau's conference in Chicoutimi, as mentioned in your annual report.
I bemoan the fact that you are a great unknown quantity in Quebec. I asked my colleague, senator Kolber, if he saw your people more often than I do although I normally spend four days a week in Montreal. Your exposure, not only at the school level but also with organizations like chambers of commerce in Montreal or the Canadian Club, is quite low. I happened to invite some of your people and none of them responded to my invitation.
The Canadian Club is not a political organization. It is a discussion group made up of francophone and anglophone business people from Montreal. We would appreciate that your people's involvement be more important in regions. Taking into account that the Canadian dollar was presented during the referendum campaign as the symbol of our collective wealth, I would suggest that those who are precisely responsible for the Canadian note-processing could be more visible and that an action plan or an education program should be elaborated to help the younger and older generation to have a better knowledge of the Bank of Canada's role.
Let me tell you the wish I would like to make for today: without interfering into any political issue, you could make people aware of your role and functions. After all, your organization is vital for Canada. I don't know if my colleagues share my view on that, but I personally think that you are still not recognized enough.
Although you have a superb building on Nuns' Island -- maybe one of the most splendid to have been recently built in Quebec --, your old premises are still empty. It is rather miserable to see such a building without tenants.
I don't know if some of my colleagues could join me in elaborating a common project to rent it. We hope that you will recycle your old building in Quebec and that you will be present in our province.
Mr. Thiessen: We are already present in Quebec. We could do more, of course, and we are going to do better in the years to come. In the course of our numerous presentations, we deliver speeches. However, it may be that we do not get much exposure then. But we are expanding our staff in our Montreal office because we really intend to improve our presence everywhere in Quebec.
Ms Sheryl Kennedy, Deputy Governor, Bank of Canada: If I may add something, I must tell you that up until now all our employees in our regional offices took part in our operational activities. We have 500 employees outside Ottawa. Most of them carried out our bank note distribution services. In Montreal and Toronto, they are the ones who make surveys in the financial markets and who are responsible for our operations in that area. We are undergoing a major restructuring in those areas. That's why we are emptying and selling out some of our buildings throughout Canada. Those are buildings especially designed for that kind of operations.
From now on, those responsibilities will be contracted out and their costs will be transferred to the private sector. Thus, we will have not only additional Bank staff in our regional offices but also employees who will have different tasks and resources. They are prepared to communicate with everyone and to represent all our Bank's functions. They are not operational people. They gather information from regions and give us a better feedback about what is going on in regional economies.
For the last few years, we have been carrying out a liaison program which brings together all governors and deputy governors in each province once or twice a year. That's not enough. We cannot be everywhere in Canada. That's why we had to establish those regional offices in order to have more visible employees on the site throughout the year.
[English]
The Chairman: Governor, I have a brief supplementary question on your first response to Senator Hervieux-Payette. In responding to her question about consumer spending, you detailed the sectors in which a significant amount of increased spending is taking place. I noticed, however, that in all the sectors you mentioned, the increased spending is being done largely through debt rather than out of savings. I say that because they are large capital items, and I also notice that cumulative credit card debt in the country is very close to record levels.
In addition to that, consumer bankruptcies in Canada continue to be at record levels in spite of the low interest rates in the country. No one in Ottawa seems to understand the real causes for that. We are in the process of undertaking a joint study with Industry Canada to get a handle on the causes of that.
However, that leads me to wonder whether spurring economic recovery through increasing consumer debt does not leave consumers in a position where a relatively small change in interest rates will cause a significant increase in the number of bankruptcies.
To what extent do you see the level of consumer bankruptcy, the level of consumer debt and interest rates as being interrelated?
Mr. Thiessen: I take a more optimistic view of the future. It is true that consumer debt levels are high. It is also true that debt servicing costs of households as a share of their after-tax disposable income have been declining as interest rates have declined. There has been a substantial decline in debt service costs for mortgage debtors.
For example, five-year mortgages which came due over the course of the past year, which had initially been taken on in 1991, enjoyed very substantial reductions in interest rates. Many of those people have a major increase in their disposable income. They are not taking on more debt and may decide to pay off their mortgages somewhat more rapidly, as well as reduce their payments somewhat. Therefore, they will have more income left to spend on other things.
The other thing that strikes us from the data is the increase in the net worth of the household sector. Assets held by the household sector have been increasing faster than debts; therefore, net worth has been rising. In these circumstances, they do have more capacity to make purchases. That may involve taking the gain they have earned on some of their investments or perhaps selling some of their assets, but I do not believe that the current circumstance with respect to consumer debt is a major impediment.
