THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, November 7, 2024
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:32 a.m. [ET] to study matters relating to banking, trade and commerce generally; and to examine and report on Canada’s monetary policy framework.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello to everyone in the room and those joining us online. Welcome to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin, and I serve as the chair of this committee.
I would like to introduce the members of the committee: Our deputy chair Senator Loffreda, Senator Fridhandler, Senator Marshall, Senator Martin, Senator Gignac, Senator Varone and Senator Yussuff.
We are going to continue our testimony on a wide range of banking issues. Yesterday, we had with us the superintendent of the Office of the Superintendent of Financial Institutions, or OSFI, for an annual visit to talk about a wide range of matters, including, of course, issues surrounding the TD Bank operations in the U.S.
Today, we have the pleasure of welcoming in person the following witnesses from the Financial Transactions and Report Analysis Centre of Canada, or FINTRAC: Sarah Paquet, Director and Chief Executive Officer; Philippe Blanchette, Acting Deputy Director, Supervision Sector; and Annette Ryan, Deputy Director, Partnership, Policy and Analysis Sector. Ms. Paquet, I believe you have opening remarks, so the floor is yours.
Sarah Paquet, Director and Chief Executive Officer, Financial Transactions and Report Analysis Centre of Canada: Thank you for having us today. We’re happy to meet with you today to support your study. As mentioned, I’m joined by Mr. Philippe Blanchette, Acting Deputy Director of Supervision and Chief Compliance Officer, and Annette Ryan, Deputy Director of Partnership, Policy and Analysis. I will briefly describe FINTRAC’s mandate and provide some background on our supervisory model and operations.
FINTRAC is one of 13 federal departments and agencies that play a key role in Canada’s Anti-Money Laundering and Anti-Terrorist Financing Regime, which is led by the Department of Finance Canada. FINTRAC ensures the compliance of the thousands of businesses that have obligations under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act, including to establish a compliance program, undertake know-your-client measures and due diligence, keep records and report certain types of financial transactions to FINTRAC.
We work with businesses across the country to ensure that they understand their obligations under the act. We also undertake hundreds of assessment activities every year, including examinations and other supervisory activities, to ensure businesses are fulfilling their requirements.
When we observe non-compliance, FINTRAC employs a range of enforcement measures, including administrative monetary penalties. Under the act, penalties are issued to encourage change in the non-compliant behaviour of businesses. The act and associated regulations establish penalty ranges for each violation, and penalties are calculated based on the nature of the violations. Penalties are regularly complemented by FINTRAC’s request for an action plan, with robust monitoring and reporting requirements to address deficiencies. Following the action plan, we have robust monitoring and reporting requirements to address the deficiencies.
I informed businesses last year that we were actively stepping up our enforcement action against businesses that were not fulfilling their responsibilities in relation to combatting money laundering and terrorist activity financing. Since then, we have levied the four largest penalties in FINTRAC’s history. In total last year, we issued 12 notices of violation in the amount of more than $26 million. We also disclosed the largest number of cases of non-compliance to law enforcement for potential criminal investigation.
I was pleased to have the opportunity to meet the CEOs and boards of the largest financial institutions over the past year to discuss the multifaceted risks facing the industry and how we can work together to address them. In these meetings, I was clear that compliance with the act should never be viewed as a cost centre or an expense. Our collective efforts must not fall victim to economic challenges or downturns.
Money laundering is not a victimless crime. Proceeds of crime are generated through drug trafficking, fraud, human trafficking and online child sexual exploitation. Those are terrible acts, and we need to confront those crimes with private industry, government and law enforcement together. It is our moral and social duty to do so. It is imperative.
Compliance with the act ensures the centre receives the information needed to produce financial intelligence for Canada’s law enforcement and national security agencies. In 2023-24, we generated more than 4,600 financial intelligence disclosure packages. They were based on 1,783 unique disclosures, and those disclosures contained nearly a million transactions for a total value of $44 billion. Our financial intelligence contributed to 266 significant, resource-intensive investigations and hundreds of others at the municipal, and provincial levels. We also work with our international colleagues to support their investigations.
In conclusion, it takes a strong, equipped and committed network to defeat modern criminal and terrorist networks. FINTRAC is critical to Canada’s ability to combat money laundering, terrorist financing and sanctions evasion, and to protecting Canada and Canadians.
Thank you. I am pleased to take any questions in support of your study.
The Chair: Thank you very much. Just before I go to the deputy chair, yesterday, at the end of our session, Senator Deacon posed a question to the superintendent as we’d gone back and forth about what the obligations are and how you uncover this. I think everybody was a little surprised to learn that there’s absolutely no obligation on the part of financial institutions to report bad or criminal behaviour to OSFI. Is there any obligation for them to report to FINTRAC directly if they discover something or fear something?
Ms. Paquet: It works with our regime. Their obligation is to report different transactions. There are thresholds that will require them to report information to FINTRAC. Those threshold reports would be a large cash transaction report, or it could be totally legal. It is just a threshold report.
They also have to report suspicious transaction reports. When they see a transaction that meets some indicator of money laundering and terrorist financing, this is when they need to file a suspicious transaction report, and there’s no threshold for that. It can be a $6 transaction. That’s how they send us the information through reports.
More precisely on your question, if they see something happening and it’s important and urgent, they will call us to tell us that they are filing a report, it’s important, be ready to receive it.
The Chair: I think we’ll pursue this as we go on here. We’ll go to Senator Loffreda to begin our formal questioning.
Senator Loffreda: Thank you. I think the priority of financial crime and what we’ve seen lately with the industry is that many criminal organizations are international. How does FINTRAC collaborate with international bodies in its fight against financial crime? Are there any new or strengthened partnerships or trends we should be aware of?
What’s important, I think, in banking, based on my experience of so many years, is training and awareness. The bankers must be trained. If we look at what happened with TD Bank in the U.S., I don’t think the training was there. I don’t think they were aware of what exactly was going on for many different reasons. What efforts are in place to improve awareness and training for FINTRAC’s partners in the banking sector regarding the new financial crime trends, because it’s such a dynamic environment, it’s not static at all? And compliance expectations. We talked about compliance.
Ms. Paquet: First, your question about international. FINTRAC is part of an organization called the Egmont Group, which brings together 177 financial intelligence units, or FIUs, from 177 member countries. Through that group, we have something called the Egmont Secure Web, where we are exchanging information from FIU to FIU.
For example, an international counterpart is looking into an investigation of cartels that could have links to Canada, through the Egmont Secure Web, they will send us a request, and if we have information, we will send it back to them through the Egmont Secure Web. It is a very efficient tool that FIUs use to support each other in an international investigation. When you look at the invasion of Ukraine, the Five Eyes, Western allies all got together to exchange the information that we had for all of us to be able to follow the sanction evasions more efficiently.
We also have what we call public-private partnerships, or PPPs. With that, we will decide on a high-risk situation. I will take, for example, child sexual exploitation over the internet, then we will work to share with each other the indicators, build operational alerts and now we will all be looking for the same type of behaviour and exchange information among ourselves. The international corporation and the FIU unit is happening every day. It’s very efficient. Just last year, FINTRAC responded to more than 200 requests from our international partners.
In terms of training and awareness, each institution has to have their own compliance program. As part of the compliance program, they need to have a training component. If you have a program but your employees are not trained, they won’t be able to deliver on their obligations. It’s very important for FINTRAC that reporting entities are aware of their obligations. We do a lot of training through conferences and associations, and even direct training when some entities ask us. Training is a key component for employees to be aware of what they should be looking for and what they need to report.
Senator Loffreda: Thank you.
Senator Marshall: Thank you for being here. Canada is known as a money-laundering country. Is there any way to measure progress as to whether we’re getting a handle on this? If we are, how do you know that? I’m just trying to get a sense of whether we’re getting better or whether we’re deteriorating further?
Ms. Paquet: Thank you for your question. Money laundering is a huge problem globally and Canada is not unique in facing that situation. FINTRAC is one of the 13 departments at the federal level that is involved in combatting money laundering and terrorist financing. We’re also working with law enforcement, provincial regulators and, like I just mentioned, international partners and also international regulators.
