THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, December 12, 2024
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:30 a.m. [ET] to examine and report on Canada’s monetary policy framework.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: This is the final meeting of 2024, so welcome and thank you for being here. Hello to everyone in the room and those joining us online. My name is Pamela Wallin, and I serve as the chair of this committee.
I’d like to introduce the members with us today: Senator Loffreda, who is the deputy chair; Senator Fridhandler; Senator Gignac; Senator Ringuette; Senator Varone; and Senator White. Thank you, all.
Before we begin, I’ll just take a moment to recognize and welcome Senator Fridhandler. He has joined the committee, but for everybody’s information, he is also the newest member of our steering committee. Welcome.
I also want to thank all senators for their contributions and cooperation on our interim report. It got some decent coverage, and I think it was important that we were out there, as we have seen what’s happened, even in the last 24 hours.
Today, we have the pleasure of welcoming, by video conference, Jeremy Kronick, Vice-President, Economic Analysis and Strategy, C.D. Howe Institute. Mr. Kronick, I’m sure you have some opening remarks, so we will turn the floor over to you right now. Go ahead.
Jeremy Kronick, Vice-President, Economic Analysis and Strategy, C.D. Howe Institute: Thank you to the members of the Standing Senate Committee on Banking, Commerce and the Economy for having me here today. It is always an honour to appear before you.
The Bank of Canada is a critical institution in this country. Its mandate, as set out in the Bank of Canada Act, provides important principles on stabilization policy, but it also clearly lays out the fact that the bank has to confront its own limits. Monetary policy can’t do everything, and that is vital to remember as we start to consider adding more goals for the bank to achieve.
While I appreciate the concern that this committee has about the increased complexity of the world we live in today and the need for more transparency in our institutions, I do worry that people are misinterpreting the events of the last few years and using those as an opportunity to make significant changes to the bank’s goals when it’s unclear that they are needed.
Despite this recent inflation episode, since January 1996, once the 2% inflation target was firmly in place, inflation has averaged 2.1%. That is a remarkable success. This stability in prices allows consumers and businesses to make decisions with greater certainty than in the environment that existed before. We saw the importance of those anchored expectations in getting inflation back to target during this recent surge.
The interest in the dual mandate is completely understandable, as it would entail an economy operating at its maximum employment. However, if one believes in the importance of central bank credibility and accountability, as I do, then one must acknowledge that adding another goal where the target is an unobservable variable poses risks and challenges. This is even more worrying when we look at the last renewal agreement from 2021 between the bank and the federal government, which was significantly longer than past agreements and included goals that were unambiguously worthy, like climate change and inequality. It’s difficult to make specific goals of a central bank.
A central bank needs goals that are easily understood by the public, easy for the public to determine whether the monetary authority has been successful and feasible for that authority to achieve. Many of these goals — and, I would submit, including the dual mandate — do not fit the bill, whereas inflation targeting does.
On transparency and accountability, there absolutely might be scope to have the governor do more and testify more often, for example. However, before we suggest that there are bigger issues at play on this front, we should note that the bank now has an external deputy governor — soon to be two — publishes a summary of its deliberations, has a quarterly Monetary Policy Report explaining its thinking and has a press conference after each fixed announcement date. Its communications with the public have increased tremendously in the last 30 years. At some point, more risks politicizing the bank. We have seen signs of that happening already here in Canada, and we have certainly seen it happen to the Fed in the U.S. There is a critical threshold to meet on transparency and accountability, but it’s not clear to me that we currently do not meet it.
Quickly, on the core inflation measures, I agree with past witnesses that there is scope to think about the consumer price index, or CPI, measures that exclude what we would consider endogenous components, like mortgage interest costs. How much that will actually matter relative to existing core measures depends upon how often those mortgage interest costs actually end up in the tails of distribution. However, that is worth considering.
I’ll stop there. Thank you again for the opportunity to discuss this vital institution. I’m very much looking forward to your questions.
The Chair: That’s wonderful. Thank you very much. You’ve raised some interesting questions there; it’s different from other testimony that we’ve heard. I think we’ll just dive back in. I’ve got a couple of questions for you, but I’ll wait until we hear from others. The deputy chair will go first.
Senator Loffreda: Interesting points have been raised already. Thank you for being here this morning.
You mentioned that monetary policy can’t do everything, but my concern is this: 60% of Canada’s GDP is the consumer. When you look at household debt to disposable income, it’s extremely high. Even compared to Germany and the U.S., which are 100%, Canada’s rate is over 175%.
Given the rising household and public debt levels — and they are growing concerns — how should the Bank of Canada balance the monetary policy to address these risks while maintaining economic growth?
Mr. Kronick: That’s a great question.
The problem with debt-to-GDP as a measure that we tend to focus on is the fact that it conflates stock and flow variables. Debt is a stock variable, and GDP is a flow variable. The missing component there is the interest rates. If you look at household debt-servicing ratios, which is how much you have to pay out of your income every month to service your debt, over the last 35 years, it has actually fluctuated between a range of 12.5 to 15 — not a huge range of fluctuation. That’s because for the last 25 or 30 years, for the most part, interest rates have fallen, so the interest component of your mortgage, for example, has gone down while the value of the asset has gone up. So the servicing costs are not that much different, even though we’ve had this debt-to-GDP increase this whole time.
My preference is actually to look at the debt-servicing ratio when we think about how much risk exists in the economy. The reason that Canada has continued to see its debt-to-GDP ratio increase is because we didn’t get that crash in 2008 that the U.S. had, for example. They had a period of time where that debt-to-GDP ratio came down before it started to go back up.
That doesn’t necessarily answer your question, but I wanted to point that out because it’s important when we think about the variables we’re looking at.
In terms of the bank’s role in asset prices, this is certainly something that they consider. They consider the effects that, for example, their interest rate changes are going to have on the housing market, which is really the biggest asset we’re talking about here. They want to understand if they lower rates or increase rates, how will that affect the consumer, both from the perspective of the mortgage that they have to pay off and also what that then means for consumption spending and the rest of the economy?
Just because it’s not an explicit component of the bank’s target or goals that we set out, it doesn’t mean it doesn’t factor into their considerations when they are implementing monetary policy.
Senator Loffreda: Thank you.
Senator Gignac: Thank you to our witness. I share your view regarding the transparency and communication. They have improved a lot in the last few years, at least.
My question is regarding the mandate. You have a strong view — I appreciate that — but why would having a dual mandate like the Fed undermine credibility? We have some other witnesses who do not share your view. Could you elaborate on that? The Fed is credible, so if the Bank of Canada has a copy-and-paste of the mandate of the Fed, why would it undermine their credibility?
Mr. Kronick: I think you’re right: The Fed is obviously a credible institution. However, the Fed has acknowledged the thorny issues that sometimes come with a dual mandate. A big part of my concern is that maximum employment, which is what you need for the dual mandate, is an unobservable target. What is maximum employment? Is it 3%, 4% or 5%? Does it change this year versus next year based on economic conditions or demographics? A whole number of things change the value of maximum employment.