If you are asking whether it will slow down consumer spending relative to a situation where debt was much lower and we had the same interest rates, the answer is obviously yes. However, I do not think it is sufficient to prevent what we see as a continued expansion of consumer spending.
Mr. Charles Freedman, Deputy Governor, Bank of Canada: Perhaps I could add to that. We did a survey a couple of months ago on the nature of residential mortgage borrowing as well as other kinds of household borrowing.
The Chairman: What do you mean by "the nature of residential mortgage borrowing"?
Mr. Freedman: I mean the terms of maturity.
For December 1995, which is a year out of date but nonetheless indicative of where we are now, five-year mortgage loans were 44 per cent of new mortgage loans. In other words, at these low interest rates many households are locking into longer-term loans and therefore will not be as sensitive to interest rate movement upwards. This compares to years when we had very volatile interest rates and people were afraid to lock in, for obvious reasons, to long-term rates.
The Chairman: The 44 per cent compares with what percentage, say, three years earlier when rates were much more volatile?
Mr. Freedman: Unfortunately, we do not have those numbers. In the mid-1980s it was 32 per cent. In the early 1980s when there were very volatile interest rates and again in the early 1990s when there were very high interest rates, there would have been considerably less in the way of long-term mortgages.
Also, although credit card borrowing has been growing quite rapidly, it is $17 billion of the bank credit card borrowing, compared to almost $200 billion for mortgages. Mortgages are by far the largest proportion of borrowing. Of course, people take on mortgages in order to buy houses, so there is an asset on the other side of their balance sheet.
Senator Oliver: My first question has already been partly addressed in response to questions by Senators Angus and Hervieux-Payette. It relates to the issue of your inflation targets and unemployment in Canada.
Of all the things you have done in the last year, the thing for which you have probably received the most criticism and the most coverage is the relationship between your low-inflation targets and unemployment in Canada of over 10 per cent.
There have been major editorials written in The Globe and Mail and The Toronto Star. In particular, Pierre Fortin wrote in The Globe and Mail on Thursday, September 26, 1996 an editorial headlined "Raise the inflation target and let Canada recover". He says that he wants you to immediately terminate your inflation targeting experiment of keeping inflation low so that unemployment can have a chance.
You said earlier, in response to Senator Hervieux-Payette, that you think things are starting to get a little bit better now, but that jobs always come after the economic recovery. However, if you raised inflation earlier, would the jobs and the recovery not take place faster?
Mr. Thiessen: No, I do not believe so. I believe that notion assumes that you can somehow fool workers and get them to accept lower wages by undermining the value of their wages with a higher inflation rate. That is effectively to say that we should have an across-the-board cut in wages and salaries.
I do not believe that most workers will simply stand by and accept that in order to employ more people. I believe that that is not a practical suggestion at all because it assumes that you can fool these people, that you will effectively cut their salaries with inflation, that they will not realize it and that it will be cheaper for employers to employ more people. I really do not think that is a practical suggestion at all.
The point I was making to Senator Hervieux-Payette is that we are going through a major transformation in this country. I think we are through the worst part of it. I think we are starting to see the net benefits coming. We see a Canadian business sector which looks to us to be more efficient and productive than it has been for a long time.
We have not seen all of those benefits yet. I believe that as the economy picks up, we will see increasing signs of that more efficient and productive business sector. In those circumstances, you will gradually see the economy getting stronger, and as that happens, you will see employment improve.
I am not suggesting that it will happen as quickly as we all might like. However, what makes me optimistic about our circumstances is that the basic foundations of our economy look to me to be so much healthier than they have been for much of the last 20 years. I see this efficient and productive business sector. I see the fiscal position improving dramatically, which I think has been a very worrisome part of the scene in Canada. As well, I see inflation, which was a problem for the previous 20 years, down at very low levels.
Put all of that together and you have the foundations for better economic performance than we have had in a long time. That makes me feel rather optimistic about the future.
In terms of the process of the economy starting to pick up, which we are already seeing, I mentioned some of the improvements in consumer spending. That will take a while before it is reflected in employment. However, we believe that we will see stronger employment growth through the course of 1997.
