Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 26 - Evidence

The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:00 a.m. to examine and report upon the present state of the domestic and international financial system.

Senator E. Leo Kolber (Chairman) in the Chair.

[English]

The Chairman: Honourable senators, I have the honour of introducing Mr. David A. Dodge, the seventh Governor of the Bank of Canada. He was appointed on February 1, 2001, after serving a distinguished career in the Canadian public service. He most recently served as Deputy Minister of Health. His previous public service positions include Deputy Minister of Finance and Deputy of the G7. This public service experience must be seen alongside Governor Dodge's distinguished academic background as senior fellow at the University of British Columbia and Simon Fraser University, Professor of Economics at Johns Hopkins University and Queen's University, which happens to be an alma mater of a number of central bank governors.

I am especially pleased to welcome Governor Dodge before the Standing Senate Committee on Banking, Trade and Commerce in this troubling period for Canada. Since September 11, we have seen terrorism on an unprecedented scale on North American soil, a recession has, it seems, commenced in the United States and a war is being fought in Afghanistan. Canadians are very interested and concerned for their economic well-being.

A crucial role for the Governor of the Bank of Canada is to act as the guardian of the currency in the country and to keep close watch on the state of economic activity in the country. It is also the task of this committee to seek answers on behalf of Canadians from the Bank of Canada about the state of our economy.

It is with this in mind that we have invited the governor and his deputies here, to assist us on behalf of all Canadians in reflecting on the progress of the Canadian economy and to assist us in considering the best course ahead.

With that in mind, I invite you, governor, to please give us your statement and then we will proceed to the many questions senators have for you.

Mr. David A. Dodge, Governor, Bank of Canada: Honourable senators, it is a great pleasure to be with you today in what I hope will be a semi-annual appearance in front of this committee. I am joined by Mr. Knight, and together we will do our best to answer any questions you may have.

What I thought might be useful is to start off with something of an exposition, which I hope will be done in a way that makes what we do at the bank clear in setting monetary policy. If honourable senators will bear with me for about 12 minutes or so, what I would like to do is to take you through it and then we can use that as a basis of discussion.

[Translation]

The bank has a commitment to contribute to the economic well-being of Canadians. This means that we must conduct monetary policy so that it fosters sustained solid economic growth.

As I said to you last March, the unique contribution that monetary policy can make to good economic performance is to preserve confidence in the future value of money. When people can count on their central bank to keep inflation low, stable and predictable, they can make sounder economic decisions.

The bank pursues low inflation within a framework based on an explicit inflation target, supported by a flexible exchange rate. The target was renewed in May for a five-year period. The current target is to aim at the 2 per cent midpoint of a range of 1 to 3 per cent over the medium term.

I say over the medium-term because a certain amount of time, from 18 to 24 months, is needed for the effects of monetary policy to be fully felt on the economy and on inflation.

In setting monetary policy the bank needs to look ahead and make judgment calls about future economic developments and about the timing and final outcome of any actions we take today.

Since their adoption in 1991, inflation targets have proved very effective in keeping inflation low and in anchoring people's inflation expectations. They have also provided the bank with a useful mechanism for assessing and dealing with pressures on future inflation in a way that helps to keep the economy on a more even keel.

Let me to explain how the inflation targets work to guide monetary policy and to allow the bank to help stabilize the economy.

At any point in time, there is a certain level of output that the economy can sustain without creating upward or downward pressure on inflation. This is what economists call the potential output or production capacity of the economy. The level of potential rises over time as more workers join the labour force, businesses increase their investments in new technology, machinery and equipment, policy measures are taken to make product and labour markets more flexible, and all of us become more productive.

It is difficult to accurately measure potential output because it depends on many factors. By analyzing the trends for these factors, we can nevertheless roughly estimate it. The approach we adopted to control inflation has proved to be particularly useful when the time comes to measure potential output. It helps us avoid systematic errors in our calculations.

For example, if inflation was coming in persistently below our expectations, it would be a strong signal that production capacity was higher than our estimate and vice-versa.

[English]

At the bank, we estimate that potential is likely to rise at about 3 per cent per year over the medium term. I show this in my chart 1. You will notice that we have drawn the line very widely. In fact, we should have put confidence intervals around it because we cannot estimate it precisely. This is not a precise science. However, we can get a fix, and that shows how it works.

In terms of setting monetary policy, when the economy is likely to be operating above potential, or when it does operate above potential, the pressure on inflation is increased. When we see that occurring, what we do is tighten monetary policy. On the other side, when we are operating down here, or are likely to be operating down here, that will put downward pressure on inflation. It is in those periods that what we try to do is ease monetary policy. That is basically the objective and how the system works.

What you will notice is that inflation control works symmetrically. It allows the bank to take policy actions to prevent overheating when the economy is strong and pushing against its capacity limits but to support growth when demand is weak.

It is useful to try to relate this theory, if you will, to the recent practice. I turn now to chart 2.

If we go back to late 1998 and early 1999, we will see that the economy was operating below potential. What we were doing during this period, which is signified by the blue bar, was easing monetary policy to try to ensure that we got back to the potential line. Indeed, you can see that the economy did respond quite strongly to the actions we took during 1999 and the first part of 2000. However, as we got to this point, it was clear that we would overshoot and that there would be upward pressure on inflation. Thus, we began to tighten monetary policy through this period to try to keep the GDP growing roughly in line with potential and not have inflationary pressures.

As it turned out, because of strong foreign demand during this period, we were operating for a period in the early and middle part of 2000 well above potential. In fact, we were getting inflationary pressures in the economy. However, because monetary policy works with a lag, as we got into the second half of 2000 those pressures began to dissipate. They dissipated more and faster than we had expected at the time, in large part because of the collapse of investment in the telecom and information sectors abroad. When this became apparent in the early part of 2001, that is, that actual GDP would start to head below potential, what we began to do was loosen monetary policy. We did this starting with our first fixed action date this year.

During the first half of this year, the information available to us was broadly in line with our expectations. However, by mid-summer, evidence began to accumulate that the recovery in U.S. investment that we were expecting, because of the easing of policy in the United States that was going on, would be delayed and that the slowdown in our country would last longer than anticipated.

Moreover, economic activity outside North America had also begun to show more clearly the effects of weaker U.S. growth and the ongoing global retrenchment in the information and telecom sectors. Here, for the first time, during the course of the summer, we could see signs that domestic demand, which had actually held up very well during this early part of the period, was weakening and that our inventory adjustment was not taking place as fast as we thought.

Thus, we revised down our view with respect to where the economy was going. We could see that we would be likely to be heading below potential, which is why we again lowered interest rates at the end of August.

As the chairman mentioned, then came the terrorist acts in the United States and the resulting worldwide fallout, which introduced a whole new layer of uncertainty into the global political and economic picture, further dampening growth prospects.

Honourable senators, I do not have to tell you how difficult it is to assess the ongoing economic effects of those disturbances, which seem to have had a significant effect on the psychology of North American households and businesses. However, as I said before, because monetary policy is forward-looking, we must make the best possible evaluation.

As we look out to 2002, the timing and extent of recovery and economic activity will depend crucially on two things. The first is the geopolitical situation; the second is how quickly confidence returns to normal.