It’s actually the same thing with the so-called neutral rate. The neutral rate changes; it’s not a stagnant rate. It’s difficult to determine what that is. I do think that when you explain to the public — if you take this recent inflation surge — it’s easy for the public to see that we missed the 2% target, and we are going to do everything we can to bring our monetary policy back in line with that 2% target.
How do you approach that with maximum employment?
If you look at the Fed’s statements, yes, they put in comments about maximum employment, but most of the focus is on the inflation target. I don’t see what value you’re really adding. The way the Bank of Canada approaches this, as most central banks do, is they use a form of what’s called the Taylor rule, which has the output gap in there. The bank is taking into consideration the output gap as it adjusts its monetary policy in order to hit the inflation target.
I take the point that the Fed is credible — it absolutely is — but I don’t see what value-add we have here. In fact, the flexible inflation-targeting regime that we have is the right balance between not being too obsessive about the 2% target — there is a bit of flexibility allowed in it — in order to take into consideration what’s happening on the employment side.
Senator Gignac: My second question shifts topics. It’s about the lack of diversification or the perception of the lack of diversification around the table at the Bank of Canada.
Contrary to other countries — the U.S. is a different system, as you know, as is the U.K. — in Canada, it is the Governor of the Bank of Canada who chooses their colleagues. Basically, would you be comfortable if we import the best practices we see on the outside, like maybe from the U.K., where it’s more of a board of directors? Maybe even parliamentarians are involved in the process of the hearings for the nomination of a deputy governor.
Mr. Kronick: That’s a good question. I’ll admit I don’t have a terribly strong view on that. In Canada, the governor is appointed by the government, as is the senior deputy governor. There are two members on the council — and it’s not a big council — who are appointed by the government.
Again, it’s unclear to me that it has become a major issue here. What I did think was an issue, which I was glad to see done — and this was coming from the U.K. — was an external member on the council. I do think there’s a lot of value in that, and I was glad to see that. Nicolas Vincent was the first one, and they’re now adding a second one. I think there’s a lot of value in getting views outside of the folks who work for the Bank of Canada.
I thought that was a best practice that we imported. Like I said, I think having two members who are appointed by the government is a good approach.
I don’t know that I have strong views against it, but I don’t believe I have overly strong views for it.
The Chair: I just want to clarify a couple of things you said to Senator Gignac, referring to monitoring employment as an unobservable mandate and that they would be required to seek maximum employment. It’s the same issue we have with interest rates. There’s a range: 1% to 3%. They aim for 2%, but there’s room to manœuvre there.
For the unobservable mandate, it means they just might not be able to accomplish that or they shouldn’t be attempting to accomplish it?
Mr. Kronick: It’s unobservable in terms of defining what “maximum employment” is. Maximum employment is not zero. They would be striving for a natural rate of employment that allows for enough people to match up with their right jobs and a whole bunch of structural employment that we consider.
The challenge is what maximum employment is. Is it 3%, 4% or 5% — it’s not whether you hit it. If they define it as 3%, then, sure, you can judge the bank against the 3% maximum employment. The question is this: Is that the right one? That’s really hard to do. It’s really hard to define whether maximum employment is right. I think there’s an issue there that’s setting up the bank for quite the challenge.
The Chair: And you’re not comfortable with the range, which we see on the other issue, which is 1% to 3%? It’s 6% to 8%, or 5% to 7% — whatever it is they might want to look at.
Mr. Kronick: Right. You could do it that way, but to be clear on the inflation mandate, yes, there is a range, but the target is 2%, and it’s very clear that the target is 2%. That is what the bank is striving to do. They’re not striving to be within the range. They know they’re going to fall within the range for a certain amount of time because it’s not a perfect science, but the target is 2%, and that’s how the bank is typically judged.
I just don’t think you can define the maximum employment target in that same way and provide the same opportunities for success.
The Chair: Thank you. That’s much clearer.
Senator Fridhandler: I just wanted to follow up on Senator Gignac’s question regarding the diversity at the senior executive level at the bank. To add to that, I’m wondering about the need to mandate geographical diversity, considering the geographical differences that run across this country, from Newfoundland to British Columbia to the North. Should we formalize that more?
Mr. Kronick: It’s a good question. In some ways, that is the ideal set-up, where you do have that geographical representation across the country.
However, with monetary policy and the way we operate with these goals, it’s not a 2% inflation target by province, city or municipality; it’s a 2% target on aggregate for the country. The Fed has their Federal Reserve Banks across the country, and there are different pressures and challenges with setting things up in that way, but I think the fact that monetary policy operates with a blunt tool to achieve a Canadian target makes the need to mandate geographical representation a little bit less.
Ideally, though, you would have representation across the country. I think we all know that people want to feel like they are represented at our different institutions, but I don’t know that I would go as far as to mandate it.
Senator Fridhandler: To follow up on that, if there’s more to say — although I think you’re pretty clear on it — can you speak more about your thoughts on the balance between mandating additional transparency or accountability from the senior levels of the bank versus unintended risk and politicization?
Mr. Kronick: Like I said, there is a bar that you need to clear when it comes to transparency and accountability, or else institutions of that nature will fail.
What I am worried about, and we’re seeing it again — we’ve seen it here and elsewhere, certainly in the Fed — is the politicization of our central bank and central banks in general. The separation of the ability to print money and spend money is a really critical component of any country. I worry that the more and more we put central bankers in front of Parliament where things can get politicized, the more the bank will become politicized. That is a worry of mine.
But, again, I think you have to meet a certain threshold. If we want to mandate the governor having to appear before Parliament once or twice a year, that’s probably an acceptable compromise. I’m not sure I want to take it much further than that. Like I said, I think they’ve done a lot when it comes to their communications with the public over the last three decades.
Senator Fridhandler: Thank you for the clarification.
Would you go so far as to require the bank to produce the detailed transcripts of discussions on setting rates from time to time?
Mr. Kronick: I think the summary of deliberations is the right balance because you want the conversations in those meetings to be free-flowing. It is the same reason we use the Chatham House Rule at our C.D. Howe Institute events: You want conversations to be free-flowing. We don’t need the verbatim transcript of what happened in those meetings; I think the summary is probably the right balance to strike.
Senator Varone: Thank you, Mr. Kronick, for being here. One of the quotes I was fascinated by, which was attributed to you, was this:
The regime we introduced in the early nineties ain’t broke — quite the opposite — so we shouldn’t try to fix it.
I understand that wholeheartedly with respect to the single mandate of the Bank of Canada in fighting inflation. What confuses me now is your comment on employment and that it’s hard to pinpoint.
Let me draw you to where I got confused with early deputants in terms of the inflation rate being tied to the CPI, but then they introduced terms like CPI-trim, CPI-median and core CPI, and it really mixed me up in terms of what is the measurement of inflation.
When you say that since the average has been 2.1%, I assume you’re talking about the fullness of the CPI and not some other index. If they’re using these other tangibles for other purposes, then why wouldn’t it be the same for employment? If you have a core employment mandate, but then you can define structural employment or the other forms of employment, then they’re just targets all around. I can’t see why one is hard and one is not. I’m not sure if I got that point across.
Mr. Kronick: I think so, but if my answer doesn’t cover it, please follow up.