Mr. Freedman: One of the consequences of the period of low inflation, coupled with the improving fiscal situation, is the low interest rates we have had. Not only have they been low in absolute terms, they have been low relative to the United States, something we have not seen for many, many years. One could argue without question that if we had a higher rate of inflation, we would have higher interest rates. Of course, we are basing our view of the economy picking up precisely on those lower interest rates. The fact that lower inflation leads to lower interest rates is itself one of the causative factors in our view that there will be an increase in demand and then in employment.
Senator Oliver: What if Mr. Greenspan raises rates in the United States by three-quarters of 1 percent in the next two or three months? What will that do to your optimism?
Will you not have to follow?
Mr. Thiessen: We will have to wait and see. If increases in U.S. interest rates reflect a stronger U.S. economy, which is already operating at full capacity, then more American spending demand will spill over into imports. A large chunk of those will come to Canada. We may well see as a result of all that an even stronger export sector than we had before. If and when the Americans raise rates, we will have to look at what all of that means for Canada.
One thing which I probably did not make as clear in my response to Senator Angus as I should have is that we now have much more room to manoeuvre as the Canadian central bank than we had during the period when debt levels and inflation were high and there was a lot of concern about the financial situation of Canada. What you see now is a great deal more confidence and credibility with respect to Canada. That leaves us more room to manoeuvre in responding to events like that.
As I said to Senator Angus, you cannot ignore them. I cannot say to you, "It does not matter what the Americans do; it will have no effect on Canada." That would be wrong. However, as the central bank, we have more room to manoeuvre than we had before.
Senator Oliver: There was an amendment to the Bank of Canada Act not so long ago whereby the chartered banks were released from the requirement of putting a portion of every deposit into an interest-free reserve. Some people have criticized that, saying, "All you have done is freed up more money for the chartered banks, which is why they are making such big profits and nothing is being done for small business." What is the fiscal reason for making that change and what effect is it having on excess profits for the banks?
Mr. Thiessen: There is no doubt that those reserves were essentially a form of hidden taxation. These were reserves which they had to hold at the Bank of Canada. The Bank of Canada was not empowered to pay interest on them. Essentially, they were a form of tax. Once upon a time, we, and other central banks, ran monetary policy relying on those reserves. Over many years that tended to result in depositors going elsewhere because they could get a slightly better interest rate from someone else who was not subject to that reserve requirement. For us and the government that seemed to lead to a non-level playing field. Certainly we did not need those reserves to run monetary policy.
Senator Oliver: What was the gross amount of the reserves freed up for the chartered banks by that amendment?
Mr. Freedman: The numbers declined over time. The dollar deposits at the Bank of Canada held by chartered banks were $3.5 billion in 1983. They are now $500 million. They came down gradually. Even throughout this entire period, of course, we had a situation in which the deposits of Canadians at the mortgage loan subsidiaries of the banks were not reservable either. As the mortgage loan subsidiaries were growing and as mortgage credit was very important, that part was not reserved at all.
Mr. Thiessen: We had a silly situation in which it was in the interest of all banks to direct both deposits and loans into mortgage loan subsidiaries which were not subject to reserve requirements. We were ending up with distortions in the system that just did not make any sense.
Senator Oliver: Do you think this $3 billion that has been freed up is something at which the Department of Finance should be looking?
Mr. Thiessen: I do not really think so. Some of this will end up reflected in narrower spreads between lending rates and borrowing rates than there were before. I do not think there is a kind of fund which the banks can end up using.
Mr. Freedman: Senator, it is not $3 billion; it is the interest on that amount that is relevant. At today's interest rates, we are talking about $120 million.
Senator Stewart: My first question is entirely descriptive. Would you tell us about the techniques you use in monitoring the inflation rate? Is this done on a weekly, a monthly, a quarterly or an annual basis? I assume it is done on a fairly short range because you talk about being able to respond quickly to any change.
Mr. Thiessen: The information on the Consumer Price Index comes out once a month. We get a fix on it once a month, but we also look at a number of other things. We look at other price indices, such as wholesale prices, producer prices and so on. We are always checking what the Consumer Price Index tells us against what other price indices tell us as well.
Also, we are looking at what seems to us to be the pressure of the economy on capacity, or the lack of it, and whether that is likely to lead the Consumer Price Index to rise or fall. We are looking at the expansion of the money supply to see whether that is telling us something. That is the monitoring process we go through, Senator Stewart.