As we discussed in our monetary policy report, which we issued at the beginning of the month, we can envisage two scenarios. These are shown by the dotted lines here on chart 3. The first is a more optimistic scenario, that there will be no further geopolitical disturbances and that consumer confidence and business confidence will be restored very quickly. The other scenario is that of an unsettled geopolitical world, where consumer and business confidence will remain weak.

In the first scenario, you can see that we will return relatively quickly to potential GDP, but not during the course of 2002; there will be a gap right through the year. In the pessimistic scenario, we would be well out into 2003, or even 2004, before we got back to potential.

[Translation]

How has the bank responded to all this? To underpin confidence in the wake of the extraordinary uncertainty generated by the terrorist acts, we took the exceptional step of lowering our key policy interest rate by one half of a percentage point on September 17, outside our regular fixed announcement schedule.

We moved again to ease rapidly - by three quarters of a percentage point on October 23 and by one half point again on November 27.

The cumulative reduction in policy interest rates since the beginning of the year amounts to 3.5 percentage points, of which more than half - two full percentage points - since late August. This substantial amount of monetary stimulus will work to support a resumption of healthy growth in output, investment and employment, given Canada's solid economic foundations.

In view of the ongoing uncertainties, it is still to early to characterize the economic outlook with great assurance. Nonetheless, signs that the geopolitical situation may be stabilizing and that households and firms are beginning to adjust to the new environment - somewhat less stable with reference to the last date, October 23, when we lowered interest rates. This suggests a somewhat greater likelihood that the bank's more optimistic scenario may come to pass than was the case a month ago.

[English]

In closing, let me stress that I have oversimplified how the bank goes about its operations and judges performance of the economy relative to potential. I have not mentioned all of the factors that can influence growth and potential and the future path of inflation. What I have tried to do is provide you with the basic elements of the inflation targeting approach that we use at the bank to help promote good economic performance.

Mr. Chairman, in my remarks today, I have focused appropriately on the contribution that monetary policy can make to sustain growth.

In closing, I want to emphasize that while low inflation is essential in this context it is not sufficient by itself. Other policies, both macro and microeconomic, must continue to focus on enhancing productivity and raising our production potential over the medium term. This focus is extraordinarily important if we want to achieve solid economic growth and rising standards of living over time. In this time of uncertainty, we should not lose sight of it as we go through our current short-term difficulties.

Honourable senators, Mr. Knight and I would be pleased to answer questions and provide clarifications.

The Chairman: Before we start questions, I would be remiss in not welcoming Mr. Knight. We are glad you are with us, sir.

Senator Angus: We all look forward to what you have now confirmed will be your semi-annual visits before this committee. It is important for all Canadian that we have this opportunity to have a dialogue with you.

I would like to start this morning by focusing my questions on what I believe is a matter of great concern to all Canadians and, indeed, to yourself, if I can believe what I read in the press, namely, the current low level of the Canadian dollar vis-à-vis not only the U.S. dollar but other currencies in the orbit in which Canada trades.

Before specifically questioning you about the dollar, however, I will enunciate a couple of assumptions that I will make in my questions and ask you to comment on them.

My first assumption is that you believe we are indeed in a period of short-term turbulence characterized by tremendous uncertainty. I base that assumption on your remarks this morning and earlier this month before the House of Commons Finance Committee as well on other public statements you have made.

I am also assuming that, in your view, the outlook is bright in the long term. I gather that this is due to your view that we have very strong fundamentals in the Canadian economy and that these fundamentals, aided by what you call automatic stabilizers, will assist in a recovery in the relative short term, although, as you have said this morning, you cannot say exactly when.

My third assumption is that, although you will not say anything that could be interpreted as undermining the confidence of Canadian business and consumers, you will give us the straight goods because, after all, we are here to elicit from you your and the bank's understanding of the real state of the Canadian economy.

Finally, I am assuming that you believe that the monetary policy that has been in effect for the past decade or more is sound - namely, that you will continue to target low inflation, in the range of 2 per cent, and that you firmly believe that the best way to treat our dollar is with a flexible and floating exchange rate.

Could you comment on those assumptions, please?

Mr. Dodge: I think you have captured it very well, senator.

Senator Angus: I will then proceed.

As I suggested earlier, Canadians are very concerned about the dollar. They have observed a 6 per cent decline in just this year against the U.S. dollar. In particular, those who travel to the U.S. or purchase goods and services in the U.S. have seen a decline in their purchasing power, an erosion of their net worth, basically, a decline in their standard of living, which is very troublesome.

What has happened to the Canadian dollar? Why is it so low and what are you doing about it? You have suggested this morning that lowering the interest rate is not the only thing that can be done to help our current slowdown - if I can use that word - and that other factors must come into play.

Canadians are asking why the dollar is so low. I echo that question and would like to develop this subject with you. It is on everyone's lips.

Mr. Dodge: You said that Canadians suffered a decline in their purchasing power. It is true that at 2 per cent inflation this year's dollar will purchase 98 cents worth of goods next year, and so on. However, since the beginning of the decade, coming down from rather high rates of inflation in 1991, for the basket of goods that Canadians consume, which includes foreign goods, foreign travel and foreign services, we have averaged a rate of inflation of just slightly over 2 per cent. At the same time, Americans have seen the purchasing power of their dollar, for the basket of goods they consume, decline by about 3 per cent a year.

Therefore, it is just not true that the purchasing power of the Canadian dollar for that basket of goods and services, including imported goods and services and foreign travel, has declined. In fact, Canada has had one of the best performances.

Senator Angus: Excuse me. I do not want to interrupt your train of thought, but we obviously have a disagreement there. You have indicated that what I suggested is not quite accurate. I suggest that you spend a couple of weeks in the U.S. to find out about the purchasing power of the Canadian dollar.

Mr. Dodge: Senator, it is undoubtedly true that the price of travel services, which forms part of the basket I am talking about, has risen very quickly. On the other hand, the market is sending the signal that if you want to travel to warm places in the winter travel to a country other than the United States. Go to France, Japan or Australia, where the purchasing power of the Canadian dollar has risen over the decade.

It is undoubtedly true that the particular single item that you have chosen is more expensive today than it was in 1991. That is in part because U.S. prices have risen faster than Canadian prices and in part because the value of the Canadian dollar expressed in U.S. dollars has declined.

As against the other five major currencies over that same period, we have declined approximately 5 per cent in 10 years - very different than against the United States. Putting it differently, the U.S. dollar has appreciated tremendously against all major currencies of the world during the 1990s, particularly since the mid-1990s.

Senator Angus: Do you agree that people are concerned? Are you concerned about the level of the Canadian dollar? Two weeks ago, it was at an all-time low of 62 cents. You seem to be saying that given the history it is not so serious. This is the first question Canadians ask me wherever I go. I tell them that in times of economic downturn there is a flight to strength and security in the U.S. dollar. They ask what that means and I refer back to your answers, but I cannot get a clear definition of that. Perhaps you could include that in your answer.

Mr. Dodge: There are some safe haven currencies. Gold, Swiss francs and the U.S. dollar have traditionally been safe-haven currencies for short-term capital flows.

You have asked the more fundamental question of why the U.S. currency has appreciated over this period relative to virtually everyone else. Fundamentally, the U.S. has been short savings over this entire period. They have been sucking in capital from the rest of the world, including Canada. Over this period of the 1990s, they have built up an extraordinary amount of international indebtedness. At some point, they will have to start paying for that. However, while you are sucking in capital, that is, borrowing from foreigners and using their savings, that tends to put upward pressure on the currency. It does not matter whether we are talking about the United States in the 1990s, about Canada in the 1970s, about Mexico or France today, or about Japan in the 1970s and the 1980s. That is the capital account and it tends to work that way.