To be clear, the bank’s target is headline CPI, so it’s the entire CPI. That’s what we’re targeting when we’re targeting 2% inflation. On the core measures — CPI-trim, CPI-median, et cetera — the bank isn’t targeting those. Those are tools that the bank uses to try to extract the underlying trend in prices. The CPI includes things that are very volatile, so you want to take those out as you’re thinking about where the underlying trend in prices is going. That’s where the total inflation — total CPI — will be after 18 to 24 months once all the shocks have worked their way through the economy.
The bank is not targeting core. They’re using those core measures as tools. They publish them to show folks what is being used as underlying trend measures.
I don’t see it as a clear relationship between that and this issue of a dual mandate. The issue is what is the equivalent of total CPI that you would target under a maximum employment regime? That is the challenge. You would have to define that somehow: What is maximum employment? Again, it changes. It’s not the same. It’s not like inflation. Maximum employment could be 4% in an economy in one year, and then if the demographics change, and if we have 25% tariffs coming in from the U.S., maybe maximum employment is a little bit different. Will you change that target next year and explain to people that we’re now targeting 5% or 3%? It’s a challenging thing. Again, if you look at the Fed’s statements over the years, when they make their announcements, it’s in there but it’s not in there the same way as the inflation target.
You could do it, but I suspect it won’t change very much in terms of the way that the central bank operates. Again, we operate with a flexible inflation-targeting regime to allow us to not mechanically do things to set us on a bad track for the economy just for the sake of hitting 2%. We allow for that flexibility in it. I hope that answers the question.
Senator Varone: Yes, it does. Thank you.
Senator Ringuette: My question is kind of a follow-up to Senator Gignac and Senator Fridhandler.
We’re now looking at the mandate review to make recommendations. I see that we also have some responsibility to ensure that the structure that we have is a helpful tool for the bank. In that regard, the structure is at arm’s length from government regarding their operation, mandate and objective.
Recently, a certain politician threatened to fire the governor of the bank. Regarding arm’s length and its necessity for the integrity of the bank and the work they do on behalf of Canadians, how helpful is that for the credibility of the bank with Canadians? It also has a certain impact outside of the country. I’d like to have your opinion on that.
Mr. Kronick: Thank you for the question. This is not unique to Canada in terms of the way people have reacted, such as politicians and other folks, when it comes to central banks as inflation has surged. In fact, I think it’s actually a reason why the inflation mandate is so critical to keep. Many people forgot what it was like to experience high inflation because we went so long without it. Now that we’ve faced it after our last renewal when we put all these other things in, I think it should reinforce to folks that inflation is awful. It’s awful for the people at the lowest end of the income spectrum.
I hope that this is a bit of a wake-up call. What’s not helpful is the political side getting involved in saying what the central bank should and shouldn’t do. However, the central bank is responsible to the public and to the government. It is a function of government and an institution of government. When it doesn’t meet its requirements, there is a question as to what you do.
The judgment of a central bank governor shouldn’t necessarily be that they hit or didn’t hit their target. It’s what you do when you miss the target. The Bank of Canada, yes, fell behind on raising rates to slow inflation. Admittedly, it’s about as unique a set of circumstances as we could have ever expected, but it was one of the first central banks, if not the first, to start tightening monetary policy. When it realized the mistake it made, it reacted. That’s a good sign from an independence perspective.
I don’t think statements are helpful from politicians when it comes to the central bank, but at the same point, when inflation gets really high, it becomes a political issue.
Senator Ringuette: Thank you, sir.
Senator Yussuff: Thank you, Mr. Kronick, for being here. The bank plays a very important role in Canadians’ lives, not just in the economy in general but also on a personal level. If you own a home, mortgage rates will impact you. If you have a job and if the bank increases rates, it could slow down the economy, and that will impact your life.
Recognizing the important role of the bank, we want to ensure that the bank has legitimacy, not only in the context of the political structure that it has to report to, but, writ large, we also want it to have legitimacy with Canadians who are concerned when the bank does take decisions to ensure that they’re not an abstract thing or the furthest thing from the bank’s consideration.
Given that reality and that the bank has done a better job in trying to engage the public in what it’s doing and its objectives, do you think we could do a better job in adding more requirements for the bank? If you live in B.C. or Ottawa, it’s a whole different reality regarding how you hear about and relate to the bank. It’s really critical that Canadians have a better understanding of the bank’s role in their life, but equally what it’s trying to achieve in the greater good of managing inflation and also, at the same time, recognizing that it is trying to look at all the variables it has to consider when making a decision that will impact their lives and, for that matter, the economy.
Mr. Kronick: The end of your statement there is, I think, how I would have answered that. When the Bank of Canada sets interest rates, yes, it’s doing it with the inflation target in mind, but a big part of the equation is the output gap. That’s the difference between actual output and potential output. The bank is very aware of the state of the economy. In fact, that is driving a big part of its decision. It’s not just mechanically moving rates up because inflation is down. It’s looking at the state of the economy on both the actual and potential side.
You’re right that there is a need to try to talk to Canadians more. I mentioned a bunch of different things, but the bank is on social media now. They are in many different places to try to connect with people in different ways. If there are ways to make it even clearer to the public about what they do and how it affects them, then I’m all for that. I believe in that. I do think they are doing a ton of things. Is the governor appearing before Parliament a way of improving it? Perhaps. Once or twice a year, perhaps that would be valuable, but I think they’re trying a lot of different ways to communicate with the public. I don’t know that I see the benefits of more necessarily outweighing some of the challenges that this would pose from a politicization perspective.
Senator Yussuff: If I may, in regard to my colleague’s last question to you, it’s also a way to take political interference with the bank’s mandate, if the bank is talking to Canadians and if they have a better appreciation of the bank’s independence in doing what it’s doing on their behalf.
Mr. Kronick: Do you mean by speaking in front of Parliament?
Senator Yussuff: No, I’m talking about when it engages with the public in general, writ large, because they’re the ones where, ultimately, if they’re satisfied with what the bank is doing, despite what political criticism may come, at least there is an appreciation that the bank is actually having them in its mind in how it makes its decisions, rather than the political criticism it receives because it’s not doing something that a politician may want to hear.
Mr. Kronick: Sure, but I guess I would suggest that they’re doing a lot of that. That is a lot of the way in which they are coming at what they’ve added to their repertoire of ways of communication over the years.
Again, the press conference after every one of the fixed announcement dates gets huge coverage. I did the CBC and BNN Bloomberg yesterday to talk about the bank’s decision.
If anything, you could make the argument that since the financial crisis when fiscal policy did very little — because we were, sort of, in an era of austerity then — central banks had to come in and do a whole bunch of things, and they were brought out of the shadows and, arguably, given too much credit and blame for what they can achieve with their tools.
We haven’t talked about fiscal policy once so far in this conversation, but fiscal policy, at the end of the day, is the biggest driver of the economy’s potential. Monetary policy has one tool. You can add quantitative easing and forward guidance, if you like, as unconventional tools, but it has one pimary tool: a blunt interest rate. We’re talking about it trying to do a lot of things with that one tool.
I sit there and look at fiscal policy, and that’s the biggest driver when it comes to government policy. Fiscal authorities have far more control over the state of the economy’s long-run potential than a central bank does.