Senator Stewart: There has been something of a controversy in Washington as to the accuracy of the monitoring or measuring that takes place in the United States. First, is that controversy of interest to you as it might influence the policy of the Federal Reserve System in the United States, and, second, as it might bear upon our own techniques of measuring or monitoring inflation in Canada?
Mr. Thiessen: Certainly that study did elicit a lot of interest here. However, first, I should like to put in two advertisements, senator. The first is for Statistics Canada, which I think does a superb job. A lot of the biases that were discovered in the United States are biases that either do not exist here or Statistics Canada has reduced them to a very low level.
I should also like to put in a plug for the Bank of Canada because we did a similar study back in 1993. We found a bias in the Consumer Price Index that was at the maximum about one-half of 1 per cent. We will be looking at that again because some interesting stuff has come out of this American study. It may well be that the bias is slightly larger than that, but probably not much.
Basically, it looks to us that the Consumer Price Index in Canada is better constructed than the one in the United States. Therefore, the estimate of an error of one percentage point a year does not look to us to be the case here in Canada.
Senator Stewart: Nevertheless, if the American system is biased and the Federal Reserve's policy there has a considerable impact on what happens here in Canada and on your policy, their system would, regardless of the accuracy of our measurement, have an influence in Canada. Is that not correct? For example, if they saw inflation that was higher than in fact was taking place and changed their interest rates accordingly, that might have an influence on what you would do with regard to the money supply in Canada.
Mr. Thiessen: However, it would not prevent us from pursuing a rate of monetary expansion which we thought was appropriate for Canada and achieving what we thought was a sensible and appropriate inflation rate for Canada. When the Americans move, it will have an effect on interest rates in Canada and on the exchange rates, but it does not prevent us, especially now that the public finances in Canada are in good shape, from pursuing the rate of money growth that we want and achieving the rate of inflation that we want.
Mr. Freedman: Perhaps it is worth adding that now that they are aware of the bias, they do take it into account in their decision making as well. Considering the 1 per cent that came out of the Boskin report, if they see their inflation rate as 3 per cent and if they believe the 1 per cent is a reasonable estimate for their situation, then they say, "Well, the inflation is really 2 per cent," which in their view is still too high, but it is not quite 3 per cent.
The issue in terms of whether they will raise their rates is not so much the level of the inflation rate but the direction of the movement and the upward pressures.
Senator Stewart: We could go on further, but I think we have tilled most of the arable ground. Let us move on to another question which is directly related.
Twice, governor, you have referred to full capacity in the U.S. economy. We have talked about the measurement of inflation in Canada. Let us put this in elementary terms. Let us say that prices in the United States go up by reason of the full capacity there. That means goods and services imported into Canada from the United States go up in price. In turn, presumably, higher prices in the United States will have an upward pressure on prices of Canadian exports.
To what extent is the inflation rate in Canada influenced by the inflation rate in the United States? How much of the basket that you measure is independent of the price of those goods in the United States? We can take simple examples, such as citrus fruits.
Mr. Thiessen: There is no doubt that the import component of Canadian consumer expenditures is fairly large. You are absolutely right: if prices go up in the United States, the goods we import from the United States will come into Canada with higher prices than they were before.
One of the reasons we can have an independent monetary policy and an independent inflation rate is because of our exchange rate. What you expect to see in the circumstance where the American inflation rate is higher than the Canadian inflation rate is a gradually appreciating Canadian dollar. If the difference in prices between Canada and the U.S. is, say, 2 percentage points -- and it will not happen every month or week -- on average you will see the Canadian dollar rising relative to the U.S. dollar at about 2 per cent a year.
Senator Stewart: This takes us back to the beginning when I asked you whether you did your monitoring on a weekly, monthly, or quarterly basis. You talk about a gradual appreciation in the value of the Canadian dollar and an average. Is it averaged over one year or five years or twenty years? What does the word "average" mean in this context?
Mr. Thiessen: I cannot give you a precise answer to that because there are so many other things affecting the Canadian dollar at the same time. While the inflation rate differential might be leading the Canadian dollar to rise by 2 per cent a year, if we had a situation where commodity prices -- the price of wheat, for example -- were suddenly tumbling, you would see that giving some downward pressure on the Canadian dollar. The dollar is responding to so many different things that it is hard for me to say to you that it will reflect this difference in inflation in a nice, precise way.
It is certainly true that on average, over the course of a year or two, you will see that. However, I certainly agree with you that you will not necessarily see it every month or every week. You will see movements up and down in the Canadian CPI, but we have noticed over the last number of years that we are certainly capable of running it at a lower rate of increase than in the United States, and doing so quite successfully.