How do we measure progress? That’s a good question. Our mandate is to deter, detect and prevent any activities that would facilitate money laundering. I would say that the PPPs, I referred to earlier, are very efficient tools that we have developed over the last 10 years. We work with the private sector, we work with not-for-profits related to the crime we are investigating and we work with our domestic partners. The way we do PPPs, when we are bringing all our knowledge together, we are able to develop the indicators associated with the crimes. We are able to develop operational alerts with the indicators associated with the crime. We are able to inform the public and also the reporting entities about what to look for. Then they start reporting on those, and we receive more reporting related to those crimes. When we receive more, we learn more about those crimes, and then we are able to add to our list of indicators and then you see the cycle.
Senator Marshall: You and your partners are going through all these processes. How do you know that your processes are effective? We’re spending millions of dollars in an anti-money laundering programs. How do you know, at the end of the day, that the money is spent wisely? Are you having any impact? Money laundering is so extensive in Canada, and we’ve been spending a lot of time on it, but we don’t really have a handle on whether our programs are effective. I’d like to know whether everything that we’re doing, looking at transactions, is effective. How do you know it’s effective? Are we just going through the motions?
Ms. Paquet: To finish on what I was saying, when we started the PPPs, we saw an increase of 800% of disclosure on those specific crimes because entities now knew what to report on. When we receive better information, we can provide better disclosure, which is actionable by law enforcement.
We have a very thorough process for examining institutions and for analyzing the information we receive. As I said earlier, we were able to disclose more than 4,000 packages to law enforcement within the last year, which supported them in their investigations. In some of their investigations, they were already aware of it, and some of their investigations are new. They didn’t know this was happening, and because of FINTRAC disclosure, they were able to proceed on them.
Having metrics is very difficult. As I see the quality of the reporting we’re seeing, the quality of the relationship we have with law enforcement and all the reporting we see in the media when we are actually able to make progress and save victims, this is where I see we’re making progress. Every day, we come to work thinking about those victims and how we can be more efficient.
[Translation]
Senator Gignac: I want to welcome the witnesses. Yesterday, my colleagues tried to obtain a clearer picture of the TD situation. The superintendent was unable to comment on specific cases. Can we ask him a bit more about TD to obtain further information? When did the Department of Justice inform you that there was an issue? Are any other Canadian banks in the authorities’ sights?
Ms. Paquet: I can’t share more information than has been shared publicly given the way things work. We carry out a risk-based review. We have a wide range of tools for determining which review to carry out in any given year. We used these tools to determine that we would carry out the TD Bank assessment. It’s not like in the United States, where the Department of Justice must be involved. Our reviews are based on our risk assessment tools.
Senator Gignac: The Canadian banking system was a source of pride for Canadians during the financial crisis. Our major banks are headquartered in Canada. What entity in Canada is taking the lead on this?
It seems to be the Department of Justice. Here, no one can comment or say more than the information disclosed. What entity is taking the initiative in the fight against crime?
Ms. Paquet: As I tried to explain in my opening remarks, many players are involved in the fight against money laundering and terrorist financing. These include 13 departments and agencies just within the federal government.
Senator Gignac: I’m looking for the entity in charge. Which entity is in charge? When 13 organizations are involved, some entity takes the lead.
Ms. Paquet: FINTRAC’s mandate is to deter and prevent terrorist financing and money laundering. We aren’t the lead organization. The lead at the policy level, in terms of legislation and regulations, is the Department of Finance. Our responsibility is to put things into operation and to ensure that the legislation and regulations are implemented.
Senator Gignac: Is the finance minister giving you instructions because she wants to check all business practices in Canadian banks operating in the United States, to prevent a repeat of this experience? Are we waiting for the United States Department of Justice to come up with more? If a bank such as TD has made missteps, it raises questions about our governance and control measures. Do we need instructions from the deputy minister or the finance minister? Who takes the initiative to ensure that Canada isn’t passive, but proactive?
Ms. Paquet: It’s definitely FINTRAC. FINTRAC is an independent organization and it conducts its own reviews.
Senator Gignac: So it’s you?
Ms. Paquet: Yes. Sorry. I misunderstood your question. That’s why different Canadian banks are assessed through this risk lens. That’s why we decided to assess TD Bank last year.
Senator Gignac: Given your experience with other Canadian banks, can you reassure us that we’re now unlikely to see a repeat of the TD situation? Canada’s image has taken a beating.
Ms. Paquet: In our assessment and review process, we don’t just conduct reviews. We also carry out many supervisory activities. Last year, I told some financial institutions that they weren’t doing enough to fight money laundering and that FINTRAC would be upgrading its measures to implement the legislation and regulations. That’s why you saw the four biggest penalties that FINTRAC imposed.
However, the failure of some banks to fulfill their obligations doesn’t indicate a widespread issue with financial institutions in Canada. In recent years, FINTRAC has assessed 150 financial institutions. Of the 33 that received penalties, nine are banks.
[English]
Senator Varone: Thank you for being here. When I reviewed the background information, I was curious in following what Senator Deacon asked OSFI, yesterday. I would like to put it in reverse. All terrorists are criminals but not all criminals are terrorists. When you look at the volunteer nature of banks sharing information with OSFI, FINTRAC and all the authoritative bodies and then in the material I read that, “. . . voluntary information from police, law enforcement, security agencies, foreign financial intelligence units . . .” can be shared. You’re authorized to share your information with other people. In another paragraph it says “able to share.” Why aren’t you mandated to share and collaboratively work with everybody in the enforcement supply chain? To me, I find it problematic that you’re able to share information but you’re not mandated to share it among law enforcement agencies. How does that work in terms of the police not sharing information with you and you not sharing information with OSFI? It seems as if it’s a voluntary kind of group that’s not mandated.
Ms. Paquet: I would say the authority we have to share, we are using it. At FINTRAC, we shall disclose. When we receive reports on transactions that meet the reasonable grounds to suspect money laundering or terrorist financing, we would share it with law enforcement. If law enforcement comes to us through a voluntary information request and we have the information that meets the threshold, we will share it with them. We have authority to share with OSFI on compliance measures, so we do share with them. Also, OSFI is now a discloser recipient in terms of integrity and security, so when we have information that would be of interest to them, we shall.
Senator Varone: You shall, which is still voluntary on your part, not mandated.
Ms. Paquet: The way we are interpreting our mandate, it is a must. We need to share the information when we have it.
Senator Varone: Does the RCMP share with you at all levels?
Ms. Paquet: Yes, the RCMP comes to us when they are looking for information to support their investigation. That was in reference to the 266 intensive investigations where we collaborated with the RCMP on over the last year.
Senator Varone: Thank you.
Senator Yussuff: Thank you, Ms. Paquet, for being here. I don’t envy your responsibility and the challenges you face. Money laundering is a very sophisticated process, and individuals and groups that are involved will do everything possible to ensure you don’t find their efforts and crack down.
Given my colleague’s question earlier about whether we’re making progress, let me put it a different way. Obviously, light has been shining more and more on international obligations at the Group of Seven, or G7, and our responsibility to try to weed out money laundering. We’ve had our own expose with casinos in B.C. and other places that have shined the light on it and said that money laundering is prevalent in certain industries and we need to do better.
Given all of this knowledge of money laundering, in terms of your responsibility, would you say we’ve made progress in the last five years compared to the five years before that? How diligent are institutions becoming in detecting but also working with you and law enforcement agencies to do a better job in ensuring money laundering is not part of the Canadian financial system?
Ms. Paquet: I would say that we are maturing. Are we better? I think we are, and we continue to need to be better. At FINTRAC, we launched our new vision last year, which is FINTRAC in real time. It’s not enough to have a vigorous process and provide good information. It needs to be timely for law enforcement to be able to do their investigation.