The Chair: I didn’t get a chance to hear your comments yesterday, but what is your take on the rate cut this week? Is that in anticipation of tariffs, or is it more in anticipation that the rates may have to go back up again if we really are headed into recessionary territory?
Mr. Kronick: I think it’s more the former than the latter. That was my main point.
If you looked at the domestic data and if it wasn’t for the threat of those tariffs, I think domestic data would have called for a 25-basis-point cut. You saw upticks in consumer spending in Q3. We saw upticks in housing construction. Business investment continues to be very weak, to my point about the economy’s potential.
I think that the balance of data and those core measures that are still above 2% — 2.4% or 2.5% or around there — called for 25 basis points, but the threat of those tariffs called for a 50-basis-point cut.
I really wasn’t sure which way they were going to go, but regarding the labour market report last Friday, to the point about the dual mandate, I think that uptick in the unemployment rate sealed the fate for 50 basis points.
The Chair: That seemed to be your point at the beginning: They already do incorporate their concerns about the employment issue. Hence, you don’t need a specific second mandate. Is that what you’re saying?
Mr. Kronick: Yes, I think it’s unequivocally a tool. It’s part of the equation, and I think that’s the way it should be, as I said, given the fact that defining maximum employment and defining potential outputs is hard to do, and it changes. I don’t think that’s the kind of mandate or goal you want for a central bank.
It’s better to know that they’re doing it, and they are. You have to. To set interest rates properly to hit the inflation target, you have to understand the difference between the actual and the potential, so let it be something that they estimate and they try to determine, but not something that we put out into the public as something they have to hit every six weeks.
The Chair: Thank you for that.
We’re going to do a quick second round here. Our witness is only able to be with us until a quarter after, so we’ll try to give him a few minutes there.
Senator Loffreda: My question is this: Are you not concerned about our weakening dollar possibly getting weaker with the recent interest rate cut? Maybe you can say a word or two on how well Canada’s monetary policy framework aligns with federal fiscal policies? Should we have any specific monetary policy tools, such as quantitative easing or yield curve control, that you believe should be permanent features of Canada’s policy framework?
Mr. Kronick: Those are two separate questions, so let me try to answer them separately.
On the exchange rate, yes, I’m worried. However, the economy that existed 30 years ago was two thirds goods and one third services, and the exchange rate there really matters. In an economy where you’re two thirds services and one third goods, it matters a little bit less.
On the gap between our overnight rate — our policy rate — and that of the feds, there is a little more scope for that gap to widen and have the exchange rate depreciate before it necessarily becomes an issue in my mind. That, hopefully, answers that first part.
On fiscal and monetary policies, one of the advantages of the 2% target is that it’s supposed to constrain fiscal policy. It’s supposed to act as a constraint because if the federal government were to overspend — as you could make a pretty credible argument that they did after the first part of COVID — it’s going to lead to inflation, and then the central bank is going to have to come in and raise interest rates. People aren’t going to like that, and people aren’t going to like inflation. It acts as a bit of a tool to make sure that fiscal policy is moving in an appropriate direction.
On the question of quantitative easing, it is a tool in the tool box. As far as I’m aware, there is no law against doing it. I think it is getting, perhaps, too much credit — and I mean that in a negative way — for its impacts on inflation this time around. I don’t believe that the purchases of the debt were necessarily inflationary. I think the spending itself was what was inflationary.
Whether the government could have spent the way they did without the central bank purchasing, my guess is they could. It might have been at slightly higher interest rates, but my guess is they would have been able to do it anyway, so I’m not in the camp that thinks that quantitative easing was responsible for much of the inflation that we saw.
However, you would also have to explain why in 2008 when other countries did quantitative easing, you didn’t get that kind of inflation, so I don’t think that’s as big a driver as some have made it out to be. I think it’s a valuable tool in the sense that it does lower longer-term interest rates, and there is probably a bit of a boost to inflation that you can get from that, but it’s probably not as big as people are making it out to be.
Senator Loffreda: Thank you.
Senator Fridhandler: The lawyer in me wants to make sure that we check off the things that we need to do. Part of our study is to review any legislative changes required of the Bank of Canada mandate.
Is there anything that you or your colleagues at the C.D. Howe Institute think need to be addressed in the Bank Act or related regulations or other legislation?
Mr. Kronick: No, I don’t know that we need to make any changes. I’m not a lawyer, so you guys might be better to answer that question than me.
What I will say is that what I’ve always liked about the mandate is it gives us the flexibility to have these kinds of discussions. It allows for the government to put in place the mandate that it believes is the right one, and it asks the central bank to be operationally independent.
I should clarify that point. The bank is not independent in a complete sense. They are operationally independent. The government can set whatever mandate and whatever goals they want for the central bank to hit, but it should be up to the bank to hit them.
To me, this session is about the mandate itself and other things that we’ve discussed, but I think there’s a difference between pure independence and operational independence.
Senator Gignac: Mr. Kronick, let’s go back to this discussion of the dual mandate. You can send us a written answer later on.
Of course, defining the maximum employment rate is a real issue. The Fed has the same challenge. They have the dual mandate. What I have noticed is, yes, the Bank of Canada is credible on the inflation fight.
If you do a post-mortem on what happened, the unemployment rate in the U.S. is at 4.2%, and it is now 6.8% in Canada. This is the biggest gap in 30 years. In Canada, the unemployment rate shifted from 6.5% to 6.8%. In the U.S., it was more or less stable at around 4%.
Core inflation in Canada is 1% less than the core inflation in the U.S. If you check the Monetary Policy Report, in the U.S., they make forecasts on the unemployment rate. In Canada, you have no word and no forecast from the Bank of Canada on the unemployment rate. It seems they don’t care about what is going on in the labour market. Maybe I’m too severe.
Could you help to convince me it’s better to stay with the mandate as it is, because it seems that in the labour market, they suffer from this severe monetary policy conduct in the last two years?
Mr. Kronick: Yes, I don’t think one can look at the differences in the two economies and suggest it’s monetary policy that’s been the driver of the success of the U.S. economy. We could have an entire other session here on what I think has been the driver of Canadian economic success versus U.S. economic success.
If you look at the policy rates and the tightening of monetary policy, it’s been almost the same. In fact, if anything, my argument holds even more in that scenario because the central banks did largely the same thing in responding to inflation above target. One had a very different impact on the economy than the other. That actually suggests it’s even harder to define what maximum employment would be in those two situations.
I should also point out they do calculate unemployment differently there than we do here. That’s a whole other issue that we should also have a conversation about.
I don’t look at the two scenarios and think that is an argument for a dual mandate.
The reality is this: On the U.S. economy’s potential in the last three years, whatever you think about the Biden government’s Inflation Reduction Act — the name of which is silly — it is incredibly powerful from an investment perspective and from the perspective of the U.S. economy’s potential.
Most of our fiscal policy in the last three years has been about encouraging consumption. The Inflation Reduction Act is all about encouraging investment. If you increase investment, you increase the potential of your economy. That’s what they’ve done there.
That allows for the actual economy to grow more. If we had done the same thing, we could have gotten a similar reaction. It has nothing to do with monetary policy, in my view.
The Chair: Excellent. Thank you.