Senator Angus: In your view, will our dollar keep going down vis-à-vis the U.S. dollar? I am told that the U.S. is in a recession, that you do not like to use the "r" word for Canada. We can draw our own conclusions if you do not want to use it. I have read your material, governor, and I have a sense that you feel the dollar might go down into the 50s.

Mr. Dodge: I would make no comment, and you would not expect me to make a comment on any precise value. There are three fundamental things going on here. First, as I mentioned, the U.S. is borrowing from the rest of the world at a ferocious pace. When the U.S. stops borrowing from the rest of the world, as they will at some point, then there is, as I have said before, the potential for an enormous correction in the value of the U.S. dollar. We just hope that takes place in an orderly fashion.

Second, Canada has been getting rid of its net international indebtedness. Five years ago, our net international indebtedness was 35 per cent of GDP. Today, we are down at around 20 per cent. That is really good for us as we look out to the next decade of this century when we will have a smaller proportion of Canadians in the labour force.

However, as you go through that adjustment, it has the opposite effect on the price of a currency as compared with what is happening in the United States. That is the second point.

Third, if you look at our balance on the current account, that is, trade in goods and services, what you will see is that while our exports of all sorts of things have increased dramatically during the course of the 1990s, under the impetus of the free trade arrangement and NAFTA, at the same time it remains true that the net balance for primary products is still what really contributes the most to the net surplus we have on current account.

It is true that when people look at Canada, both Canadians and non-Canadians, they observe this. They see the price of primary products at the moment being extraordinarily weak, in part because of weak world demand and in part because of actions of the United States to bar our lumber, which is very competitive because we are extraordinarily efficient producers of lumber. They say with weak commodity prices and weak world demand for commodities, perhaps the outlook on current account is not quite as good. Over the past eight months or so that has tended to exhort additional downward pressure.

As we look out to the future, as we get back over here, we are looking at a world where exactly the opposite will be taking place. The pressures at that point will be very much in the other direction. I am just a dumb economist, senator, and exactly when that will happen, I cannot tell you.

Senator Kroft: I have but two questions. First, I wish to indicate from where I am coming.

My concerns are predicated on a great concern in the area of economic sovereignty or independence, whatever language you choose to employ. The two indicators of that to which I would like to refer are the value of our currency and the value of our assets or resources.

Let us look at Japan, for example, and what appears to be an agreed set of facts as to the concerns that Japan has, along with the broadly held view that a devaluation of Japanese currency may well be the only solution that they have. It is the view of many that that could trigger a competitive devaluation throughout much of the world, including China, in spite of its powerful economic performance. That would put pressures on the system. Add into that the deficit on the current account that the United States is carrying. Therefore, my independence question in terms of currency is this: If the currency of the United States were to fall, and perhaps be under dramatic pressure, would we end up being viewed as a North American currency and be locked into the American currency in those circumstances?

Or, in light of the other factors that you are speaking of, do we have some capacity to retain an independent status for our currency? Or would we just be caught up in the American currency? In that regard, I am not asking you to predict numbers or anything else.

The second part of my question is also tied to the value of the dollar and it relates to our resources, now more recently triggered by geopolitical forces that place a great premium on politically safe resources being in place, most specifically energy. The combination of our dollar vis-à-vis the American dollar and the political imperatives is leading to what we see as an attractiveness of Canadian resources and the ability of foreigners, in particular Americans, to buy those resources at a very substantial rate. What is invisible is the difficulty Canadians have in buying from the Americans at the same rate because the dollar is the other way around.

I am inviting a comment on your comfort level with our economic sovereignty and independence in terms of the two issues that I have raised.

Mr. Dodge: Those are excellent questions, senator. I hope between the two of us we can provide you with some answers.

John Donne said no man is an island. It is absolutely true in the 21st century that no country is an island. In a very real sense, what globalization means is increasing interdependence. That is particularly true for smaller countries, but it is equally true for larger ones.

The term "economic sovereignty" is one with which I have some trouble coming to grips because the great expansion in wealth that we have observed over the last 40 years has in no small part been driven by the fact that we have gone from being a relatively closed economy to a very open one. In so doing, of course, you give up some of your economic sovereignty, and that makes a whole lot of sense because there are real gains from trade.

Every country, including the United States, is, in that sense, considerably less sovereign than they were 40 years ago. Quite frankly, that is a good thing for our living standards and for the wealth and well-being of Canadians.

In that sort of world, no country is absolutely independent in pursuing its policy. Well, you can be in Albania and put up all sorts of barriers and go into total poverty. However, no country is totally independent. Indeed, we are all competitors in a very real sense with one another and we must follow policies that keep us competitive. While we are probably not number one in following policies to make us competitive, we are in the top of the world league in getting there.

It also means that there are big flows of capital, not just trade but capital. Indeed, over the last three years, if you look at the numbers, what you find is that Canadians have been making direct investment abroad in record levels, at about the same rate that foreigners have been purchasing Canadian assets in terms of direct investments.

What we also see, of course, and this comes back to the question that Senator Angus posed, is that Canadians are diversifying their asset holdings. They have been buying, on a portfolio basis, more foreign assets than foreigners have been buying in Canada. Therefore, on the capital account, it is not the direct investment that has been having the impact, it is the portfolio.

That comes to the issue of why Canadian firms want to buy, invest in directly, foreign countries, and why foreign firms want to invest here. The answer is that they see it as a way of growing the strength of the company and of diversifying, and you make those investments where you think you can get a high return. Canadians have been making investments abroad in areas of where they think they can get a high return; and foreigners have been making investments here in areas where they think they can get a high return.

It is the return on investment that is the real driver of the price - and it would not matter whether that investment were denominated in Euros, pounds, U.S. dollars, Brazilian reals or Canadian dollars. What we have seen is that in some sectors foreigners think Canadian investments are just terrific; in other sectors, Canadians think that foreign investments are just terrific. That is what an interdependent world is.

In that interdependent world, we have the same absolute degree of control. That is absolutely true.

For years, Mr. Knight has observed this sitting at the IMF and watching the processes around the world. Let me say a word on Japan. The primary problem in Japan is not macroeconomic, it is structural. For 11 years now, that has been clearly evident. For 11 years, Japanese society, in their political system, has not come to grips with that. Until those structural reforms begin to happen, the macroeconomic side really will not engender very much. We certainly hope it will happen, because Japan is a very important trading partner and very important to the health of parts of this country, such as the B.C. economy, for example.

Mr. Malcolm Knight, Senior Deputy Governor, Bank of Canada: On your first point concerning economic independence, we have an economy that, as the governor has said, is integrated with the rest of the world in terms of production and consumption. Of course, since the U.S. is our closest neighbour, it is very integrated with the U.S. economy. Nevertheless, we believe it is important for us to have policy independence, that is, a regime where we target low and stable inflation and have a floating exchange rate. We tried a fixed exchange rate from 1962 to May 1970. That period of the fixed exchange rate ended because the United States was inflating more rapidly than we wanted to inflate. It was creating very large capital flows into our economy, which we could not control under a fixed exchange rate system. Thus, we let the exchange rate float at that time.