We launched that modernization, which means we are reviewing the use of our tools, modernizing our tools, changing the mindset of our people to make sure they’re always focusing on being more efficient and getting as close as possible to real time. We are streamlining our processes to increase the number of disclosure packages that we share with law enforcement and national security agencies.
When we launched that process, I spoke to the reporting entities and the financial institutions, telling them that if FINTRAC is able to give itself such a vision and mission, you can do the same. I was happy to see their reaction. They are investing a lot of money to combat money laundering and terrorist financing, and we all want to do better. We all come to work in the morning thinking, what can I do to save more victims today? I think we are doing better. I think it will always be difficult to demonstrate what we have prevented, but definitely, our maturity level is increasing, and we’re not done. We need to continue to become better.
Senator Yussuff: The Canadian public often reads, when money laundering is covered in the media — what is the requirement for you to disclose in terms of your efforts, what you’ve been able to prevent and what you’re also finding? How often is that required? How much of it is public? I realize you have to maintain some degree of secrecy for the survival of the agency. How can the Canadian public learn how this is helping to bring our system into compliance with the international arm and also ensure that they are confident money laundering will not be tolerated in any way, shape or form in our society?
Ms. Paquet: Obviously, when we are working with law enforcement because we have information that we can share to help their investigation, we don’t want to tip off anybody that we are doing that. That’s also part of the problem, but where you will see those results is most often in the media. When law enforcement will have concluded an investigation or will have pressed charges, very often you will see that they thank their partners, and FINTRAC will be part of them.
Senator Yussuff: But are you required by law under your statute to disclose your efforts and your effectiveness to the public? “Hey, listen. Here is a report for our activities this year.” After all, the taxpayers are funding the agency, and they have some responsibility to know what is going on in the agency.
Ms. Paquet: In our annual report, this is where we will disclose all our activities.
The Chair: By name?
Ms. Paquet: By name? No, it will be by numbers, the numbers of exams and disclosures —
The Chair: Thank you. Senator Martin, I know you were following up on a question. Go ahead.
Senator Martin: Yes, I have two questions. One is a supplementary question to what Senator Marshall was asking. But first of all, thank you for the work you are doing. This is a very important area of concern for all of us. I’m from British Columbia, so it’s something we’ve lived with for the last decade in terms of what’s in the news.
My first supplementary is related to the public-private partnerships, or PPPs, and international cooperation that you are doing. But you said that having metrics is difficult. My question was going to be, what are the metrics FINTRAC uses to assess the success of the collaborations? Would you clarify what you meant by that?
Ms. Paquet: What I meant by that is when we try to deter or disrupt criminal activities, it is difficult to number them and to have strong metrics to say the number of them and the impact we had. But on the PPPs, when we work together, we share information. We share context about the crime. We know more about the crime. We are able to develop better indicators. Then we see the returns because we are receiving more reports. When we receive more reports, we are able to do more disclosure to law enforcement.
That’s why, with those public-private partnerships, we really see efficiencies. We are not only seeing it at the domestic level because now we have elevated them in the last year to the international levels. That exchange of information is happening between countries as well.
Senator Martin: Thank you for that clarification. Obviously, this is a growing issue, and it is reflected in your budget, which has doubled from $56 million in 2020 to $112 million last year. The agency lapsed $7 million in funds and achieved only 50% of the targets with the spending of $77 million in 2023. This is from the government’s Departmental Results Report.
My question is, given this significant increase in the budget, how does FINTRAC justify its spending? What steps are being taken to improve accountability and ensure that taxpayers’ money is fully utilized and translated into concrete results? You’ve talked a little bit about it, but it is a significant increase, so would you speak to that?
Ms. Paquet: Yes, we were very fortunate to receive over $175 million over five years in the last four budgets. The reason you have seen lapses is that part of the money is to modernize our IT system. As we go through procurement and the different steps to modernize our IT system, that money is spent just for that purpose. When we will contract and move on with our modernization, that’s when you will stop seeing those lapses. But we are accountable, and we are appreciative of the money that was given to us. We were able to increase our staff by 65 employees because of that money.
We took to heart the fact that not only did we get new authorities throughout those, but we got new money to modernize our system and that new money is really at the core of being more efficient.
The Chair: So procurement is a problem.
Senator Martin: I have a quick question. In terms of modernizing your IT system, is the system interoperable? You have international partners. Can this information and everything else be shared across the board, so to speak?
Ms. Paquet: The system we use to share with our international partners is a secure web, which I was talking about earlier. That system is really how we are communicating with one another, which is completely separate from FINTRAC’s internal system that we are modernizing.
Senator Martin: I see. Thank you.
Senator Fridhandler: Many financial regulatory agencies operate whistle-blower programs or reward programs relative to whistle-blower reporting. Do you operate any of those programs, or do your peers in this space operate similar programs? Would they be helpful?
Ms. Paquet: We have a tip line, but we don’t call it a tip line. We have the possibility for the public to submit voluntary information to us. So there is that. We are under the umbrella of the federal government for any wrongdoing legislation. We don’t have a specific program at FINTRAC, but we are under the federal umbrella.
Senator Fridhandler: Can you briefly describe that federal umbrella and the reward program that exists relative to it?
Ms. Paquet: I would turn to Mr. Blanchette to explain the wrongdoing and how all of that works.
Philippe Blanchette, Acting Deputy Director, Supervision Sector, Financial Transactions and Report Analysis Centre of Canada: It is called the Public Servants Disclosure Protection Act, and that’s in terms of wrongdoing in the public service. Anybody can bring any wrongdoing anonymously, and it will be investigated. The voluntary information request or information disclosure is available to any citizen, business or anybody who would want to flag something to FINTRAC in terms of anti-money laundering or terrorist funding. Information is publicly available on our website. They can provide us that information, and it feeds into our system. When we get it, it feeds into our financial intelligence.
With that voluntary request coming in and the intelligence that we have in terms of transaction, all that information could provide reasonable grounds to suspect that we could disclose in terms of financial intelligence. There is no reward program, no, but there is a way for people to bring up things that they would have seen or experienced in terms of anti-money laundering. We would take that from a transaction perspective, and we may disclose that to law enforcement if there are reasonable grounds to suspect.
Senator Fridhandler: On that second area, what are your comments on your work with virtual currencies or crypto? Do you have tools? Are there gaps that you need to see filled that would be within the potential mandate of FINTRAC?
Ms. Paquet: I will ask Ms. Ryan to answer that question.
Annette Ryan, Deputy Director, Partnership, Policy and Analysis Sector, Financial Transactions and Report Analysis Centre of Canada: Thank you. We have some very robust tools at different levels. Starting in June 2020, we required all virtual asset service providers — essentially crypto dealers — in Canada or foreign crypto dealers who have business dealings in Canada to register with us. They began reporting in June 2021. Essentially, that gives us a vista into how that virtual world has a footprint in Canada. That’s a very powerful way of looking into that space.
We also received investments to be able to have specialist analytical tools that help us unlock some of the specialist technical aspects of it. That, in fact, gives us quite a compelling way of looking into that space and following the money.
Ms. Paquet: I would add that we are receiving good reports from virtual currency dealers. We were able to disclose actionable intelligence to law enforcement and we had results. We also found our first virtual currency dealer last year just using blockchain analytic technology to actually perform the examination.
The Chair: I have a quick follow-up for Mr. Blanchette. Senator Fridhandler was talking about rewards for participation. I am asking the flip side, which is protection. We’ve seen civil servants come forward on the matter of many issues over the last year. That has been a risky operation. We’re asking a lot of questions about, “You can’t say much about TD Bank,” but how do you protect those who come forward?
Mr. Blanchette: Yes, they get the same protection as anyone who submits information to FINTRAC. We are highly protective of our information; that’s the main part of our mandate. When we disclose intelligence, it is based on the transactions and that financial intelligence. It’s not based necessarily on the complaint or the observation that we received voluntarily.
The Chair: I am going back now to Senator Marshall because when you heard the words, “We think there is progress being made,” I could see you wanting to come back in.