Mr. Kronick, thank you for your time and comments here this morning. It’s most helpful. Thank you, Jeremy Kronick, Vice-President, Economic Analysis and Strategy at the C.D. Howe Institute. We have got you out on time. Thank you.
Mr. Kronick: Thank you to all of you. This is an incredibly important thing.
The Chair: Thank you. We agree.
Our next witness is Douglas Porter, Chief Economist at BMO Financial Group. Mr. Porter has been commenting on our economy for years. We are pleased to have you with us today as we pursue our study on the mandate of the Bank of Canada and other related issues. Welcome. Please go ahead with your opening remarks.
Douglas Porter, Chief Economist, BMO Financial Group: Thank you, Madam Chair and honourable senators. I’m pleased to have the opportunity to join you today to assist in your study of Canada’s monetary policy. My name is Doug Porter, and I am the Chief Economist of BMO.
As the chief economist of one of Canada’s largest banks, the study of Canada’s monetary policy is a critical topic for my team as our clients from across the country and around the world navigate their own financial situations.
The last several years have represented a period of unprecedented upheaval, with the COVID-19 pandemic leading to vigorous stimulus measures and record-low interest rates, followed by a dramatic worldwide spike in inflation and a corresponding rise in the Bank of Canada’s overnight rate.
It is my view that the run-up in inflation was caused by both supply and demand factors in broadly equal measure and by both global and domestic factors.
Given the similar pattern of inflation performance seen around the mature economies in recent years, it appears that global factors played a somewhat more prominent role in the inflation spike.
Today, we find ourselves close to the target inflation rate that the Bank of Canada aims to achieve. Recent rate cuts bear out this success.
Yesterday, the Bank of Canada cut its overnight rate by 50 basis points to 3.25%, which is the top end of the bank’s view of neutral interest rates, and it’s a full 175 basis points below the rate of just six months ago.
In my view, the Bank of Canada has weathered these storms reasonably well. Certainly, the bank made decisions which, in hindsight, could have been executed differently. Our central bankers’ efforts have been positive overall. Any difficulties they have had were by no means unique to Canada, while many of the circumstances facing all policy-makers in recent years were unique.
We are fortunate to have been afforded a relatively stable monetary system over the years through the bank’s prudent measures, independently achieved. I’m happy to provide my perspectives on how these efforts have been working and the outlook for Canada’s economy.
I look forward to taking your questions. Thank you.
The Chair: Thank you, Mr. Porter. We will begin with Senator Loffreda, the deputy chair.
Senator Loffreda: Thank you, Mr. Porter, for being with us here this morning.
I have a general question: What is your short-term and medium-term outlook for the Canadian economy? How should the monetary policy framework adapt to these projections? There is a lot happening. There is a lot to discuss. I give you a blank sheet there.
Mr. Porter: Thank you, senator. Yes, it is an incredibly complex environment. We’ve seen somewhat more complex situations before. This is, indeed, another unusual set of circumstances.
If we looked at the domestic factors alone, I had become much more upbeat on the Canadian economy over the short term, which is over the 2025-26 period.
When we look in the rear-view mirror, there is no question about it that Canada has struggled heavily, especially compared to the U.S., but even against some other mature economies. I don’t think it is that complicated as to why we have struggled relatively.
Put simply, Canada is one of the most interest rate-sensitive economies in the world; it is both because of our relatively high levels of household debt and how quickly that debt turns over, and the importance of the housing sector in our economy has a much greater weight than many other economies. Of course, housing is very interest-sensitive.
That’s been a burden on the Canadian economy in the last couple of years. Now with interest rates coming down quickly, the double-edged sword of being an interest-sensitive economy now cuts in our favour.
We think a great weight will be lifted off of the housing sector and the Canadian consumer over the next couple of years. Even in recent months, we have seen the housing market begin to stir.
We’ve actually seen some relatively positive developments on the consumer spending side. Looking at the consumer spending and housing sectors, we were looking for the economy to get back to normal growth rates in the order of around 2% over the next couple of years after struggling to grow by a little bit more than 1% in the last couple of years.
Of course, that outlook has been heavily clouded by this new big risk of trade uncertainty. We’re all grappling with exactly to what extent these are meaningful threats, whether they’ll actually be enacted, how long they’ll stay in place and how broad the tariffs will be.
There have been a number of economic studies that have looked at the potential impact on Canada. It does matter to what extent Canada retaliates. In the event of no retaliation, the best estimates that we see do suggest it could cut Canadian GDP by as much as 2%.
I would expect economic policy would not stand still in that case, if we were hit by 25% tariffs. I would suspect interest rates would likely come down even more rapidly than they’re already set to come down.
I would also expect that fiscal policy would probably turn up even a bit more stimulative over the next couple of years, and I also suspect that the Canadian dollar would adjust quite heavily. All of these things would somewhat offset the impact of tariffs, but there is no question that it would be a very important negative for the Canadian economy, were we to face broad 25% tariffs. Even with a very heavy-duty policy response, our best estimate is that it would probably cut Canadian GDP by one percentage point or more.
The Chair: I have a point here on the possibility of a recession. I know there is a lot of uncertainty. We’ve been talking about the tariffs and at what rate and the implementation rate, et cetera. This week, the governor said he didn’t anticipate any of that, but we have an awful lot of other economists saying we’re already there, technically speaking. What is your assessment?
Mr. Porter: Thank you for that question. The governor was actually asked that question directly yesterday about how he would respond to the contention that the economy is in recession. He pointed to the semi-official definition of recession being at least two quarters of negative GDP. We have not gone through that.
I think the one aspect that you could point toward to suggest that we’re in a stealth downturn, perhaps, would be looking at per-person GDP. I don’t think that’s necessarily the perfect measure either. If we look at broad indicators — things like consumer spending, auto sales, home building and that sort of thing — it’s just not consistent with what we would consider a traditional recession.
It’s definitely been a period of very sluggish growth. It has been a struggle. We have seen the unemployment rate rise over the past year, but it’s notable that Canada has actually managed to create a lot of jobs over the past year. In fact, employment growth has been as strong as it has been in the U.S. Instead, what we have seen is that the economy and employment growth have not been able to keep up with the very rapid population growth we’ve seen, and that is what has tended to drive the unemployment up over the past year and the very strong labour force growth.
It really doesn’t fit the traditional definition of recession, but there is no question that it’s been a tough period for the Canadian economy in the last couple of years.
The Chair: Thank you.
Senator Ringuette: I would like to have a clearer opinion on the following three questions.
First, in regard to the current mandate of the Bank of Canada, would you support it remaining the same or including a dual mandate in regard to maximum employment?
My second question is in regard to the review period. The current review period is five years. Should it remain at five, or should it be lowered to three to be more in the current moment of the economy?
Third, should there be more external deputies attached to the bank?
Mr. Porter: Thank you for those questions. I might go in reverse, senator. In terms of more external deputies, it’s been an interesting development that the bank now has one external deputy governor and is looking for a second one. In part, that’s in recognition of the difficulties that all central banks have faced with the inflation challenge coming out of the pandemic.