I know this is ancient history, but it is very interesting that it was at that time that the Canadian dollar went to a significant premium against the U.S. dollar. We are now in a different situation. We are in a situation where, as the governor said, the U.S. dollar is very strong relative to all other currencies. If we take a weighted average of the currencies that we trade with, other than the U.S. dollar, the Canadian dollar has appreciated quite strongly against those currencies since 1998.

Despite the fact that our exchange rate has increased against these competitor countries, we have maintained our market share in the United States, which is our most important market. This is quite a significant performance. That performance comes from the fact that Canadian firms have restructured and increased their efficiency significantly over the past decade under the influence of the FTA and the North American free trade area.

Even though our economy is integrated with the rest of the world, if we want to continue to maintain a low and stable inflation rate, and if we had a different structure of production from our trading partners so that we are affected differently than they are by economic shocks, then it is important for us to have a flexible exchange rate. That is not to say that we do not think that that rate is important. We watch it all the time. It is a sensitive indicator of what is going on. However, despite the degree of integration we have in production and consumption with our neighbours, it is important that we maintain that flexible exchange rate.

With regard to your second question about energy, I am not an energy economist. With current levels of activity, energy prices have weakened significantly in recent months. Therefore, I personally think that the geopolitical factors suggest that the longer-term prospects for the Canadian energy sector are pretty good for the reasons you suggested.

Senator Oliver: Governor, my questions all relate to consumer confidence. I have read the booklet put out by your bank, the Bank of Canada "Monetary Policy Report," dated November 2001. You referred to it today in your opening statement. On page 11, chart 6 is a consumer confidence chart.

One of the things that the report says is that there are three main factors that really account for the current state of the Canadian economy. They are falling exports, which you have referred to already, weak household demand, and cuts to capital spending. Our companies are simply not expanding and enlarging and spending capital the way they were, which has helped to slow down the economy. You also say that growth of household spending is weakening in the face of falling consumer confidence.

By looking at the charts that you have shown us, if you expect a growth of 1.5 to 2 per cent and so on over the next year, consumer confidence is a key risk in what that figure will be. We love to hear from you on this semi-annual basis about what you see in terms of monetary policy. However, we are really public policy-makers.

Given the state of consumer confidence today, and given its role in the declining Canadian economy, what public policy items do you think that we as the Senate Banking Committee should be looking at in terms of strengthening consumer confidence on the basis that consumer confidence, if strengthened, would help bring about an economic recovery more quickly?

Mr. Dodge: That is an extraordinarily tough question, senator, and a very good one. One of the reasons that we have been as aggressive this fall in reducing interest rates as we have been is to help the household sector to maintain its confidence. As mortgage rates and the prime rate have come down, it has given consumers some confidence that they will not be overburdened by interest payments. In our own domain of policy, we have been doing what is appropriate for the economy, but extraordinarily appropriate for the consumer, as has been the Federal Reserve Board in the United States.

Having said that, the psychological shock of the events of September 11 is obviously greater south of the border than here. Nevertheless, we certainly do feel it here. The preliminary numbers on retail sales show that in September they took a fair bath. However, we also see that they rebounded by an equal amount in October. As we talk to the retail sector in this country, we find that sales this month appear to be reasonable. They are not outstanding, but they certainly have not fallen out of bed.

The story is somewhat different in the tourism industry. Travel is still down. It is clear that Canadians have less fear of flying than others because Canadian overseas air travel has declined considerably less than that of American and other foreign air travel.

The best thing that I can say is that there have been some indications over the last four or five weeks that the psychological shock here in Canada has not been as big. In the U.S., their Thanksgiving weekend sales, which are always an important indicator, were down, but not disastrously so by any means.

It may well be that this will not be quite so bad, although the jury is still out.

It is critical that governments continue to focus on what will help people and productivity over the long haul. Giving people confidence that over a period of time there will be real opportunities is probably the best thing we can do for households.

Senator Oliver: That is just an expectation.

Mr. Dodge: Expectations are critical, however. You are the experts on how to gauge those other policies, but it is really important, as I said in my owning statement, that we focus on what will help us over the medium term and that we do not think only of the next six months.

Mr. Knight: There is no doubt that consumer confidence was dealt a very large blow in September. Since that time, the monetary policy actions that have been taken, both in the United States and in Canada, have helped.

Senator Oliver: As well as Europe.

Mr. Knight: To a lesser extent, Europe. They have helped to underpin consumer confidence to some degree. It is interesting to note that the latest figures on consumer confidence in the United States are weak in terms of the assessment by consumers of the current situation. However, the index that shows future consumers' expectations actually rose. Under the influence of low-interest rates, automobile sales surged last month in the United States. That will probably not be sustained, but it surely shows the impact of interest rate reductions on consumption spending. Similarly, purchases of existing homes in the United States rose a lot in recent months, also a reflection of lower interest rates.

This is a time of great uncertainty for consumers, partly because employment prospects are important for them, and there are some uncertainties about that given the uncertainties the governor has spoken about. However, the actions we have taken are having an impact on consumer confidence and consumer spending, particularly on durables and housing.

Senator Oliver: You are here really to talk about monetary policy, but it is very difficult sometimes to separate fiscal and monetary. On November 19, The Globe and Mail reported that one measure actively under consideration, and perhaps for a budget, would be a one-time supplement to the GST for low- and medium-income Canadians.

Would such a payment have a lasting and significant effect on consumer confidence?

Also, in the conclusion of your report you made a statement about September 11, which I found very surprising. You said:

These assumptions are that there will be no further major escalation of terrorism, and that consumer and business confidence will return to normal levels in the second half of 2002.

I find that surprising. What is your measure for saying that there will be no further escalation? If there is, what will then happen to the Canadian economy?

Mr. Dodge: As you know, senator, Mr. Martin will bring down his budget in a little over 10 days, so I do not think it is appropriate to comment on any particular fiscal item. I will repeat that we have spent a decade with the provinces and the federal government digging themselves out of a very deep fiscal hole that threatened to destabilize the entire Canadian economy. That was a difficult and painful thing for Canadians to do, but one result of that is that we do have room to allow the automatic stabilizers to work. By that I mean that the tax revenues for federal and provincial governments will undoubtedly be considerably weaker than would have been anticipated 12 months ago. Some expenditure, such as employment insurance expenditures, welfare and so on, will automatically rise. We have said that it is appropriate to allow that to happen. As long as we focus on continuing to reduce debt levels over the course of the business cycle, it is not inappropriate for those automatic stabilizers to work.

With respect to your second question, senator, these are two things that are well beyond the domain of conventional or even non-conventional economic analysis.

September 11 was a shock, a psychological shock. It had a major impact that really changed the geopolitical situation and how the United States was operating geopolitically.

We are saying that if that situation stabilizes, the situation in Afghanistan stabilizes, and there are no further shocks, the impact on the economy by the time we get out into 2002 would be relatively small.

Second, we think that if things look like they are being well managed, the sharp hit to consumer confidence that we saw in September will dissipate.

Those are things that we cannot know, so we must set out our assumptions up front.

[Translation]

Senator Hervieux-Payette: Thank you for having commented in French. This was excellent for the edification of francophone senators and the people who will be watching the rebroadcast of this meeting.