Senator Stewart: Using rough figures, what is the U.S. import component of the basket you use for measuring inflation in Canada?
Mr. Thiessen: That is a good question. Imports are about 20 per cent of GDP, and the U.S. is about 80 per cent, so that would be about 16 per cent. That is quite rough and ready and off of top of my head, senator. Perhaps it could be higher on the consumer basket side. That is an interesting calculation, senator. I will go back, do my homework and determine that.
Senator Grafstein: I am not a member of this committee, but the chairman was kind enough to invite me again.
Governor, I asked you a question last time, and I am delighted that the results were positive. I asked you about the historic differences between real interest rates in Canada and the U.S. and why they had lagged behind, and you solved that problem. Now I can move on to my more intractable issue.
You touched on the difficulty we are having with respect to employment as we go through the massive transformation of our economy. There is no question in the minds of many that our job situation is lagging the U.S. in terms of reaching the full capacity levels we would all like to see. The difference between 5 per cent and 10 per cent unemployment has a massive, positive difference on the economy.
I have heard debates dealing with micro-issues. I know you dealt with macro-issues here. Let me deal with a micro-analysis to see if you could shed light on this debate.
The debate is that Canada has not been as successful in transforming its economy as, say, the United States from a rust-belt economy to a modern, technological, value-added economy. Particularly as we have more competition with low price products from around the world, we are a trading nation and must emphasize our value-added products.
The argument made for lagging behind is that we do not have a consensus on a number of key points, political and business. For instance, our literacy rate in Canada lags dramatically behind many of the developed countries. The statistic I saw yesterday was the comparison between Chile and Canada. Our illiteracy rate varies between 18 per cent and 35 per cent, while in Chile it is 4 per cent.
R&D in Canada is going downwards as R&D in OECD countries is moving upwards. At another hearing last week on post-secondary education, we heard that our component of research and development is lagging behind all countries in the developed sector, save perhaps Italy.
Regarding international students, the United States has 10 per cent of its classes of international students; we are at 3 per cent. In these micro areas like post-secondary education, we are lagging behind in terms of investment. In secondary education, we are lagging behind in investment. This is not caused by one government. It appears to be a general lack of political consensus to move forward to an information, technologically-based, next economy. We are lagging.
Could you comment on that? Is that a fair analysis, having in mind that you have given us a very positive analysis in terms of the bank's job? Now we are talking about the wider spectrum.
Mr. Thiessen: Some of the senator's comments are getting out of my field. I am a little hesitant to go too far.
You said that we have not been as successful as the U.S. in the process of transformation. To a certain extent, that is a question of lag. The Americans started before us in the midst of the 1980s. We did not essentially start that process until the beginning of the 1990s, so we were running behind.
One of the things about that inflationary period of the 1980s that I really do regret is that, in my opinion, it delayed the process of economic transformation that needed to occur in Canada in response to changing technology and the opening up of markets. We were running behind. The Americans were ahead. I must say in our defence that the Americans were ahead of everyone. They were in on that very early on. The new Asian economies must start from scratch, but among the industrialized economies, the Americans were very quick off the mark. We still have a way to go to catch up on that side.
From that point of view, it is not surprising that we are finding the head winds somewhat strong in terms of our economic situation. I believe what is happening here is very positive.
There is no doubt that a number of the micro areas you mentioned are important. However, I do not have enough expertise to make a judgment on just how important they are. I would be surprised if literacy is worse in Canada than in the United States, if that is our standard of comparison.
On the R&D measures, that may well be true, although I know there are some terrible problems with measurement there.
I suspect the things you are mentioning are significant. There is no doubt that our labour market is not as flexible as the American market. No labour market in the world is as flexible as the American market. I am always amazed at the willingness of Americans to move from one end of the country to the other in the event that they think there are jobs there. Suddenly, in New England, when their 1980s expansion slowed down, a remarkable number of people ended up moving to the southwest. That does not tend to happen in Canada or in any of the industrialized countries which I know. It is also the case that no one has an unemployment rate in the industrialized countries as low as the Americans.
These are difficult issues. If we understood them as well as one would like, we would not have such high unemployment rates around the world.
The OECD has done a major study on this. I am quite impressed with it. It puts much emphasis on labour market flexibility, training and education.