Senator Marshall: I would like to know a little bit about your compliance program. When I read your annual report and other documents, I wonder about your compliance officers. Are they on site at the FINTRAC offices all the time, or is there actually a presence out in the organizations which you are responsible for monitoring? Give me details.
Ms. Paquet: Thank you for the question.
Mr. Blanchette, do you want to explain the process?
Mr. Blanchette: Yes, we have a compliance program. We have talked a lot about the exam and getting to the penalties, but really we start by assisting reporting entities. Then we assess, and there are different tools of assessment. When we do an exam, typically, it requires us to be on site. We do have that exchange of information. We go on site. We have periods of time. What happens is an examination could last between 6 to 12 months, sometimes 18 months, depending on how complex it is. There will be a period where they are submitting information to us. We analyze that information. There is an exchange of information, and then we do on site visits as well to those reporting entities.
There are several other supervisory activity tools, like risk questionnaires, supported by evidence. On that, we would do more of a desk audit. That would be done internally. If we have further questions or if we need to go in to check something because we see discrepancies, we would go on site as well.
Senator Marshall: When I was looking at your website and the annual report, I thought about the Canada Revenue Agency and the work that they are doing, say, for example, on the underground economy. Is your emphasis on the education of the institutions, or is it actually keeping an eye on what they are doing? Where is your emphasis? Canada Revenue Agency’s emphasis is on education. Is that where yours is?
Mr. Blanchette: The emphasis is on the whole evolution, right? So we educate, we assess, and then we enforce if we need to. Our emphasis is on the full continuum. We can provide risk questionnaires and go in for an exam. We could do a desk audit or use a targeted approach. For example, if we have high-risk mortgage lenders, we can go in and measure the risk. We might find 15 organizations where we want to have more information. We look to see whether they are compliant with our act and our regulations. It is not necessarily meant to educate at that point. It is really on compliance and whether they are meeting what they are required to meet.
Senator Marshall: Assuming the whole assembly line is 100%, what percentage is education, and what percentage is actual work? When you said the term “desk audit,” an alarm bell went off in my head.
Mr. Blanchette: Yes. Anything that comes out to an enforceable action will have gone through an exam and a rigorous exam. In terms of spending time, the more complex area, where we spend a lot of effort, is when we do those rigorous assessments and exams. That’s where it requires a lot of effort from our folks.
If you are asking me about effort, it is there, but a lot of effort goes to education and making sure they know why we’re doing this and why it’s important to be compliant as well.
Senator Marshall: Thank you very much.
The Chair: I need to come back to Ms. Paquet for a moment because, in answers to several questions here, you’ve said, “We think we’re doing a better job. We’re trying really hard. We feel that we’re doing a better job.” I come back to what Senator Marshall had asked in the first place, which is, how do you measure success? There have to be some actual metrics and checkmarks beside boxes that say, “We have made an improvement. We’re catching more bad guys.”
Ms. Paquet: We’re not in investigation, so we’re not the ones catching bad guys, but I will turn to Ms. Ryan to talk about the framework.
Ms. Ryan: Yes, thank you. A performance management framework has been established and made public. There is a logic model for the entire suite of how the different federal agencies work together to get those results. That was made public in March of 2023 through the Department of Finance website. It speaks of measures of success, yes, for FINTRAC in terms of our assessment and on, and also down the chain in terms of investigations and prosecutions and those measures that are closer to the end of results. That may be in the space of what you are looking for, senators.
Senator Marshall: Earlier, Ms. Paquet, you said there are 13 departments or agencies involved in the chain. Who is the lead? At the end of the day, Canadians, we see ourselves as a money-laundering country. We even have our own term, “snow washing.” Canadians want to be assured we are making progress in this area. You say there are 13 organizations. Who brings them together so they can assure Canadians that we’re making progress?
The Chair: This was Senator Gignac’s point as well. So we just need a —
Ms. Paquet: Out of the 13, the Finance Department is the policy lead, definitely. They are the ones bringing all 13 departments together, but through the 13 departments, we all have different roles. In the same way, we are operational, so we are in the lead for operationalizing and ensuring compliance with the act and regulations. The act is responsible for the sanction regime. The RCMP is responsible for enforcement. The borders are responsible for what is happening at the borders. The policy lead is definitely the Finance Department, but we all have our different responsibilities, some that are niche and some are on which we all work together.
The Chair: When you say policy lead, that’s not — I think what people are trying to get at is, who is in charge of these operations? Yes, you can or may and sometimes you must talk to one another, but if a whistle-blower comes to you and says, “We believe this money-laundering activity is going on,” do you automatically take the lead because they came to you? Or do you hand it off to the RCMP? We are trying to figure out how, operationally, it functions.
Ms. Paquet: If a whistle-blower comes to us, yes, we will do it, but the overarching lead is the Department of Finance.
The Chair: But we’re talking about actual events — not thinking big thoughts or frameworks about how the government responds. We are asking how we deal with bad behaviour. How do we get at it more quickly in real time? How do we involve all the agencies? Who decides whom to bring to the table in the first 15 minutes?
Ms. Ryan: Right. We do have clarity among ourselves in terms of who is responsible for what step in that chain. The director described how whistle-blowers can come to us through our portal that’s on our website. It describes how people can bring information to us.
We also maintain buffers for privacy and constitutional rights which are important as well, to define why we have separate entities. But we have rules and procedures as to when and how we can hand that off to RCMP who then have established rules and procedures on how they can take that to an investigation and lay charges and how to hand off to prosecution.
The role of the Finance Department arises when there are gaps in terms of legislation, whether it is in our statute or in the Criminal Code, or when there are gaps in investments and so on; that’s the role they play. But there is considerable clarity among ourselves about who does what and how we coordinate.
Senator Loffreda: I’d like to ask a question on the risk-based approach. Analyzing risk is always a priority. How do you implement a risk-based approach when assessing institutions? What criteria are used to prioritize certain institutions, and are some institutions audited more frequently based on what has occurred recently? My question was on current trends and emerging risks, but will you modify your risk-based approach based on what happened with TD Bank?
I would just like to make a comment that I have often heard that Canada is not doing an exceptional job with respect to money laundering, but I looked at Basel AML Index, which ranks Canada 94 out of 152 countries with a score of 4.68 out of 10; Transparency International Canada ranks Canada 13 out of 180. Maybe you can comment on those statistics. With the comments I heard this morning, I would believe we would rank a lot worse than what I’ve seen here.
Mr. Blanchette: I can talk about the risk-based approach. In terms of the risk-based approach, in the last two years, we have reorganized ourselves to go into enhanced risk-based. That allows us to tackle, like you just said, trends and analyses. We were doing it by cycle before. We were going through a cycle, and every five years, the bank had a cycle and went through the exam and so forth. In risk-based analysis, we are considering different risks for different sectors in order to decide which sort of supervisory activity we will do and with whom and when. That’s our risk base.
We are looking at indicators — anything from transaction volume, types of service, history of compliance — any events that would be signals in the media. These are all things that inform our risk base. That allows us to also evolve. Our director talked about real time. That allows us to evolve our compliance model, our compliance efforts and supervisory activity in the moment, which means that when there is an event, we could decide to go in and do a supervisory activity. It doesn’t mean that because it wasn’t on the list at the beginning of the year that it wouldn’t change as we are moving forward.
That’s how we measure risk, but there are several risk indicators. There are about 23 risk indicators that we are looking at, but these risk indicators also change. When we determined our risk, we based ourselves on the national inherent risk in terms of anti-money laundering and terrorist financing, which is published by the Department of Finance Canada every few years. The last one was published in 2023. That is about trends in money laundering and terrorist financing. It determines the risk per sector per activity, and that informs our risk-based model.
The Chair: Thank you for that.
Senator Loffreda: How about our assessment with respect to our rankings with respect to money laundering? We could do better, but how do we rank internationally?
Ms. Ryan: If I may, senator, we are subject as a country to a very rigorous international peer review every 10 years. In the last review by the Financial Action Task Force, which is the international peer review body, Canada was reviewed as having many strengths that do not necessarily figure in media reporting about Canada as a regime. For example, in that last review, Canada was deemed as having a very reasonable approach to risk-based supervision of [Technical difficulties]. We are currently getting ready for the next 10-year review by international peers.