You spoke about the factors affecting the dollar that were of concern to Senator Angus. Could you tell us whether output with respect to the various investments in equipment and machinery between the United States and Canada have an influence on trade in the dollar? What action should be taken, what corrective action? Would reducing interest rates help increase investment in equipment and consequently increase productivity in Canada, and in the longer term the value of the Canadian dollar? Could you, and your expert, agree with this suggestion?

Mr. Dodge: It is true that if credit conditions become very tight, it would be difficult for companies to finance such investments. We are trying at the moment to establish market conditions that would loosen credit restrictions to encourage companies to make such investments.

Senator Hervieux-Payette: On the assumption that companies are encouraged to invest, and if we make some headway compared in terms of the current situation in the United States, if our productivity improves, would there necessarily be in the equation an increase in the value of the dollar, or is there no cause and effect relationship?

Mr. Dodge: There is a relationship, but it is not quite so simple. In the long term, it is extremely important that our companies invest in the new technology that comes with investing in machinery and equipment. It is true that in 1994, 1995 and 1996 Canada was somewhat behind in such investment. For the long term, for the value of the Canadian dollar, for the growth rate of the Canadian economy and the living standard of Canadians, it is extremely important that companies should make such investments.

Senator Hervieux-Payette: Earlier, you raised the issue of raw materials for Canada and the United States.

We export a great deal of semi-processed wood because all we ship is lumber. This industry is extremely important to Canada. Then there is energy, including oil and gas, both of which are important in terms of exports. Even though many trucks have been held up at the borders in recent weeks, we can still say that we are not exporting enough finished products. If the raw materials issue is settled by better prices, will this encourage an increase in processed goods and returns for Canada with an impact on the whole economy? All this would help strengthen the value of the dollar. Is there a direct link between the fact that oil, wood and Canadian raw materials, including aluminium, are all semi-processed - and the value of our dollar?

Mr. Knight: Given the production structure of our country and that of the United States, it is true that in the production structure, the percentage of commodities and raw materials is higher for Canada than the United States. The gap is not very great, but our geography gives us certain advantages in this area. Our exports are more concentrated on this type of product than are U.S. exports. So in net terms, the Americans are importers of these products and we are exporters.

There are many secondary products made on both sides of the border and which cross in both directions.

Senator Hervieux-Payette: Like automobiles?

Mr. Knight: Yes the automobile sector, the aerospace sector and the chemicals sector. What is important for us is not a question of more processing, but of trying to reduce production costs by increasing productivity in each of the sectors.

As the governor said, the Americans have begun to invest much more - particularly in machinery and equipment, and have adopted the latest advanced technologies - during the 90s, not only compared to us, but compared to all other countries. Since 1996, our rate of investment in machinery and materials has greatly increased as well. We are now in the middle of a slowdown. Investment plans are somewhat weaker than last year, but as time goes by and economic conditions improve, we will once again be able to increase investment and productivity.

Senator Hervieux-Payette: If I understand correctly, interest rates and an economic recovery will mean that people will have the money needed for new equipment, and when the customers are there, we will reap the benefits of action taken now?

Mr. Knight: That is correct.

[English]

Senator Kelleher: I have a theory, not necessarily backed up by statistics.

Senator Tkachuk: Or fact.

Senator Kelleher: The reason you are not overly concerned about the dropping dollar - and this is my opinion - is that the government thinks this is great for trade. It makes us more competitive; it results in a very competitive price for our trade goods. This in turn keeps the economy moving because it is creating jobs or keeping the job levels up.

As I am sure you are aware, if I am correct in that, there is also a negative side effect to this, in that it ultimately reduces our net worth or our purchasing power.

I have somewhat of a background in trade. That is what I believe and I would like your comments on my observations.

Mr. Dodge: First, senator, it is important to return to what I said at the start. Our regime, which we have been following since 1991, is a strict regime to preserve the purchasing power of the Canadian dollar. Over that decade, we have done a good job at it, frankly, a better job than the Americans over that period.

That is our anchor. We try to direct monetary policy to keep the economy moving along at its potential. We have one tool, and that is monetary policy. We can have one target, and what we have chosen is inflation.

That means that the exchange rate will move around. That is the nature of a floating exchange rate.

You said I am not particularly concerned. Probably the thing we spend the most time thinking about is indeed what is happening to the external value of the Canadian dollar. That is an extraordinarily important thing. We think about it in the words I just used - "the external value of the Canadian dollar" and what that is meaning here for our economy.

The external value of the Canadian dollar, except against the great appreciator, if you will, of the 1990s, has been solid. What we have is a U.S. dollar that is extraordinarily strong at this point, for the reasons I have tried to explain, largely on capital account and largely because of a deficiency of savings in the United States, if you will. I tried to explain why, but it is not the purchasing power of the Canadian dollar that is weak. In fact, the purchasing power of the Canadian dollar, in the basket of goods that all Canadians consume, is very strong.

Senator Kelleher: Do you not agree that the effect of a dropping Canadian dollar is great for our trade?

Mr. Dodge: It depends who you are. If we had Senator Bryden in the room trying to run the Ottawa Senators, he would not agree with you.

Senator Kelleher: I am a Maple Leafs fan.

Mr. Dodge: It is a price, like any other price, and relative prices move around to try to allocate goods and services appropriately. It is, in that sense, doing its job.

As governor of the bank, am I happy to see the currency for which Mr. Knight and I are responsible in the paper every day being termed "weak"? No, I am not happy. However, in the long run, that currency can only be as strong as the economy. The appropriate thing to be doing for the economy right now is to be supporting growth and investment through lower interest rates and supporting households through lower interest rates, and that is what we are doing.

Mr. Knight: I would add one point to what the governor said. At this time, even though activity and total demand in the United States are declining, the current account deficit of the United States - the difference between exports of goods and services and imports - is running on the order of 4 per cent of U.S. output. U.S. output is about one fifth of world output.

It could be that the investors in the rest of the world will be happy to send their savings to the richest country in the world forever at that rate. It would be historically unprecedented. In the longer term, it looks fairly likely that the U.S. current account will have to decline so that the U.S. does not keep borrowing at such a high rate from the rest of the world.

One of the mechanisms by which that current account adjustment will take place will be through a movement in the value of the U.S. dollar relative to all its trading partners, or its trading partners as a group. Let us not put it in terms of specific ones.

This is a very large element. It is very important. Actually, for the adjustment of the world economy, my own personal view would be that it is better that we have an adjustment through the exchange rate of the U.S. dollar relative to other currencies than through some abrupt drop in U.S. demand, which could be quite serious for everyone.

Mr. Dodge: Equally, through an abrupt increase in U.S. protectionism.

Senator Furey: My first question stems from one of many comments made by Senator Angus in his opening statement in regard to the U.S. economy.

Recently, the National Bureau of Economic Research indicated that the American economy is, indeed, in recession. Are we doomed to the same fate? If not, how can we avoid it and, if so, when can we expect it?

Mr. Dodge: Statistics Canada will be releasing tomorrow its estimates for the third quarter of the year, the period up until September. We do not know exactly what that will show. What we have been monitoring, in looking at the economy, is that in the third quarter we probably will have had a decline in GDP in the order of 0.5 per cent; it will be somewhere between 0 and minus 1, on top of a second quarter that was 0.4 or around a half.

Essentially, from the end of March until the end of September, we had no growth in the Canadian economy. That compares to the period of a year earlier, if one takes that same six-month period, when we had been growing at very close to 5 per cent.