I have to say the bank actually does reach out a lot to the private sector. We have official meetings with the bank at least once a year. They certainly solicit our opinion through other channels on a number of occasions. I’m well aware that they follow what the financial markets are expecting for them. I’m on the C.D. Howe Institute Monetary Policy Council, which tries to suggest what the appropriate Bank of Canada rate would be the week before the bank makes its decision. I understand the Bank of Canada does listen and follow what the council suggests. I actually think there is a fair degree of outreach. In terms of whether they need even more, I would leave that to others, but I think they actually do a reasonably good job of soliciting the opinion of others.
In terms of shifting the mandate from five years to three years, I think, as a general rule, five years is appropriate. You could perhaps make the case that during the exceptional circumstances of COVID and what unfolded on the inflation front when coming out of that, it might not have been the worst idea to have a rethink or relook at whether the mandate was appropriate in a slightly more accelerated pace in the face of those very exceptional circumstances. But I think, as a general rule, five years is about appropriate. More or less, it spans close to what would be a typical economic cycle. Perhaps it’s a little shorter than an economic cycle, but I think five years is a reasonable period of time. In some respects, that will lead into your final question.
Overall, I would say the mandate has served us well. It’s been relatively successful. That’s not to suggest that it can’t be slightly changed, tweaked or reviewed. I think it’s appropriate to seriously review it every five years and always question whether it is the appropriate way to go. That does play into whether we should look at a dual mandate or not. I personally come down on the side of keeping it as tight and as focused as possible simply because — and I suspect that you’ve heard this before — they realistically only have one major tool at their disposal, and that is interest rates. Essentially, that means they can effectively only achieve one target.
Initially, when the mandate was set up, the view was that the most positive thing that the Bank of Canada can do for the economy — and that does include employment — is set a very stable and predictable landscape for inflation. I’m not here to tell you that is the be-all and end-all and it is necessarily going to guarantee success, but I think we also have to be careful in not asking too much of monetary policy and expecting too much of it. I do tend to believe that, yes, it’s best to stay focused.
I like the slight tweak that they made the last time to also be conscious of what’s going on with employment and to keep an eye on it just to ensure that the balance hasn’t tipped too far in one direction or the other. Maybe that’s the appropriate way to look at it, but, in general, my short answer would be that I do think it’s been generally successful over the 30 years that we’ve been doing it. I wouldn’t be in favour of making big changes to the mandate.
The Chair: Thank you very much.
Senator Yussuff: Other central banks in a number of other places have changed the mandate of their central bank, and whatever measurement or metric you’re using to evaluate, it seems to have done very well, despite the fact that they’ve added a dual mandate to their responsibility. I hear what you and your colleagues are saying, but if that were the case, given what we can look at and measure from other experiences, this does not in any way take away from what the bank’s core mandate is in terms of managing inflation.
At the same time, recognizing that we do want to ensure that the economy and Canadians in general have jobs, we need to figure that out, recognizing that the bank only has one tool. It’s an important tool because if that tool is used in a way that could cause a lot of grief to individuals and companies in borrowing money, it’s going to have an impact. It’s not a neutral tool. It’s a tool that does a lot of things, and it depends on how aggressive the bank is when it takes advantage of that tool. In this case, it is to get inflation down.
Other mandates of other central banks seem to have been easily accommodated and serve the purpose of what their political institution has made as a decision. If we were to do that here, it wouldn’t be in any way a dramatic addition to the bank’s responsibility, would it?
Mr. Porter: Thank you, senator. It wouldn’t be a dramatic change; that’s true. I would submit that, ultimately, the Bank of Canada, of course, wants the most success for the Canadian economy in any event, and that does include as low an unemployment rate as possible.
I believe an earlier witness had suggested that over time, what we would view as full employment or a successful unemployment rate has changed. For instance, when I first started following the economy, it was seen that an 8% unemployment rate was the neutral or natural rate of unemployment back in the 1980s. That would have been seen as a great success for the economy. Now I think we would view an 8% unemployment rate as being a very unsuccessful level of unemployment.
It’s been a floating target over the years, and to a great deal, it can change with the demographics.
I would be a little bit concerned about trying to achieve both an inflation target and a specific unemployment rate target at the same time. As I suggested earlier, I think their latest tweak in the last mandate to also consider the level of unemployment and to try to achieve as full employment as possible within the inflation targeting is probably a good way to do it without getting tied up on a particular figure.
I would stress again that I do believe that, ultimately, the bank’s view — and I would tend to agree — is that having a stable inflation mandate, achieving the 2% inflation rate, is probably one of the best things that monetary policy can do to help achieve a relatively low unemployment rate.
It just so happens that in recent years, those two have been somewhat in conflict coming out of COVID. We were in a situation in 2022 when we probably had the tightest or healthiest job market that I have ever seen and that many of us have ever seen. The unemployment rate got below 5%. We had more than a million vacant jobs at one point, which is as many people as there were unemployed. We had not seen such a tight unemployment rate.
Unfortunately, at the same time, we also had the highest inflation rate that we had seen in 40 years. Clearly, at that point, those two goals were somewhat in conflict. Had we stayed at such a tight job market, it probably would have meant that inflation would have been sustained at those high levels for some time. Unfortunately, policy had to work to somewhat loosen the job market to bring down inflation.
Senator Fridhandler: I believe that under Governor Macklem, the bank has made a significant stride forward in improving their transparency and reporting to the public. I would like to hear your views on that and whether you think there are other things that the Bank of Canada might address to continue to improve on this subject.
Mr. Porter: Thank you, senator.
It’s interesting how the communication strategy has evolved over the years. In general, I would say the Bank of Canada has become much more open, much more transparent and much more involved with the public. Overall, those are positive moves.
For instance, it was only a little bit more than 20 years ago when the bank first moved to the so-called fixed action dates where they had specific dates on which they changed interest rates. In the 1980s and 1990s, they could basically change them whenever. It actually caused a great deal of uncertainty in financial markets and to the public more broadly.
The bank has increasingly done more of an outreach program. It gives many more public speeches, for instance, to chambers of commerce around the country. The press conferences are relatively new. Even speaking after each and every decision is a very new development that’s really only happened under Mr. Macklem.
There is also the summary of deliberations, which has only begun recently. Those give us an idea of what was discussed at each interest rate decision.
It’s been steady progress over the years toward being much more open and transparent. I would say that’s positive overall. To your point, it has improved even further under Mr. Macklem.
I would say that it’s not that you want to keep some mystery; they can’t be completely open simply because, frankly, the future is unknown. They don’t want to lay all their cards on the table, because circumstances can change very dramatically. They certainly don’t want to be making promises they can’t keep and making directions that circumstances and events can push offside.
I wonder if we haven’t actually reached the point of maximum reasonable openness and transparency. I’m really not sure what else we could ask of the central bank at this point — maybe a few more speeches per year. We certainly get a lot of speeches from the Federal Reserve, but I would say, overall, it’s been a very positive move. They are much more open than, say, even 20 years ago.
Senator Fridhandler: I have a follow-up going back to Senator Ringuette’s question about deputy governors. Are we sufficiently represented within the executive levels of the Bank of Canada for regional diversity in this country, or should we be mandating that deputy governors be appointed from the various regions of the country?
Mr. Porter: Thank you.
As I understand it, they do endeavour to have as much diversity as they can regionally and in other ways, but with a relatively small group of deputies, you’re not necessarily going to adequately represent absolutely every portion of the country.