The Chair: Is there an international ranking? I think that’s what —
Ms. Ryan: There are rankings against a range of criteria right now.
The Chair: There is probably not enough time to get through all of those things.
Senator Varone: I fully understand that you are one of 13 organizations that are led by Finance, but don’t you suffer a credibility loss when the largest fine levied was against a Canadian bank, TD Bank, and no one went to jail? No charges have been laid on individuals who perpetrated that crime. In everyday life, crime equals punishment, and the only people who paid in that TD Bank case are the shareholders.
Ms. Paquet: As I said earlier, our mandate is to ensure that institutions are complying with the regulations. It is a non-punitive, administrative process. When we are levying the penalties that we did in the last year, they are related to non-compliance with the act. We are not talking about criminal offences.
Senator Gignac: First, how do you establish your penalties? Because I notice that the U.S. Department of Justice has $1.8 billion tagged on TD. I thought there was one zero missing, but apparently there is only $9 million in penalties from FINTRAC. How do you establish the size of the penalties?
[Translation]
Ms. Paquet: Our legislative framework includes 200 possible violations under the legislation. A guide assesses these violations and determines the associated amounts. In TD’s case, we acted to the full extent of our authority.
Senator Gignac: People are surprised about how little Canada imposes.
[English]
Is it the same model in the U.K. with 13 different departments? Because the U.K. central bank has much more power — monetary policy, financial stability, regulation, you name it. Are we structured in the same way as the U.K., or do we have a lead out there? Do you talk to your counterpart?
[Translation]
Ms. Paquet: Yes. We talk to our counterparts all the time. However, we’re structured differently.
[English]
Ms. Ryan: Yes, it is absolutely similar in all countries. There are a number different departments, agencies and ministries that cooperate in the same way as Canada. In the U.K., if I may, the financial intelligence unit is not housed within the same entity as the supervision, which, from their perspective, is something on which they have thoughts about how it affects their ability to coordinate.
Senator Gignac: To answer the question that you have been asked three times, does the finance minister call the shots, the chancellor, or is it different?
Ms. Ryan: Essentially, most countries are either coordinated by the finance ministry or the public safety ministry. In some cases, there is more coordination through the central bank.
Ms. Paquet: It is important to understand that the financial intelligence units are independent. In no country should examination be directed at the ministerial level. That’s an important criterion that all FIUs need to abide by.
The Chair: Thank you, ladies and gentlemen. Thank you very much for attending today and taking our barrage of questions. I hope we will have you back again.
Senators, as you know, we are doing a study on the mandate review for the Bank of Canada and what should fall under its auspices. We have an expert on this. I’m just so pleased that James K. Galbraith, Professor, Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin is with us. He has written and spoken about this on many occasions and he has joined us on earlier occasions. Welcome back to this committee. I’m sure you have some opening remarks, Mr. Galbraith, please go ahead.
[Translation]
James K. Galbraith, Professor, Lyndon B. Johnson School of Public Affairs, University of Texas at Austin, As an individual: Thank you. I’m pleased to be here with you today, especially given my family’s Canadian roots.
[English]
The Canadian monetary policy framework is a standard statement of conventional economics based on the pleasant fiction of a central bank with psychological reach into the inner workings of Canadian society and freedom of maneuver with respect to conditions and decisions taken to the south. This is the meaning of language about “targeting,” “expectations,” “credibility” and “independence.”
In fact, since around 2015, the Canadian dollar has moved in a very narrow band relative to the U.S. dollar. The range is roughly 1.2 to 1.4 compared to a low of 1.6 in 2002 and a peak of 0.94 in 2007. This, and a glance at Canadian interest rates relative to those set in the U.S., tells the real story. It follows that inflation, unemployment and growth in Canada also closely track their U.S. equivalents. It could scarcely be otherwise.
The 2% inflation target was enunciated with pride in 2021 based on the low inflation of the preceding years, reality hitting when prices started rising post-pandemic, driven by energy costs and supply-chain disruptions.
Faced with the conditions that actually generate increasing prices, the central banks of the U.S. and Canada could do nothing, except, of course, raise interest rates, with the intent of imposing an economic slowdown and bringing prices down through hardship.
They started doing this in March 2022, and the U.S. rate had risen only 75 basis points when the inflation rate peaked in June 2022 and began to decline. There was no intervening recession, rising unemployment, nor any other standard effect of restrictive monetary policy, and there hasn’t been since. So one must either believe that central banks indeed have a magical grip on expectations and behaviour or that their actions were irrelevant to a rate of inflation that was likely to decline in any event.
In the U.S., despite what economists and central bankers often say, the Federal Reserve is not legally independent. It is a creature of Congress, and has a mandate of Congress of full employment and price stability. The main advantage that this has is it prevents the central bank from speaking frankly and not to operate under the pretense that it’s restricted to a single target when, in fact, it’s pursuing other priorities.
It may be that employment and growth targets cannot be hit with any precision by central bank policy, even in a large country like the United States. Fiscal policy was called to the pandemic. It was obvious, but it’s also the case that central banks cannot control inflation.
Indeed, the entire practice of assigning inflation control to central banks, as economists concede, is a long-defunct textbook theory. Perhaps this can be taken into account when the monetary policy framework is revised on the schedule now foreseen.
I thank you for your attention, and I look forward to any questions that you may have.
The Chair: Thank you so very much for your frank and focused remarks. It’s going to help us very much with our study on this. Let’s begin with Senator Loffreda.
Senator Loffreda: Thank you for being here this morning. My daughter went to the University of Texas in Austin. I’m a little biased, but it is a great university. Thank you for being here.
We could be critical of Canada’s monetary policy, and I think at times it leads to better future policy and better thought and measures. But if we look at the last 50 years, how critical should we be? My question is more if you can elaborate on particular strengths or weaknesses that stand out that could be improved.
I do know our Bank of Canada’s mandate is different from the feds, obviously. With Donald Trump’s recent victory and potential imposition of tariffs on Canadian goods, should additional emphasis be placed on managing currency evaluation? You discussed it briefly to make us more internationally competitive. What specific adjustments or strategies could potentially strengthen the framework we currently work in?
Mr. Galbraith: Well, I didn’t frame my remarks in order to criticize the actual policy of the Canadian central bank, but rather to discuss the framework, which is really clearly not closely connected to the policy as it actually is. As you look at the numbers, it’s clear that since at least 2015, the exchange rate for the Canadian dollar has been held to a relatively narrow band with respect to the U.S.
I don’t have a view as to whether that is a good or bad policy. I think the reasons for it are reasonable, and it reflects effectively the fact that we’re in a single, integrated North American economy.
If you depreciated the Canadian dollar in order to achieve international competitiveness, it would have two effects. One would be, of course, prices of things coming across from the United States would be higher. Secondly, you might get in over some substantial period of time some advantage of third markets, but that’s a very slow process.
I’m disinclined to believe that you can use the exchange rate manipulation, if you like, to improve the competitiveness of Canadian industry. That really has to be the subject of a concerted industrial strategy focused on particular targets of opportunity and on the competencies of Canada’s firms, particularly those in industrial areas that have the potential access to world markets.
Senator Loffreda: Thank you for that. You’ve mentioned this single, integrated North American economy. I like that, but given Donald Trump’s recent victory and his isolationism priority, do you still believe we will have that going forward? How should we adjust monetary policy, according to your perspective and thoughts on that?
Mr. Galbraith: I do think that the Trump strategy, while it may impose some additional tariffs on Canada — and that has happened in the past; it happened under George W. Bush with softwood lumber, as I’m sure you remember — but detaching Canada from the United States is not a practical proposition, given the fact that the geography of the two countries is not something that an American president with all of his powers can do much to change.
If anything, the effect of a more protectionist policy in the United States will be on corporations operating in Europe. For example, he may move factories to North America. And corporations operating from Asia, which may find it advantageous, for example, in the case of Chinese electric vehicle producers, simply not to exercise much energy in the North American market and sell their wares in other parts of the world, which they can do very successfully.