Mr. Freedman: One of the things from which we take a certain amount of comfort is the growth of exports. In particular, in the last years, there has been a growth in non-traditional exports. In the non-auto-manufacturing component, we have done very well particularly into the United States but even overseas. When someone told me we were also exporting machine tools to Germany, I thought we had finally reached the millennium. This is something I had not expected to see.
This is not to say we are at the best of all possible worlds, but there are many good things going on there. We do need more trained people. Two days ago, an engineer in Ottawa was telling me that there is a shortage of engineers. It does get to very interesting questions of how we will meet the needs of the future.
One of the things about getting monetary fiscal policy right is that you can turn to really tough micro-questions. If you do not have the framework policies right, you have to focus on those. However, once you have the framework and the fiscal and monetary policies right, then you get into the deeper structural issues of the sort that you raised. Those are very tough issues which really require that the framework is right before they can even be addressed.
Senator Grafstein: Again, I find that we are living in two worlds. Everyone talks about it being the education century, the technological century and the scientific century. Yet one of the side effects of your deficit-cutting, inflation-fighting policy is to transmit a value system to the province of Ontario, as an example. I represent the province of Ontario. That policy says that, in order for us to achieve our macro objectives, we will slash education. The educational system in Ontario, as it was in Alberta, is under tremendous stress. Whether that stress will be positive and cause them to re-orient their organizational structures in a different way is one thing.
Yet on the other hand, there appears to be a misallocation or a bad mix of policy objectives. The one good sound is, "Let us get the economy in order." The bad sound is, "Let us slash education, R&D, scientific research and social research and engineering research."
We heard from the engineering council the other day in another committee that their budgets have been frozen for the last five years, yet there is a demand for engineering students at the under-graduate and post-graduate levels. There appears to be a poor mix of policies here. Some of that comes from the overwhelming concern of the bank to fight inflation. Is that fair?
Mr. Thiessen: No, I do not think it is it, senator. Of course, I cannot comment on the individual expenditure items that governments choose to reduce or to increase. However, there is no question that the fiscal situation we created was a very difficult one which needed resolution. There was no option out there to just leave that aside and do the stuff that we thought was good and important. That was not an option. Had we tried to do that, we would have had more of what we were seeing in 1995, which was a singularly unpleasant period when the Canadian dollar was dropping and interest rates were rising all the way out the yield curve.
In order to calm things down in the markets, we found ourselves needing to go through a temporary period of tightening monetary policy. Otherwise, we had a situation where people were losing confidence in the Canadian currency. This is a very bad scene. It is one that imposes huge costs on Canadians. It means that interest rates are higher than they need to be. It means that interest payments to foreigners are larger than they need to be. A larger proportion of our national income is devoted to paying those interest rates which are high because people are worried about our situation. That is far more costly over any length of time than what has subsequently happened.
Senator De Bané: Mr. Thiessen, I would like to talk to you about the issue of the separation of Quebec. On the sociological front, of course, it has divided society in Quebec. On the issue of policies, it has taken much energy both at the federal and provincial levels.
Tell me about the consequences of the possibility of the break-up of Canada on interest rates? Has the Bank of Canada or other people in academic circles, et cetera, made any study of the costs to the government of Quebec, to the Government of Canada and to all the other different governments and to consumers in increased interest rates over the last 20 years because of the possibility of Canada's break-up? Has no one ever made a study about the increased costs which have been shouldered by governments and by consumers? Has any study been made on that issue?
Mr. Thiessen: There have been studies of various sorts. It is incredibly difficult to decide, with regard to high interest rates in Canada up until 1996, what proportion was due to uncertainty about the political situation in Quebec. What proportion was due to a fiscal situation that did not look like it was under control until the various budgets of 1995, and then the Ontario and Quebec budgets of 1996? Our problem is that you cannot really disentangle those two. Not only can they not be disentangled, but they are interrelated.
If you are an investor, you will be even more worried about the fiscal situation because you have political uncertainty. Similarly, if you have political uncertainty, you will be more worried because of the fiscal situation. The two are very much intertwined. It is terribly difficult to go back and say, "Well, I just happen to know that you can say 2 percentage points." You can do that, but it would not be intellectually respectable to do so.
Neither can you make judgments about what kind of investments did not take place, not only because the interest rates were higher than otherwise, but because you were just concerned about the circumstances. That kind of analysis is incredibly difficult to do. No one has managed to do it in a way where everyone would say, "Yes, we would agree with that."