Whatever name one wants to put on it, it certainly does not feel very good. It feels even worse than it might because we had been coming off such a period.

We have entered the fourth quarter of this year, the quarter we are now in. Although Christmas is a key part of this, we think we will be probably about the same as we were in the third quarter - that is, negative.

This nine-month period will not be terribly robust. Things will not feel that good this winter. On the other hand, if we are neither too optimistic nor too pessimistic, by the latter part of the spring we will start to see some recovery of investment.

It is important to realize that investment has been falling. As soon as it stops falling, it puts an impetus into the economy. We have been cutting inventories. As soon as we start to maintain or build inventories again, that will put an impetus into the economy. While that process is sort of inchoate and spread through the economy, it really does begin to turn things around. As it starts, it builds on itself. That is why, while we cannot and will not date for you exactly when we think this recovery will happen, we think it will be relatively strong when it comes because of the operation of this classic mechanism.

I cannot tell you whether that will happen in the first quarter of 2002 or in the fourth quarter. I will only say that, relative to a month ago, I am a little more optimistic that it will be earlier rather than later.

Mr. Knight: It is very interesting that a panel of the most distinguished economists in the United States is just now, in November, timing the beginning of a recession in the United States back in March. It really shows what a challenge it is to interpret economic statistics at a time like this. Our problem is that we always have to be looking forward, as much as 18 months or two years.

Tomorrow we will get the GDP numbers for the third quarter. From the partial data that has already been published, we think that we have an idea of where that is likely to be, and it will be weak.

The fact that this group of experts now places the beginning of the recession in the United States in March suggests that if the unusual uncertainties that are currently present were to dissipate, the U.S. economy could be poised for a strengthening because the normal amount of time that a recession lasts in the United States is about a year or less. It is very interesting that you made that point.

Senator Furey: With regard to the inflation rate, there are people who argue that moderate inflation does not really affect economic growth. I do not think that is the policy of the bank, because I think that in pursuing price stability the bank suggests that the inflation rate should be kept as low as possible.

Do you have any views with respect to the other position? What would be wrong with a 5 per cent to 10 per cent inflation rate?

Mr. Dodge: It is very important for the good functioning of the economy that expectations about prices be very well anchored so that people are making their decisions in terms of what is really happening, that is to say, movement in relative prices of things and areas that are really good to invest in because they will lead to real economic returns.

Anchoring inflation expectations is extraordinarily important. We have learned that across countries and across time. I do not think any of us would want to repeat the experience of the mid- and late-1970s when everything came unstuck. Indeed, the subsequent problems through the 1980s were partly due to the fact that we got all turned around in the early 1970s, made totally unproductive investments to protect ourselves against inflation, and so on. Anchoring expectations is extraordinarily important.

With regard to at what level the anchor should be, there seems to be a fairly good body of evidence that to be credible as an anchor the rate of inflation that you choose must be low enough that individual Canadians do not perceive day-to-day, week-to-week or month-to-month, in doing their shopping and living their normal lives, that prices are always rising. That is important.

It is not totally clear what that number is. Zero is somewhat tough because, first, we have a little bit of trouble with our indices. Second, at zero, prices must actually be falling at a number of points in time. Adjusting to actual declines in the overall price level is clearly somewhat more difficult than just not raising prices or not raising wages, so there is an asymmetry around zero.

We have chosen 2 per cent. A number of other countries have chosen 2.5 per cent. Some have chosen 1.5 per cent. All of these are low enough to achieve this anchoring of inflation. The experience is that if you go up to around 6 per cent it is not believable because people's daily experience is of inflation. You really notice it. Every week when you go to the grocery store, something costs more than it cost last week. It is one-directional.

In Canada, the government and the bank have agreed on 2 per cent. That is not more magic than 1.5 per cent or 2.5 per cent, but it is definitely in the right territory. It is very important that expectations in Canada now are very well grounded on 2 per cent. When the increase in the cost of petroleum last year took the overall rate of inflation temporarily up to 3.5 per cent, expectations were firmly that we would get back to 2 per cent, and we are now sitting at 1.9 per cent. Our job is to ensure that the expectations of Canadians are realized. We will go through a period in 2002 when inflation will be less than 2 per cent. We cannot hold it right on the line all the time. Our job is to operate symmetrically and get us back to 2 per cent so that the expectations of Canadians are fulfilled and they can go about their business of investing, saving and spending secure in the knowledge that we will do our job and that their expectations will be realized.

Senator Meighen: You have been very kind in answering fully the rather pointed questions asked to you by my colleagues, so I will be the nice guy and throw you a softball question.

In your opening statement, you referred to consumer confidence, household confidence and the importance that plays in the economy. When people are feeling good, they tend to spend, and on it goes.

To what extent are you obliged, therefore, to avoid depressing consumer confidence and therefore to be somewhat of a cheerleader and look at things more rosily than you might otherwise do? This is not a criticism, but it is fair to say that a very difficult art.

Since the beginning of the year, it is fair to say that your prognostications have been on the optimistic side and have not always come to pass. To what extent is it necessary for you to talk about the good things and not refer to the bad things so as to avoid depressing consumer confidence?

Mr. Dodge: Senator Angus said in his opening questions that he assumed that Mr. Knight and I would give you the straight goods. It is extraordinarily important that Canadians believe that the Bank of Canada does indeed give them the straight goods and their best judgment.

It is absolutely true, senator, that last spring our judgment was that the investment cycle would essentially begin to turn around some time in the second half of this year. That indeed turned out not to be the case. In looking at the numbers right through until May, you could not tell that that was not going to be the case. The numbers were quite supportive of our view. The first quarter numbers were much stronger than we had anticipated them.

We will not always be right. There is no claim to infallibility here. However, we will always try to tell the story straight up as we see it.

Writing this report was very difficult because the factors that would push you into this scenario vis-à-vis those that would push you into that scenario are not the normal ones with which we come to grips. We debated long and hard how to put it and then thought we better just tell the story straight and say that these are factors that are unknown, that will clearly reveal themselves.

Senator Meighen: Are you referring to geopolitical factors?

Mr. Dodge: Geopolitical and how the psychological impact of September 11 will play out on households. There are two quite distinct things. One is an inside North America factor, one is outside.

Perhaps because I spent, as did Mr. Knight, a fair bit of my life as an academic, I have grasp of Latin. Mr. Chairman, you mentioned Queen's University. Their motto is "Sapienta et Doctrina Stabilitas" - wisdom and knowledge are the strength of our times. Being rational and trying to put out the straight goods is probably the best thing that we can do for Canadians. We are not always the best explainers of what we are trying to do, but that is why I went through this story this morning.

Mr. Knight: I very much share the point that the governor made. We are obliged to explain the situation to the Canadian public as best we can.

In terms of affecting consumer confidence and spending, we do not have to talk it up. We have an instrument that does impact on consumer spending as it impacts on investment. We can use that instrument to a degree to influence consumer spending. We also tell stories about what is going on that will cause the consumer to do one thing or another, which is just beyond the way for a central bank to act.

Senator Meighen: I will move now to another area. If memory serves me well, many of our predecessors found it necessary to intervene to support the dollar. There was a speculative run at one point or the makings of a speculative run that caused Mr. Thiessen to intervene. I suppose a speculative run could be viewed as a somewhat artificial or non-fundamental happening. Is there a level at which you would think it would be necessary intervene to prop up the dollar? What guidelines would you use to come to that decision?