To some extent, that plays back into the debate that’s been going on for many decades, really, and that is this: How does monetary policy respond to regional variations within the economy? That has been an issue that has come and gone. Of course, that’s probably worthy of an entire panel unto itself, getting into that topic.
It’s interesting that over time, though, the regional variations within the Canadian economy have actually narrowed quite substantially. One thing we’ve been pointing to is the very narrow difference — one way to capture it is just by looking at the unemployment rates between the various provinces. The difference between the highest and lowest unemployment rates in the country is about as narrow as we’ve ever seen. The variations in the economy have really narrowed, and that also goes in terms of growth rates.
Of course, when you get big movements in commodity prices, you can have more marked regional variations, but in recent years, there really has not been much difference between the regions on the economic side.
In general, the Bank of Canada’s view — and I would tend to agree — is that we can only set one monetary policy. It really has to be set for the country’s economy as a whole. To some extent, it’s up to fiscal policy and, yes, even provincial fiscal policy to help smooth out some of the big regional differences that can develop. It’s a tough job for monetary policy to affect different regions of the country. I do think the appropriate response is to respond to how the overall macro economy is doing for the country as a whole, with the recognition that certain areas of the country might be doing exceptionally poorly or exceptionally well in certain circumstances, and take that on board when policy is being set.
The Chair: I just have a few quick follow-up points here. On the summary of deliberations, we’ve also heard testimony that the Chatham House Rule is there for a reason, because it would inhibit and restrict debate, and people would stop putting more interesting or radical ideas on the table if those discussions were to be directly tied to them by name. Do you share that concern?
Mr. Porter: Yes, Madam Chair, I do share that concern. Having the comments anonymous is appropriate in the summary of deliberations.
It’s interesting. They are relatively new. I think we’re finding our way. Even as financial market analysts, we’re finding our way in terms of how to use them and how to read them. I think in the limited time period that we’ve had, they actually have proven to be somewhat helpful. There was one period where we did see some mild disagreement within the governing council on what was the best way to proceed. It was actually interesting news to the public that there was a little bit of disagreement developing — reasonably so, I would say. Of course, the economy is a complex thing, and reasonable people can have differences.
But it helped in sorting out which way the bank and the minority opinion were leaning.
The Chair: Again, on your quick comment about the appointment of deputies, I think everybody is pleased that there are more, but that, again, is a decision of the governor. Do you think those appointments should be subject to parliamentary scrutiny and — well, maybe not final decision making — questioning in public and that such be mandatory?
Mr. Porter: That’s an interesting question. I would say that some degree of getting to know the new deputy governor by the public would not be a bad thing. I would not be against at least some introduction at an official level.
The Chair: Great. Thank you for that.
Senator Gignac: Welcome, Mr. Porter. Since both of us, as chief economists, have attended over the years the annual meeting of the Bank of Canada, I’m so glad you have accepted our invitation.
We have three aspects in our special study that we’re analyzing. The third one is regarding the core inflation measures. They have changed the concept over the years. It was CPIX and then CPI-trim and CPI-common among others. Could you elaborate for the committee regarding the importance and the role of core inflation in monetary policy?
From time to time, the governor seems to focus on overall inflation, and from time to time, it’s core inflation. Yesterday, in the opening press release, they said that they will watch core inflation in the coming months. Could you elaborate on how important this concept is and if the one they’re using currently is the right one? That’s CPI-trim and CPI-median.
Mr. Porter: Thank you for those questions, senator. It’s good to see you as well.
I understand this came up in the prior panel. Just to be clear, of course, what the Bank of Canada targets and ultimately what matters is headline inflation. To reiterate why they look at measures of core inflation, it’s more as a guide almost for themselves to not be swayed by some temporary developments that can temporarily push up headline inflation. For instance, even a change in the GST can have a temporary effect on headline inflation. Traditionally, central banks have tended to take out some volatile items, especially things like gasoline and food prices, because a big run-up one month can easily be reversed the next month. That’s why they tend to also look at core inflation measures.
Having said that, I am personally of the view that the more straightforward, the better. The simpler they keep things, the better. The more consistent they remain on that front, the better. I also happen to believe that headline inflation is, at least, as important as any measure of core inflation because, ultimately, that’s what individual Canadians and businesses face on a day-by-day basis. They do not have to deal with core inflation. They have to deal with overall inflation. When talking about the cost of living, that’s really what matters, and that should be what they target. I personally do not have a preferred measure of core inflation. I prefer consistency, though. I also prefer simplicity. The more straightforward, the better.
If we think back to the history of why CPIX — which takes out eight specific volatile items — was abandoned, it was because of one episode about 20 years ago where auto insurance rates shot up for a small period of time. They were included in the core inflation measure. At that time, it led to somewhat of what I would say was a bit of a policy error, where interest rates were raised when they weren’t going up in the U.S. It led to a large rise in the Canadian dollar. Then auto insurance rates backed off a lot, core inflation fell abruptly and they ended up unwinding those increases in interest rates. In hindsight, it did look like a policy error, and they thought that particular measure of core inflation had led them astray. They then began to follow other measures like CPI-median and CPI-trim.
Of the ones that they are focusing on — CPI-trim and CPI-median — I like CPI-median. It’s relatively straightforward. It’s fairly easy to explain. I’m not sure any of them are that easy to explain, but it’s relatively easy to explain, and it does have a relatively good track record over time. My bias would be to stick with what you’re using and not make a lot of changes. Even though I would not have necessarily picked CPI-median as the go-to core rate initially, now that the bank is focusing on it, I probably would stick with it.
Senator Gignac: For my next question, I will shift topics. It’s not the core of our special study, but since you are a very well-respected chief economist with a big bank, I’m just curious about your view regarding the role of the Bank of Canada and macroprudential measures. Do you believe the Bank of Canada shall play a leading role in macroprudential measures? If we’re to have more supply shock, it’s possible it would be more related to macroprudential measures than monetary policy. Are you satisfied with the way it’s done in Canada?
I thought at some point that somebody was asleep at the switch to allow half of the households with a variable rate to go up when the interest rate was at 2%, and they were screwed up in the following two years. It seemed that nobody was accountable regarding the macroprudential measures two years ago.
Mr. Porter: Thank you for that question. That, of course, is a very broad debate. I think I will focus on what I believe you’re driving at, which is basically the huge rise in home prices during COVID, as well as the 50% increase that we saw in the space of two years and the severe deterioration in affordability on the housing side that we’re still faced with even to this day.
My general view is that the Bank of Canada should take home prices and what’s going on in the housing market into much greater account when setting policy. I appreciate that in some respects, that’s in conflict with what I said earlier about focusing on one tool, one target. But I happen to believe that when we think of the cost of living more broadly, looking beyond the inflation mandate, of course, home prices and the cost of housing are captured in a very particular way in the CPI, but it can have a much broader impact on the overall view or perception of what inflation is among the general population. It has a real impact in terms of the actual cost of living, not just the perception, for the typical consumer or household.
To the extent to which home prices skyrocketed during the pandemic, I think that was a very unfortunate episode. Yes, I do believe that the Bank of Canada ultimately should take what’s going on in the housing market into much greater extent than they do when setting policy.