Senator Marshall: Thank you very much for being here this morning. We’re seeing a lot of media articles regarding the Canadian dollar, expecting it to slide. You mentioned in your opening remarks — or I got the impression you were saying that — you don’t think that’s going to be an impact of the Trump presidency. Is that correct? We’re expecting the dollar to slide quite significantly with the imposition of tariffs, et cetera. Could you just elaborate on that a little bit with regard to what you were saying earlier?
Mr. Galbraith: I want to avoid making a forecast because it will obviously depend upon —
Senator Marshall: I’m doing my best.
Mr. Galbraith: The observation I make is that for the last decade, the policy has maintained a relatively stable parity. Before that, there were considerable fluctuations, but that was the policy over the last decade.
How is that done? I think largely by maintaining the parity of U.S. and Canadian interest rates. You attract the interest rates with the two countries; they’ve moved very closely together. They came down in the periods of crisis and the Canadian interest rate started rising when the U.S. ones did. That suggests to me that this is mainly a phenomenon in the financial markets.
Now, could it be affected by some new factor like major tariffs? Yes, possibly.
Senator Marshall: You’re saying at this point in time you think that concern is unfounded?
Mr. Galbraith: I’m not saying it’s unfounded. It just hasn’t happened yet. Being averse to exposing myself to having made a false forecast, I try to avoid making them all together.
Senator Marshall: Thank you.
[Translation]
Senator Gignac: Welcome, Mr. Galbraith. I’m honoured that you accepted our invitation.
[English]
Correct me if I’m wrong, I think you were a witness when we revised the dual mandate of the Federal Reserve in the U.S. You gave testimony in 2007 and before.
Could you elaborate because we are analyzing three things, one of them being whether the Bank of Canada should adopt the mandate of the Federal Reserve or stay with the only mandate they have about price stability? Could you summarize what influenced you? I think you recommended the dual mandate or we conduct the dual mandate of the Federal Reserve? Because here we ask ourselves if we have to do the same thing.
Mr. Galbraith: Yes, thank you. I was a very young member of the staff of the Banking Committee in the House of Representatives from 1975 into the late 1970s when a small group gathered to draft what became known as the Hawkins-Humphrey Full Employment and Balanced Growth Act, which included provisions on monetary policy. In fact, they were relatively minor provisions of the bill. I was the person who drafted an original version of those provisions.
In any event, they folded the Federal Reserve into the general mandate for policy in the United States, which specifies full employment, reasonable price stability, balanced growth and a range of other targets. In fact, it’s a multiple mandate, but it’s come to be seen as the dual mandate.
That happened just before these notions of inflation targeting and initially monetarism took control of the ideas that predominated the economics profession in the 1980s and into the 1990s and beyond. The Federal Reserve had that mandate in place and it was never changed. What happened contemporaneously — and I think of considerable importance in line with this — was that the Federal Reserve came under a requirement to present a report on monetary policy targets and general economic targets to the Congress on a regular schedule, which eventually settled. It was once a quarter, but it eventually settled into every six months and it has been that way ever since. This has become the principal way in which the chairman of the Federal Reserve actually speaks not only to the Congress but to the broader public. It has greatly improved the transparency of Federal Reserve operations.
Before that, a great problem we had on the congressional side in the 1970s was that the central bank was extremely secretive and did not wish to speak to the elected representatives of the people. That has changed dramatically, and you can see this.
I think the advantage of the dual mandate is not so much that it imposes a constraint on Federal Reserve activity, but that it gives them the flexibility to, in fact, be transparent and accountable. That’s helpful to them, which is why they’ve never lobbied to change the requirement, because they can use, if you like, the megaphone that’s given to them by Congress to convey their positions to the government, the media and the public. This, I find, is a useful thing to do.
That’s the way the process has evolved over practically 50 years since I was involved as a member of the committee.
Senator Gignac: Thank you for your very concrete answer. If the Bank of Canada increased transparency, we can achieve the same objectives without having a dual mandate. When I read between the lines, this is the advantage of more disclosure and transparency, but maybe we can achieve that without having a dual mandate, or do we need a dual mandate? That’s my question.
Mr. Galbraith: If you look at the framework that was put in place in 2021, you will find it deals heavily in these constructs like expectations and flexible inflation targeting the 2% inflation target. It’s clear that from the moment that this was published, a 2% inflation target was not realistic because inflation was going up worldwide, especially in the United States, and Canada. The central bank really had no purchase on that and it could do nothing except follow the U.S. central bank in raising interest rates, which was also not useful in terms of dealing with inflation. It had no effect on it. What did was the sale of the Strategic Petroleum Reserve and clearing up the supply chain from China. Those things brought the increase of prices back under control eventually, but the central bank essentially was in a performative role. Its policy had very little effect.
In thinking about the framework, one should have a candid discussion about what the lessons of the last few years actually mean for all of this essentially theoretical discussion that is in the present framework.
The Chair: That’s exactly what we’re doing because that’s where the Bank of Canada itself is. It’s looking at this whole issue of the dual mandate but through the lens of what happened post-2008 and, of course, post-pandemic.
Senator Yussuff: Thank you, Mr. Galbraith, for being here. Looking at the responsibility of the Bank of Canada, which doesn’t have a dual mandate. Price stability and inflation have been its core focus. It carries out those responsibilities with some very blunt instruments because it can only increase interest rates to deal with inflation, and a side effect of that is unemployment rises at the same time until inflation comes down. If the bank is successful, then we deal with the other social issues that come out of its policy.
Now, if you had a dual mandate, would that be a bit of a balancing act for the bank to try to achieve, recognizing that great harm can come by just increasing interest rates when you’re not looking at how people might be able to provide for their families to a large extent? Given your experience with other central banks around the world, do you think this is a good direction for us to look at in terms of the central bank here in Canada?
Mr. Galbraith: I think it’s a good direction mainly for the reason I just gave, which is that it helps the policy climate discuss frankly what’s going on.
In terms of dealing with inflation and unemployment, I am strongly in favour of a whole-of-government effort based upon the actual sources of inflation, which is why I stressed that what happened to bring the rate of increase of prices under control in the U.S. in 2021 was the sale of oil from the Strategic Reserve, which broke the oil price, and that brought the gas price down and then things began to sort themselves out. That wasn’t the Federal Reserve.
One has to be careful not to assume that just giving them a different mandate and only the same instrument, which is interest rates, is going to achieve very much.
The other thing I would just note here is that rising interest rates, while in the 1980s that had a very serious effect on the industrial sector, on unemployment, and they broke the trade unions and the inflation rate came down as a result of those things. In this cycle, none of that happened. Why not? A couple of reasons. One is the industrial sector and the trade unions are not as strong as they were. The other is that with a very large stock of debt and payment reserves on the banks when you raise interest rates you’re putting money into the economy. So there’s a fiscal channel which is much stronger than in the 1908s. The Federal Reserve effectively did what it always does and the wheels basically spun in the sand. The inflation rate came down anyway, but these were two independent processes.
Senator Yussuff: Given the world is evolving in a very different way, globalization is the norm, we have to connect with each other, do you think these mandates are still relevant in the context of the geopolitical reality we deal with in the integration of the economies around the world?
Mr. Galbraith: That’s an excellent question. Fundamentally, the low inflation of the last 30 years was a product of globalization. There were two major forces. One was a relatively big drop in commodity prices from the middle 1980s, and the other was the entrance of China into the market for world manufacturers, which basically meant that they sold for 30 years at stable prices. The U.S. monetary policy, let alone Canadian policy, had nothing to do with either one, other than setting the conditions for them at the outset. I think that’s right.
It’s helpful to have a candid dialogue with the central bank, but a candid dialogue can’t be based on a completely artificial construct. That’s the problem with not only the framework that’s in place presently, but with the inflation-targeting framework, generally speaking, as taken up by many central banks. They’re operating because this is what economists are trained to think, but they’re not thinking clearly about the conditions that they’re actually operating under.