Mr. Dodge: Senator, we used to operate daily in the market for a number of years to try to avoid fluctuations that were too much from hour-to-hour and day-to-day. We stopped doing that. The market is deep and robust enough that it takes care of itself. You get some fluctuations, but it deals with that.

Our policy, clearly enunciated, is that we do not normally intervene in markets. It would only be in extraordinary circumstances that we would consider using the tool. It is there, it can be used, but the circumstances would have to be absolutely extraordinary.

Senator Meighen: It seems to me that we are becoming a nation of savers, and have increasingly become so, as the baby boom generation retires and perhaps converts their mutual funds into GICs. Consequently, interest rates will be of great importance to them. They already are important, particularly to our senior citizens. They are not happy right now with the bank rate they are getting on their savings. Does that not mean that in the future interest rates and your dealing with them will become a less efficient lever of monetary policy, that interest will become a more important part of overall personal income and hence you will be constrained in your ability to manipulate the interest rates?

Mr. Dodge: Let me take that in two parts. First, the worst period for people on fixed incomes was the late 1960s, the 1970s and the early 1980s, where, through inflation, we destroyed the wealth of people on fixed incomes. While nominal rates were high, real rates were negative, and without knowing it people, were consuming their wealth. That is the worst thing one can do for Canadian citizens and, in particular, for those people on fixed incomes.

It is absolutely true that over the course of a business cycle, the real rate of return, the rate above 2 per cent, will fluctuate. That is undoubtedly true. When the economy is very weak, if we are using monetary policy to try to get us back up to potential in those periods, the real rate of interest will be very low. In periods when we are at or above, the real rate of interest will be very high.

There will be fluctuations, senator. However, there is absolutely no reason for Canadians to think that over a period of time it will not be some sort of average real rate. What Canadians can be confident in, and what they must be confident in, is that we will not destroy their wealth through a resurgence of inflation.

Senator Poulin: I must tell you that the information that you are sharing with us is extremely helpful.

[Translation]

My question is related to Senator Meighen's. The word confidence has been used in your presentation at least 20 times since the beginning of the sitting.

This morning, on the radio and in a number of newspapers, it was reported that Canada was in recession because sales of lipstick had increased by 500 per cent. Everyone must have burst out laughing. Does the Bank of Canada have a communication strategy? What is it and how does it go about implementing it?

Mr. Dodge, you said that it was very important for Canadians to be informed so that they could make the correct decisions at the appropriate time. You said that even though the United States was in recession, the slowdown in the Canadian economy did not necessarily mean a recession. Could you compare the financial habits of Canadian and Americans in terms of savings, spending, investment and gifts? What impacts do these habits of Canadians have on your monetary policies?

Mr. Dodge: Those are excellent questions. Communication is extremely important and we are devoting considerable resources to improving communications with the financial community and with Canadians in general.

It is also very important for us to come here twice a year to discuss these matters with you. We feel that it is extremely important to communicate with the senators and members of Parliament who represent Canadians. Mr. Knight worked for two years to improve the bank's system of communications.

Mr. Knight: Indeed, we are rather proud of our new communication strategy, which is somewhat more detailed now. Our new system of pre-established dates for announcing decisions about our key policy interest rates is a rather important aspect of the strategy. Before, when the Federal Reserve did something from time to time, we did something the next day and everyone thought that the Bank of Canada was following U.S. monetary policy.

Now, there are several days between their decisions and ours. During the period between the two decisions, it is important for market operators and journalists to know whether the economic situation in Canada is the same as in the United States or different. If it is different, we want to know what this means for the implementation of Canada's policy in relation to the U.S. policy. We think that this strategy has very much improved communications between the bank and those who monitor what we do closely. It is important for us. As the governor said, press releases are issued as soon as our decision on rates are made public. The markets can interpret these releases and we can then read their conclusions. It is good thing. Four times a year, we also prepare a somewhat more detailed report on the results of our forecasts, our outlook on economic conditions and forecasts for the next year. This strategy is very much in keeping with more transparent communication on monetary policy with the general public.

Your second question concerned the financial habits of households in Canada compared to those of Americans. The consumption behaviour of Canadian households does not differ very much from American households. The financial habits are somewhat different. For example, in Canada, debt servicing, which consists of interest payments on disposal income, declined much more in Canada after the early part of the last decade than in the United States. In the early 90s, the percentage in Canada was approximately 12.5 per cent. This was much higher than in the United States, but it is now approximately 9 or 9.5 percent. This is slightly higher than in the United States, but it is approximately the same.

The difference between Canadian and American financial habits is to be found in the way money is borrowed. In the United States, reverse mortgages have played a much greater role for the past two years than in Canada. There are implications for the household wealth/debt ratio. It is a trend that needs to be monitored very closely in the future.

[English]

Senator Tkachuk: Governor, I want to ask a question about September 11. People were shocked at the events. I think most Canadians were worried about what happened. They have been looking to economic leadership for reassurance after that date.

I found it interesting that you chose not to make a public appearance until October 24, some six weeks after the event. As a matter of fact, it was in Moncton, which is not exactly the media capital of the world. Frankly, we did not see the Minister of Finance for about two weeks. There will not be a budget now until December 10. The last one was in the spring. I am sure that had nothing to do with the planned strategy for September 11.

Was the fact that you waited six weeks before going public and that the Minister of Finance was so quiet and put off making an economic statement until December 11 a planned strategy?

Mr. Dodge: First, senator, let us be clear. On September 17, we came out with an immediate reaction in terms of moving our rates. We had talked about doing this the previous week but simply felt it was appropriate to wait for the day that the Americans moved, as did central banks elsewhere. Hence, we did move.

Second, I cannot remember the precise dates, but we certainly had a press conference at the end of that week of September 11. We had to cancel a scheduled speech the following week that was to have been made in Moncton because we simply could not get our directors for our annual out of town board of directors meeting to Moncton, and that is the normal place that a speech is made.

I do not agree that we did not communicate. We really tried extraordinarily hard to get the information out.

Mr. Knight: I will add to that that during the week of September 11 to 14 we sent out a number of press releases indicating what we were doing in terms of liquidity to the market and also in terms of the augmentation of our swap facility with the Federal Reserve. On September 14, as the governor said, we held a press conference and answered questions, and the governor made a statement.

On September 17, a Monday, when we changed interest rates, we published a press release. On September 18 or 19, in a speech to the Canadian Association of Business Economists in Toronto, I discussed what we had been doing in terms of our work to maintain the stability of the financial markets the previous week.

Senator Tkachuk: The Minister of Finance and the Governor of the Bank of Canada are the two most important public figures as it relates to our economy. Two planes crashed into the World Trade Center and one into the Pentagon. Was there communication between the Minister of Finance and the banks discussing what needed to be done to reassure the Canadian people?

The Chairman of the Federal Reserve Board appeared on television almost on a daily basis. I was looking for you, sir. I kept seeing the Secretary of the Treasury, but not the Minister of Finance.

What would it take to get you out into the public? What kind of a bomb would have to fall for the Governor of the Bank of Canada and for the Minister of Finance to go to the Canadian people and tell them what is happening and what you are doing about it? What would it take?