Senator Gignac: In Canada, the Minister of Finance is basically the chair, if I understand correctly, of the Department of Finance which has this kind of macroprudential measure. In the U.K., it’s the Bank of England that holds that aspect. Is that correct?
Mr. Porter: I believe that is correct, yes.
Senator Gignac: Thank you.
Senator Varone: Thank you for being here, Mr. Porter. When President Trump began his first term, the Canadian dollar was flirting around an 80-cent exchange rate. As he begins his second term, we’re now at 70 cents and flirting thereabouts.
If tariffs are imposed, generally speaking, the first casualty is employment. Having said that, are there enough tools in the Bank of Canada’s tool box to adjust to these circumstances? Just having interest rates, to me, seems like we’re not prepared enough. Anything can happen here.
Mr. Porter: Thank you for that question. I would suggest that you’re right that monetary policy can only do so much in a trade war. I guess that’s the way I would respond to that question. The reality is the Bank of Canada’s monetary policy simply is not in a position to fully respond to the threat of tariffs. That’s through zero fault of their own. It’s just the reality. We would need all sorts of different responses. I think some of it would be fiscal. Some of the response, as I indicated earlier, would come through the exchange rate.
To your point, the exchange rate is at just a little bit over 70 cents, and it is about as low as we’ve seen in the last 20 years. The only other two episodes where it’s been weaker were during the depths of COVID, or in the early days of it, and when oil prices crashed in 2015 and 2016. This is a period of weakness for the Canadian dollar. It’s not by any means a record low. That was in 2002 when it got below 62 cents at one point. The common denominator through many of those episodes and one of the reasons the Canadian dollar is weak now is because, on the flip side, the U.S. dollar is very strong broadly.
It’s interesting. I was pointing out yesterday that the Canadian dollar in recent weeks and months has actually strengthened against the Australian dollar, and that’s even though Australia has not changed their interest rates at all. Their interest rates are higher than Canada’s interest rates right now, and Australia has not been threatened with tariffs. It’s interesting that much of the movement we’ve seen on the Canadian dollar since the election and even just before the election is just the flip side of a broader rise in the U.S. dollar.
While it’s certainly notable that the Canadian dollar has weakened a lot, I would suggest this is as much a broadly strong U.S. dollar story as it is a weak Canadian dollar story.
In response to your main question about the Bank of Canada’s response, realistically there’s one major tool they have, and I think they would use it. If we were to be hit by tariffs, they would support the economy as much as they could. I suspect that would mean much lower interest rates than would otherwise be the case, if Canada were faced with tariffs.
The Chair: Thank you very much.
Senator Yussuff: Right on the heels of this, I guess in this context, if there is a significant tariff imposed by the U.S., the dollar would be a saving grace in terms of our exports trying to stabilize the economy because our products would be very attractive for foreign markets. For that matter, for Americans having to pay that tariff, they certainly will be able to buy Canadian products. It’s kind of a double-edged sword on one hand. The import of stuff would be more expensive, but at the same time, given we’re so reliant on exports, the dollar could be a saving grace in at least smoothing out some of the challenges we could face with tariffs.
Mr. Porter: Yes, senator, that’s exactly the way I see it. To be clear, I don’t think the currency would depreciate enough to fully offset the tariff. I think it would be a shared burden by the economy. Some of it would be paid by U.S. consumers, some would be absorbed by our producers and some would come through a weaker exchange rate which, to some extent, makes our buying power overall weaker. It likely would lead to some upward pressure on imported goods. We see it almost immediately, for instance, in gasoline prices and some food prices — for what we import on that front, we would see some higher inflation.
It would not be a positive circumstance at all for the economy were we to be faced with broad-based tariffs. I think that’s something we can all agree on. Yes, we would probably be left with, as I said, a depreciated currency, a somewhat lower standard of living through that lower currency and probably somewhat weaker government finances as well as we respond to the tariffs.
Senator Loffreda: Mr. Porter, the last question I’d like to ask is this: Some countries have explored alternative approaches to fiscal and monetary policy. Are there any lessons for Canada from these alternative frameworks, such as modern monetary theory, people’s quantitative easing or helicopter money, debt monetization and sovereign wealth funds? You already discussed the dual mandate. Are there any lessons we can learn from these methods that have been explored by other countries? Each one carries risks and opportunities obviously. We don’t have the time to get into that, but is there anything that comes to mind?
Mr. Porter: Thank you, senator. It’s interesting; just before the pandemic, a very hot topic was the one you referenced: modern monetary theory. I would say that to some extent, we actually had a bit of a test case of that coming out of the pandemic in the U.S. We had very large budget deficits, with purposeful stimulus measures in a number of guises. This actually even occurred under the first Trump mandate too in late 2020, but it was carried on in 2021. The view was that we could run budget deficits — if you can borrow in your own currency — as large as possible and the only restraint was inflation. That is what modern monetary theory suggests.
Unfortunately, the tests showed that we ran into real inflation relatively quickly. I do believe that the very large stimulus measures that we saw, particularly out of the U.S., both on the monetary and the fiscal front, did in fact play a significant role in the inflation we saw. It certainly wasn’t the only factor. Supply-side issues were very important as well. It was a unique set of circumstances, as I said at the outset.
I think modern monetary theory failed its first significant test, and I wouldn’t care to experiment with it in Canada. I think that’s the one lesson that we did learn in 2021: It’s dangerous to try to test modern monetary theory.
Senator Loffreda: Thank you.
The Chair: Just share a final word, if you could. I know everybody is concerned about the tariffs and what it means and getting our house in order and the impact, but as we’ve studied in this committee on many occasions, until we actually deal with the productivity issue in some significant way, we’re always going to be vulnerable.
Mr. Porter: Thank you, Madam Chair. In some ways, that actually does go back to the question about the Canadian dollar. I’ve been around long enough to remember parity and even before the parity that we saw about 10 years ago. It’s interesting. We’ve gone from periods of parity to 90 cents, 80 cents and now down to 70 cents, even though we’ve had almost the exact same inflation rate as the U.S. over that long sweep of history. Why has the currency depreciated so much over time? A lot of it is we have needed that depreciation to stay competitive because of our relatively weak productivity performance that we have seen.
I know there has been a lot of concern over the weakness in productivity coming out of the pandemic. I would submit that this has actually been an issue across much of the industrialized world — not so much in the U.S. but in much of the world.
What I’m more concerned about is our underperformance on productivity over a longer period of time. If you look at it over a 30-year or 40-year period, we’ve been growing at about 1% a year on average. The U.S. has been closer to 2%. There might be some measurement issues, but I think the broader stroke there is correct, where we have had weaker productivity. Of course, that’s worthy of a full study itself as to what drives that. I think it does go back to our relatively weak levels of capital spending in this economy, and we have to ask why. Why are businesses not willing to invest heavily in this country?
The Chair: Thank you. As always, it’s very insightful and to the point. We appreciate your remarks always. Thank you, Douglas Porter, Chief Economist at BMO Financial Group.
That concludes our testimony for today and for 2024. We will return to this topic in the new year when we reconvene. Thank you, all.
(The committee adjourned.)