The Chair: Could you lay out for us, Mr. Galbraith, your notion of how this might operate better? Everybody has had a chance now to think a little bit about what happened during the pandemic and afterward. We even heard from our own governor here, very tactfully offering some suggestions that the ongoing spending, after the worst of the pandemic had been dealt with, was problematic in terms of him meeting his targets, reinforcing your entire point that it’s one instrument alone.
How would you lay it out if you were starting from scratch or if we’re going to have central banks? How would it function in a way that it could be reactive in real time and be more impactful?
Mr. Galbraith: From a constitutional perspective, starting with looking at the U.S. case, the central bank is a creature of Congress. It’s created by the Federal Reserve Act. It’s accountable to the Congress. Under differing circumstances — and circumstances change all the time — I wouldn’t propose an advance of universal formula for policy. The way you do it is that you have them come up regularly, and you have a range of independent perspectives. You pose the questions, and you make them respond to those questions. Once that process is working well, then you have a chance to meet the case, the circumstances that you’re facing at any given moment.
Who predicted the pandemic? I know I didn’t, but when it happened, certain steps had to be taken, and it imposed a big responsibility on Congress and on your Parliament to act, and you did. This was something that is generally the right way to proceed, and it’s the great advantage of this regular process, that Congress retains that authority.
However, once you allow the economist to say, “The purpose of all of this is to deal with credibility and expectations and target an inflation rate that they can’t control,” then you’ve clouded the dialogue in such a way that you’re really not speaking candidly, and therefore, you are not likely to be able to meet the case and meet specific problems as they arise.
The Chair: In terms of the mandate here, the bank appears before the House and Senate committees, but ex post facto. Every time they make a rate decision, they come to us. There’s not supposed to be any direction between government and the bank, but there has to be some coordinating process.
Can you give us your thoughts on that relationship?
Mr. Galbraith: I see no reason why an elected government should delegate an important power, including the interest rate power, exclusively to a so-called independent central bank. It doesn’t make any sense to me. It’s important to have a central bank with competent people who have appointments that are not going to be revoked for doing something that may be unpopular, but there’s no reason why the government should not be engaging them to give a full account of themselves.
It is possible in serious situations for the government to direct the central bank. I don’t have any problem with that either. In fact, I’ve drafted resolutions for the Congress in the early 1980s to try to persuade the Federal Reserve that it was in their political interest to reduce interest rates in late 1982. I don’t know if it had an effect on the Federal Reserve, but they did reduce interest rates, so I’m inclined to look back on that and say that it was at least the constructive thing for a person with some influence inside the Congress to have done.
The Chair: The Canadian relationship, the frankness of those discussions and the public nature of them is a little bit different. I know you watch it from afar. Do you have thoughts on how it operates here versus where you live?
Mr. Galbraith: I cannot give you a useful answer to that, I’m afraid. My bandwidth isn’t wide enough to be able to answer that.
The Chair: I appreciate that.
Senator Martin: In your opening remarks, you indicated that the actions of the central bank in raising interest rates were irrelevant to bringing down inflation. If I understand you correctly, our central bank has imposed a world of hurt upon Canadians to no benefit. I’m sure that’s not what you’re saying. Would you elaborate on your previous comments?
Mr. Galbraith: The rise in interest rates, which began in March 2022, had preceded by only three months and had only preceded by 75 basis points when the peak of the price increases passed in June 2022, and the rate of increase of prices have been falling ever since. That’s the first point. You cannot possibly argue that there was a magical three-month effect of a small interest rate increase when all the major increases in interest rates still lay in the future and hadn’t even been announced at that point. That’s the first thing, I would say.
The second thing is that the only mechanism for interest rates to affect the inflation rate is through their effect on the large economy. That is to say, by slowing growth, raising unemployment, discouraging wage settlements. This is the way the theory is supposed to work. Yet, there was no such effect from the rising interest rates.
I would not have done them. I don’t think they were entirely benign because they froze up the housing market and had other consequences. I would have taken a different course if I had been the policy-maker and if I had the power and discretion to act, but we didn’t get a recession. We didn’t get a rising unemployment rate, and the inflation rate came down anyway. It’s not very easy — in fact, I think it’s practically impossible — to draw a link to find the gearing that would connect the rise in interest rates to the decline in inflation. Those things keep being said in the press, and we talk about a soft landing, and the fed gets credit for it, but just thinking about this as an economist and what sorts of instruments or linkages were supposed to exist between the policy and its effect — we don’t observe them.
I would take the alternative view, which was that the economy suffered a shock to costs. Oil prices, food prices, the supply chain and some other factors related to the way housing prices are calculated. Those things were intrinsically transitory — not in something that would go away in a month, but something that would pass through the system in the course of 18 months. That was roughly what happened.
If the Federal Reserve had done nothing, it seems to me that the overall consequences would have been very similar to what actually occurred.
Senator Martin: The only thing I would say is, what happened? Even the smallest changes impacted families across our country, devastating many of them. Thank you for that clarification.
Mr. Galbraith: I don’t disagree. I think it did have an effect on people’s costs, on housing and so forth. There’s no question about that, but that’s not the channel that would bring the overall inflation rate — oil, food and everything else — down.
Senator Loffreda: Thank you for your comments. They are very insightful.
How important, based on your previous comments, is coordination between fiscal and monetary policy in Canada? We look at the bank’s independence. A substantial number of central banks are legally independent across the world. Independence varies in practice. Some may experience government influence, as we both know. Are there lessons from other economies? Are there specific examples of other countries or monetary policies that Canada should consider in refining its own framework?
Mr. Galbraith: There are, certainly, historical examples of countries or periods when the central bank did not operate independently. In crisis periods, it is not appropriate for the central bank to be out on its own. I will point to one specifically, which is something that I have considerable familiarity with. During the Second World War, the responsibility for controlling inflation in the United States, for keeping prices under control, was delegated to an agency, the Office of Price Administration. The deputy director for prices in that agency, from 1942 to 1943, was my father, a recent emigrant from Canada. They succeeded in this, but nobody said the Federal Reserve was there to control prices during the Second World War. The Federal Reserve’s job during the war was to keep the bond rate at 2% and to make sure the financial markets continued to function. It was a very small role.
It was only in the post-war period that we began to hear from a particular part of the economics profession that the central bank was the key agency for dealing with the inflation rate. That never seemed to be a plausible argument, but I believe that the evidence of the pandemic in the last five years clearly shows that it is not a plausible argument. We need to revise our thinking and move away from a set of doctrines that were extremely nationally specific, that is to say that the model of a country with autonomy, as we discussed a few minutes ago, that most countries don’t have, and extremely mechanistic in terms of the control of exactly what expectations, money supply and interest rates. That is a little fuzzy, but whatever it is, the central bank’s job is to control the inflation rate.
That is where one needs to re-examine things and say, if you have a problem, how do you deal with it? In fact, practically speaking, in 2021 in the U.S., we sold oil from the reserve. That was the anti-inflation policy that actually made a difference.
Senator Gignac: I have two questions.
The first is related to the 2% inflation target. Canada could not really adopt a different target than the U.S., and following what you have mentioned, I agree that 95% of the inflation behaviour between 1990 and the pandemic was related more to globalization and so on. If tomorrow you are consulted by the Federal Reserve, do we change the 2% target to a 3% or 4% target in this new global reality of fragmentation and so on? What would be your opinion? Do we stay with 2%? Or do we think about the possibility that it adopts a different target than 2%, which could be much more difficult to achieve in the new world where we are in right now?
Mr. Galbraith: There was some talk by some economists about, for example, recommending that the Bank of Japan to raise its inflation target. I believe they were asking the bank to do things the bank couldn’t do.