Mr. Dodge: In fact, with regard to the September 14 press conference, my recollection is that at least one network, maybe two, carried it live. Much depends on which network you watch. Obviously, CNN will not carry as much Canadian news as CBC, RDI or CTV.

I thought the press through that period did an excellent job of communicating our press releases. I am not sure I am the right person to ask what it would take.

Senator Tkachuk: You have said before that you believe that the dollar is undervalued. I believe in the House committee you said that the most important job at the bank was your product, your currency, and confidence in it. Yet our currency has dropped substantially in the last decade, no matter how we try to fudge it. Eighty per cent of our product goes to the United States. North America is where we live. There is no point in comparing it to Australia or Italy. Who we trade with is important.

You say the most important thing is the currency, and yet there seems to be a lack of confidence in our currency because our dollar has dropped substantially against the U.S. dollar. In North America, we are not considered to be as good a place to invest as the United States.

Is this the result of a failure on the part of the bank? Or is it a good thing that we are 65 cents, and maybe our target is 55 cents?

Mr. Dodge: Senator, first of all, the value of the Canadian dollar priced in U.S. dollars will fluctuate. Over the medium term, the factors that are at work on both capital account and current account ought to mean that relative to the U.S. dollar that fluctuation would be generally in an upward direction.

We do fluctuate vis-à-vis other currencies. However, if you add them all together, we have been fairly stable. What really has been fluctuating is the value of the U.S. currency against everything else.

Second, our job is to preserve the purchasing power of the Canadian dollar for Canadians for the basket of goods and services they consume. That job we have been doing well since 1991, in agreement with the government.

It is important to note that inflation targeting is not the Bank of Canada's regime; it is an agreement between the government and the bank. That agreement was entered into by the Conservative government and has been renewed by subsequent Liberal governments. Hence, it is not the central bank out there on its own; it is a commitment on both sides to deal with it.

Senator Tkachuk: I disagree with you somewhat because you talk about the basket of goods, and we have talked about the inflation targets. The Bank of Canada Act holds the bank responsible for issues beyond inflation, including unemployment, production output and the value of the dollar - not the basket of goods, of gas and tomatoes and whatever else I need to buy, but that we have a strong currency. It is not that you are downplaying it, but previous bank governors have been concerned about the value of the dollar.

The dollar dropped to somewhere around 65 cents, then after September 11 it dropped to a little below 63 cents. That is dangerous territory.

If this is a good thing, then how far do we go with the good thing? To go back to Senator Meighen's question, what happens if the dollar falls to 60 cents? Ten years ago, we would never have believed that today's dollar would be at 65 cents. What happens if it falls to 55 cents? Is that good?

Mr. Dodge: Senator, good is your word, not mine.

Senator Tkachuk: I do not know.

Mr. Dodge: You used the word, senator.

Senator Tkachuk: Yes, I did.

Mr. Dodge: The price of the dollar in terms of the Canadian dollar, in terms of the U.S. dollar, is that. It is a price, just like there is a price for oil or a price for wheat, or anything else. Those prices move around. If you are a consumer of oil, it is not so great to have a high price, but if you are a producer, it is quite a good thing to have a high price. "Good" is a peculiar word to use when talking about a price.

We focus on ensuring what that dollar buys retains its value. Over the decades and across several governments, we have been remarkably successful. In fact, one must go back a long time in Canadian history to define the period when we have been that successful.

I have said and will continue to say that I do believe as we look out into the future, both because of transactions on current account and transactions on capital account, that vis-à-vis the U.S. dollar the price of the Canadian dollar is likely to rise. I have not made statements relative to the price of other currencies.

Senator Kroft: I would like to follow on the previous exchange, which was similar to the opening exchange with Senator Angus, which was the value of the dollar.

Some of the problem seems to be a difference of views as to how important that single number should be to Canadians in terms of assessing their well-being. It is hard not to have it front and centre because every night on The National the first thing we see is an arrow pointing up or down. Every day people are forced to think about the value of the dollar. Other elements, like employment figures, trade accounts, interest rates, or elements that go into our well-being and the purchasing power of that dollar, do not get nearly the attention.

As I listen to this, it seems to me that what we need to do, whether as a government, a bank or whatever, is to discuss this subject more effectively and get Canadians to understand that their well-being should be judged on the purchasing power of their dollar rather than this single comparator of the exchange rate.

I am wondering if you feel there is any way, as a matter of communication, we can get Canadians to have a more balanced perspective, because the comparative value of the dollar is an excessive preoccupation in your view.

Mr. Dodge: In part, senator, it may be fair to say that it becomes, as you put it, the excessive preoccupation because it is the one thing during this relatively difficult period that seems to be indicating some degree of difficulty. It is easy to understand a price that is a single price.

The price of gasoline is probably the best-known price in the country because we see it each day as we drive around. If it moves two cents, people say, "I bought gas for 53 cents this week rather than 55."

Because the dollar is a single price, it is easy to broadcast on the news. It is always broadcast in terms of U.S. dollars.

If you look at the stock indices, everyone talks about the Dow, which represents 30 companies. The Dow is really not such a great indicator of the broad market.

Hence, these problems do exist, and it is important to be around the table.

We must come back to the fundamental point here. What we at the bank are trying to do, and indeed what policy ought to be trying to do, is to keep us as close to this potential line as we can be. That is our job at the bank. Your job as a policy committee more broadly is to ensure that we follow policies in Canada that keep the slope of that line as steep as possible, that is, keep productivity policies that encourage productivity to grow as fast as it can.

In the end, we can only consume what we produce, and if we are able to increase our production at 3 per cent or 4 per cent a year, we will be able to consume 3 or 4 per cent more year after year. If we are at 0 per cent or 1 per cent, we will not get any richer. In monetary policy, we are trying to keep as close to this line as we can, and that is what the inflation-targeting regime does. The second thing is to preserve confidence so that you know what that dollar will purchase as we go into the future.

The Chairman: Honourable senators, we need to have a motion to append the governor's chart to the proceedings. May I have that as agreed?

Senator Meighen: So moved.

Senator Angus: I wish to thank both the governor and the deputy governor for their candour and for giving us the straight goods.

At the risk of overkill, I would like to conclude by following on from Senator Kroft's point. You quoted John Donne, about no man being an island unto himself, and I think it would be appropriate for me to quote the people's philosopher: "It's like déjà vu all over again," as Yogi Berra said. In other words, "plus ça change, plus c'est pareil," I think is your message.

Even though we are in a situation where every night, as Senator Kroft pointed out, we are faced with the media bringing into focus the downward trend of our dollar, to now historical lows, the perception is not that it is not floating but that it is sinking. You have seen the cartoons yourself. Perception often becomes reality in the minds of the people. It becomes focused right on your desk, sir, as you know.

I think you are doing a great job, but I would like to conclude with this question: On behalf of the Canadian people, is there anything specific you and your colleagues intend to do to stop that downward drift of our dollar, or will you leave it to float and hope that it will start going up again?

Mr. Dodge: We will certainly leave it to float, senator, you can bank on that. The best thing we can do for monetary policy is to follow policies that get us back to this line. The best thing the governments can do, whether federal or provincial, is to pursue policies that will increase the slope of that line, that is, get us faster productivity growth because that is what increases our wealth. The greater of slope that we can get to that line through good policy, the stronger the Canadian dollar will be vis-à-vis the currencies of countries with which we trade.

The Chairman: Thank you, governor and deputy governor.

The committee adjourned.