Senator De Bané: You have explained the complexity of the issue. However, my inclination is that that issue has cost all of the Canadian population, whether in Newfoundland or British Columbia. They had to pay more because of that uncertainty. Would you agree with me on that?
Mr. Thiessen: I would agree with you on that. Political uncertainty exacts a cost. It exacts a cost in terms of risk premiums and interest rates which would not otherwise exist. As Canada is a national market, interest rates across the country are affected. However, to estimate the size or significance of that, I am not in a position to do so.
Senator De Bané: Would you agree with me that it is natural to say all Canadians -- starting with Quebecers -- have had to shoulder an economic cost for that political uncertainty?
Mr. Thiessen: Political uncertainty has a cost, yes. It has a cost for all Canadians.
Senator De Bané: Conversely, if that possibility was removed from the political agenda tomorrow, that would help not only the economy of Quebec, but all of Canada's economy.
Mr. Thiessen: You are correct. However, it is difficult to judge just what significance that would have.
One of the remarkable things that has happened since the referendum is the extent to which those concerns have been pushed into the background in the minds of people in financial markets. I am referring not only to those people who trade, but also to investors and people who are responsible for managing portfolios. You do not hear much about that situation.
As Canadian interest rates have narrowed with respect to U.S. interest rates, it is difficult to determine that significance. It is still there, yet the significance is unknown at this point.
Senator De Bané: Do you agree that if a referendum was called tomorrow and polls showed that separation would succeed, money markets would react quickly?
Mr. Thiessen: Yes.
Senator Angus: Governor, by and large, you have given us a bullish and rosy report on the state of the economy in Canada. You are comfortable with your policies. Inflation may be below 1.5 per cent.
Coming from Quebec, I and several of my colleagues from the province of Quebec are concerned because our economy is not rosy; it is sluggish and, frankly, stagnant. As Senator Hervieux-Payette stated, not only is the Bank of Canada building empty and up for sale, there are many buildings in such a state.
In the prime part of Montreal, street after street in the centre of town, many buildings have windows boarded up. There is unemployment far beyond the level we have spoken about this morning.
I speak against a background of university study which consisted of Keynesian economics and pump-priming. I have lived through supply side and trickle-down outlooks to fixing situations. Senator Oliver also pointed out that Pierre Fortin's view is that a low inflation policy does tend to have a downside to it, characterized, for example, by higher unemployment or a tendency to it and to recessions.
We have paid the price with recessions in recent times. I am aware of the mandate you have to monetary policy, trying to deal with situations as I have described in Quebec.
Would you not agree that something could be done to improve the Quebec issue by taking a different view? You do not agree with Mr. Fortin, but the fact is Quebec is one-third of the country. I am sure you are not suggesting that the workforce from Quebec move across Canada like the flexible U.S. workforce. What can we do about it, sir?
Mr. Thiessen: I would not agree with your analysis, senator. The recessions we have had over the last 20 years are the result of high inflation rather than low inflation.
What happens with high inflation is you get speculative booms such as we had in the 1970s and late 1980s. Those speculative booms caused the worst recessions we have had in the post-World War II period. It is true of other countries as well as Canada. Recessions tend to be much milder when you do not have an inflation problem. I would argue that, no, pursuing a low inflation policy has not been the cause of these recessions. High inflation has been the problem.
I would also submit to you that in parts of Canada where the structural difficulties are severe, which is certainly true in Quebec but it is also true in other areas, the adjustment to those circumstances works much better with low inflation. It is much easier to make long-term judgments.
The thing that strikes you about the period when inflation is higher is how short term the judgments become. We may say, "Do we make a gain on this over the next year or two?" If we want to change the structural situation in Quebec and elsewhere, we need to take long-term decisions. Long-term decisions are taken better in a period of low inflation and a period of greater certainty.
I believe the policy we are following is the best basis on which people can make judgments about responding to the situation in Quebec. It does not harm it.
Senator Angus: You do not agree with my analysis of how it could be fixed, but you do agree with the bad conditions we have in Quebec.
Mr. Thiessen: Oh, I would certainly agree that the situation is difficult.
Senator Angus: Governor, I want to be sure I have your recipe clear because I think it will bring into focus the fact that Senator Kolber did get an answer to his question ultimately this morning. You prescribe that we stay the course with your policy of low inflation, that we proceed with and carry through with the restructuring of our economy in Quebec, and that we do everything in our power to stabilize the political situation to attract investment which is being kept away. Would you agree?