I have no problem with a governmental target for, let’s say 2% inflation and 3% unemployment if it is a whole-of-government target and you use a broad spectrum of policies to hit that target and recognize that there are things happen from the outside that will affect you and that you may not have full capacity to deal with them. That’s a reasonable way to proceed. But saying it is the central bank’s responsibility to hit a 2% or 3% target, whatever you set, and that when the inflation ticks above it that they should raise interest rates, this is essentially similar to the medieval practice of tapping a vein for blood whenever someone is showing a bad humour. It is a very primitive practice and one that is not suited to the complicated situations that actual economies face.
Senator Gignac: It is not, per se, in our mandate, the specialist today. But since you are Canadian and you have a lot of expertise, I want your opinion.
In the U.S., the federal governor is free to speak. They can vote against the federal chair, and it is all public. We can figure out that it is not unanimous. In the U.K., the deputy governor is being nominated not by the governor but by parliamentarians and they can publicly disagree. In Canada, sorry to mention, it is more of a one-man show. They decide about the deputy governor, first deputy governor, and we have no clue what exactly is going on with the monetary policy. We have a clue, but we don’t have this final disclosure.
Is this something that we have to look at more, the accountability and the way they nominate the deputy governor in Canada to have a more free-speaking and more diversity of opinion? Because right now we have no diversity of opinion from o coming r central bank.
Mr. Galbraith: I think you put your finger on an extremely important problem, particularly at a time when the discussion should be unsettled and open. To have a single person as, essentially, the Delphic oracle on these questions is going to get you into trouble. We have had times when the Federal Reserve chair was seen that way in the United States, because of personal prestige or just media savvy, but the reality is that the Federal Reserve is a partly decentralized institution with a dozen regional banks. By the way, they could have functioned or were originally designed to function as industrial development of finance institutions, and they operated this way is the Depression, but what they serve now is mainly to provide a diversity of economic views. So the diversity is relatively minor. In my view, it could be much wider, but it is better than nothing. It does mean that there is a collective gathering every six weeks to discuss these things. You have to get an airing of different views before the institution comes to make a decision. That’s constructive. That increases the legitimacy of whatever the Federal Reserve is doing in the United States.
The Chair: We are looking for these issues. Obviously, more accountability — we keep asking for that, too — and more transparency in the process. As I mentioned earlier, we questioned this post facto and never prior to.
I want to go back to this notion, because when you spoke about it, it struck me as an interesting idea — in World War II, setting up the Office of Price Administration as separate and apart. Is that a model or an idea that could and should be considered when we hit a crisis, like a pandemic? We kind of take it out of the central bank and say that we’re going to have this body that is going to try to manage this and recommend ideas to the whole-of-government, bank and corporate sector a different way of trying to deal with those. As you say, in the U.S., the lever they used was the sale of the oil reserves, and that kind of accomplished that goal. To have a more public discussion about where we are at, and what is possible so people can react to it in real time.
Mr. Galbraith: In my view, when you really face a crisis, then it becomes the responsibility of the elected government to act in a decisive way and to be very open-minded and pragmatic about how you approach whatever the problem is that you are facing.
We did see that in the pandemic that the Congress moved very quickly. We saw that also during the financial crisis in 2008. I’m not saying it was the best solution, but the Congress did act, and it acted quickly.
I think that a government needs to have technical capacity to implement those decisions. There needs to be a sort of reserve ability that can be brought to bear in a crisis. If you come into a crisis and you discover there’s nobody at home who can actually respond, you will be in trouble.
It does seem to me that, in a crisis, one cannot be, let’s say, wedded to the shibboleths that prevail, even if they prevailed for half a century. That may be the reason you were in the crisis to begin with. Open discussion and planning ahead in the legislative framework are important steps in the right direction.
I’m not saying that I would implement an office of price administration. There might be some other strategic steps that one could take that would be effective. In the pandemic, for example, and in this inflationary period, we saw a lot of businesses essentially reaching to increase their margins. They were blamed for doing it, but they did that because they were faced with uncertainty. Their costs went up; maybe they would go up more. Competitors were raising their prices. If they didn’t raise theirs, they would suffer, relatively speaking. That tends to be a process which will give you more inflation than you would otherwise have. A decisive intervention to calm things down might have had the effect of reducing that shift basically toward profits and to the reduction of real wages and living standards in the post-pandemic inflation.
I would certainly consider those steps if I had the flexibility and, let’s say, the expertise on hand to move in that direction. But, of course, if you are just saying, “Hand it off to the central bank,” which is what President Biden basically said, then you are cutting yourself out of the possibility of doing things that would give you better outcomes.
The Chair: Is there a system that you think is in place and operative — a government, a country — where this works more effectively? As we look at your system, it is much more transparent and open and reactive. Ours is pretty closed. The relationship between the two, although it exists, is not acknowledged particularly. Is there something that would work better based on what you have seen somewhere else?
Mr. Galbraith: I’m not a big fan of going around and pulling models out from other countries, which have, in many cases, very different political systems. But I think the best way to proceed is to look back at our own histories and ask, “How did we do this when the chips were down, when we were faced with a serious emergency?”
One of the things that we have done — and certainly in my lifetime, I’ve seen this — is to try to erase the memory of those episodes. We’ve seen a lot of, “Oh, you can’t do that because,” then it’s never quite clear why not or it’s because it failed in the 1970s. There’s not really been a close examination of whether that’s, in fact, the case.
The first thing to do is go back and look candidly at our own histories and keep those mechanisms on reserve and, when we might need to, we can pull them out and use them again without changing our constitutional systems or our democratic procedures and parliamentary sovereignty and all the kinds of things that make us the kinds of societies that we, generally speaking, prefer to be.
The Chair: Very interesting point.
Senator Yussuff: One last question before we go. Based on your point, Mr. Galbraith, that central bankers in general — there is some difference in the United States — are more often not accountable to the public. Quite often, they are protected and guarded from scrutiny and criticism because they do their thing, and we kind of leave them alone because they are like magical politicians in their own way, and we’re not supposed to interfere in their business. But more often than not, the public is left in the dark, trying to understand the impact that central bankers are having on their lives. More importantly, people are not understanding what the bankers are doing and whether it makes any sense in their own lives.
Our political system here in Canada is exactly that. The central bank was given the bulk of the responsibility to get inflation down. Despite the fact that interest rates have risen in a significant way that we have not seen in two or three decades, the politicians basically guard themselves. “Well, you know, we have to let the central bankers do their thing until we get inflation down to the place where we can feel better.” Hopefully, magically, all the other things will return. Employment will go back up. The economy will function the way we want.
How do we build a more democratic way so that central bankers would be more, I guess, human, in regard to the decisions they make but also in the impacts they’re having on the lives of their citizens?
Mr. Galbraith: I couldn’t agree more, senator. I really couldn’t agree more. A big change happened, and I was part of it, in the mid 1970s. Up to that point, the central bankers in the U.S. simply resisted speaking to the Congress and, therefore, to the public. They might give a talk to a protected audience, but they didn’t want to answer questions from informed, elected representatives.
What we established, beginning in 1975 and putting it into law in 1978, was that they had an obligation to do that on a regular basis and to actually answer the questions. The result of that, over a period of years, really with some major turning points — I didn’t particularly like Paul Volcker’s policies, but he was a major factor in advancing this because he was a self-confident person. Plus, the quality of central bankers in the U.S. dramatically improved. They became comfortable in defending themselves and being responsive to the Congress, to the press.
I don’t think the quality of the questions that they get from the Congress has improved. Quite the contrary, and that’s a problem. But for the quality of their willingness and ability to deal with their roles in public, there’s no comparison to what it was like 50 years ago.
I really do recommend that you give it a try, bringing your central bankers to account. You will see, over time, that you will get better central bankers.
Senator Yussuff: Thank you.
The Chair: Excellent. Thank you very much. We will wrap up our session for today. This has been very helpful as we are on a bit of a deadline to do our report on this issue. You’ve been very specific and very helpful on that. Our thanks to James K. Galbraith, Professor, Lyndon B. Johnson School of Public Affairs, University of Texas at Austin — a great Canadian connection. Thanks for always saying yes.
[Translation]
Mr. Galbraith: Thank you. See you next time, perhaps.
The Chair: See you next time.
(The committee adjourned.)