Mr. Thiessen: I would agree with that.
I think it is very interesting. I do not profess to know all the details of the Quebec economy, but the thing that strikes me when our people go out to visit companies in Quebec on a regular basis is the difference between those involved in the export trade and those whose businesses are oriented solely to the domestic market. The export sector in Quebec, or certainly some parts of it, is doing quite nicely, thank you. The problem is that the domestic part of the economy is not doing well.
Senator Kolber: They are not doing well because of Quebec.
Senator Angus: Because of the stability factor.
You may not be aware of this, but our last guest at this committee at 9 o'clock last Monday morning was the Minister of Finance, the Honourable Paul Martin. It is always a pleasure to have a dialogue with him. We note that you have had a vicarious dialogue with him on the issue of what our full employment threshold is in Canada. Could you enlighten us a little bit? As I characterize the issue in the U.S., for example, they have somewhere between 5 per cent and 5.3 per cent unemployment. That is generally felt to be pretty near the theoretical threshold of full employment. However, in Canada, we are at 9.7 per cent and upwards in the bad areas. You are quoted as saying that the threshold would come in somewhere around 8 per cent, maybe even a little above 8 per cent. However, the Minister of Finance is saying that it is the same as the U.S., which is closer to 5 per cent. It would be helpful if we could put that issue to rest.
Mr. Thiessen: I appreciate you asking the question, senator, because I would like to put it to rest. What would you say if I said I had been misquoted?
The Chairman: I can assure you that everyone of us around the table who has been in politics has used that line on several occasions in the past.
Senator Angus: I anticipated you might open with that comment, sir. I respect that answer, but could you develop the issue, please.
Mr. Thiessen: Absolutely.
The Bank of Canada does not run monetary policy on some notion of what is a minimum acceptable rate of unemployment. One does not know enough about the structure of an economy to make that calculation except with a very wide margin of error. We have done research on this issue. Indeed, we published a study on the calculation some 10 years ago, which is where the 8 per cent comes from. We also pointed out that it has a very wide margin of error. I think I was asked that question at a press conference following our session last year, and I said, "No, we do not make monetary policy on the basis of some natural rate of unemployment or some calculation of a non-accelerating inflation rate of unemployment, the famous NAIRU."
Second, it is a calculation that is just not precise. The economy is hugely more complicated than that.
The interesting thing about what has happened in the United States is the way the economist's notion of what is probably the minimum non-inflationary rate of unemployment keeps edging down. You see, that is one of the benefits of low inflation -- you have room to manoeuvre. What the Americans have done rather well is felt their way down. It turns out that the unemployment rate they are at now is a lot lower than what most people would have said was the minimum they could get to without causing an outburst of inflation.
Senator Angus: Yet their rate of inflation is double ours, is it not?
Mr. Thiessen: It is, but it has been declining rather that rising. If you look through some of the volatile elements of it, it is down to 2.5 per cent. If you really believe there is a 1 per cent error, that is a pretty low inflation rate.
I think a calculation about what unemployment rate is possible or feasible is not a very useful thing. I hope that when we get to what looks like full capacity here, we will do that same kind of probing exercise. I would not wish to prejudge the level of unemployment we get down to.
Senator Angus: Thank you very much, governor. Those were very helpful responses.
Senator Stewart: You referred earlier, governor, to a bracket of 1 per cent to 3 per cent inflation as the target. Why not go for zero per cent inflation?
Mr. Thiessen: I think it is too soon to know the right number. We have been through 20 years in which inflation was pretty high. It averaged around 7 per cent through much of the 1970s, 1980s and into the beginning of the 1990s. We have had now four years of low inflation. We need to do our homework and to judge the rate at which the economy seems to function well and where rigidities do not get in the way of the good functioning of the economy. We must do some more homework.
Do we have the measurement error exactly right or do we not? I think it is too soon to judge. However, by the end of 1998, the Minister of Finance and I will discuss again what a reasonable set of targets are. Up until that time, I am agnostic.
The Chairman: Governor, on behalf of all of the us on the committee, I want to thank you again for taking the time to be with us. We thoroughly enjoyed this session. We have learned a lot, and we hope that you have tolerated this session enough so that we can look forward to seeing you next year.
Mr. Thiessen: Mr. Chairman, my colleagues and I welcome your invitation every year. I think it is a very important part of the way the central bank should operate in a democratic society where it does its accounting stewardship before Parliament. We were pleased to be here today.
The committee adjourned.