FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Wednesday, May 26, 1999

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[English]

The Chairman (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I'd like to bring the meeting to order and welcome everyone here this afternoon. Pursuant to Standing Order 108(2), we are considering the Bank of Canada's Monetary Policy Report, May 19, 1999.

I'd like this opportunity to thank Governor Thiessen and Deputy Governor Freedman for making themselves available. We always look forward to your comments.

You've been here a number of times, so you know you have approximately 10 or 15 minutes to make your introductory remarks and then we'll engage in a question and answer session.

Thank you, Governor.

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Mr. Gordon Thiessen (Governor, Bank of Canada): Thank you very much, Mr. Chairman and members of the committee. It's always a pleasure for us to appear before your committee following the publication of our Monetary Policy Report.

We released our ninth report last Wednesday. The Bank of Canada began publishing these reports on a semi-annual basis four years ago as part of our effort to increase the transparency and accountability of the bank's conduct of monetary policy.

[Translation]

The main focus of every Monetary Policy Report is how well Canada is doing in managing inflation. But controlling inflation is not an end in itself. The objective of monetary policy is to help create and maintain a monetary climate that favours good economic performance, an economy where growth and employment are strong and Canadians feel prosperous.

The Bank feels very strongly that the best thing that monetary policy can do to help long-term growth in the economy is to preserve low and stable inflation. Indeed, I believe the low and stable inflation rate we have had in Canada in recent years has helped us through some difficult times. However, I am also happy to report that the global financial system is much more stable than it was at the time of my last appearance before you six months ago.

The shock from the financial crisis in Southeast Asia, which began almost two years ago, was compounded last August by Russia's default on its external debt. The turbulence that followed has now largely subsided and investor confidence is being restored.

As a result, the outlook for the world economy has become more positive than it was last November. Financial markets have steadied in Southeast Asia, and prospects are good for a gradual recovery there.

In Brazil, the authorities have taken major steps to address their difficulties. Overall, global financial markets now seem better able to assess risk. Interest rate cuts by central banks in all major countries have helped restore investor confidence.

Most importantly for Canada, the U.S. economy has continued to outperform expectations with strong growth and, as yet, no definitive sign of inflation pressure. Nonetheless, there is still a fair degree of uncertainty about the overall external environment, given the divergent performance of the major economies. Japan is still in recession and Europe has been slowing down. Because of this, we are expecting only a slow recovery in world commodity prices this year.

[English]

In Canada, the driving force in our economy has been exports. The strong demand in the U.S. economy, the relatively weak Canadian dollar, and the increasingly competitive manufacturing sector is allowing us to sell into the United States very successfully.

What we're expecting to see now, however, is an increase here at home in consumer and business spending. We believe the improvement in business and consumer confidence that we've seen over the last few months, the better employment picture, and the recent reduction in interest rates are all going to help support domestic spending.

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To be more specific, compared with six months ago, we at the bank have raised our projection for growth in the economy in 1999 to between 2.75% and 3.75%. We have this wide range because of the international uncertainties that I spoke of a minute ago. The high end of this range of our projection is well above the latest consensus among private sector forecasters. If the economy does grow at the higher end of this range, it's likely to be because of stronger exports and more substitutions of Canadian goods for imports due to Canada's good price and cost performance. We believe our economy should continue to expand next year, the year 2000, at a broadly similar pace.

On the basis of those growth forecasts, we would expect the trend of inflation to rise modestly over the next 18 months but remain in the bottom half of our 1% to 3% target range for inflation. We see an increasing level of confidence, both at home and abroad, that Canada's inflation rate will remain stable.

Another source of uncertainty that the bank has to deal with at the present time is in estimating the margin of unused capacity in our economy. If economic activity expands as per our forecast, the traditional way of measuring these things tells us that the current margin of economic slack should be taken up sometime during the course of the second half of next year.

However, the economy does seem to have undergone some significant changes during the 1990s. The traditional estimates of economic slack may no longer be accurate. As a result, what we're going to be doing at the bank is placing an increased weight on a range of economic indicators to help us assess the degree of pressure on the economy's production capacity. What we have in mind are such things as some movement in inflation relative to expectations, the growth of money and credit, wage pressures, evidence of supply bottlenecks, and information provided to our regional representatives across the country from their business contacts.

We are not going to know just how much the Canadian economy has changed until its capacity limits come under more pressure from spending demands than is the case now. While the confidence of Canadians and ongoing low inflation allows monetary policy more room to accommodate demand pressures that will test the limits of capacity, it's going to be very important for the bank to be vigilant in following the array of indicators that I have mentioned. We must not undermine the solid basis of low inflation and low interest rates that has now been established in Canada.

Thank you very much, Mr. Chairman.

The Chairman: Thank you very much, Governor.

We will now go to a question and answer session. We will begin with Mr. Epp.

Mr. Ken Epp (Elk Island, Ref.): Thank you, Mr. Chairman, and thank you, Mr. Governor. Is that a correct term to use? I want to be politically correct here.

I think you have a tough job in your portfolio, and I appreciate the work you do. I have some questions.

You have stated—and I know this is in cooperation with the government and the finance minister—a goal of inflation being around 1% and 3%, and you're anticipating that it's going to be 2% or less this year. In your view, what has been the effect of this?

Just before you answer that, I want to backtrack a little bit. If I look back—and I'm old enough now to remember a little bit of history—in the years when we had quite a bit of inflation we also seemed to have a lot of prosperity. We had students who could go through school without having debt. We had young people buying homes in anticipation of inflation making it easier for them to pay it off in the future. Indeed, that was speculation. But it seems to me that all of these factors would have stimulated economic activity because of the things people were doing in anticipation of there being at that time a reasonable amount of inflation.

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Now there's basically no inflation. Does that not have a stifling effect on the economy, because people have to really think twice before they go into debt in order to get an education, buy a home, or start up a small business?

Mr. Gordon Thiessen: I think what we saw at times in the past was a very short-lived sense of prosperity, a misguided, I must tell you, sense of prosperity because it wasn't really there. It was typically based on borrowing large quantities of money, and then inevitably what happened is that when the various excesses and distortions of the inflation period got to extreme levels, we would end up having a serious recession. That happened to us through the 1970s, leading to a recession in 1980-81, and it happened again in the 1980s, leading to a recession at the beginning of the 1990s. That is not sustainable prosperity of that sort. It really does depend on somehow fooling people, and that just doesn't work for long periods of time.

Mr. Ken Epp: I look at the present, and even in your report you indicate that one of the reasons we are somewhat shielded from the vicissitudes of some of the other countries is that, because of our low dollar, we've been strong in export. Now you're even anticipating that there's going to be an increased market in Canada for Canadian goods because they're competitive even in our own country, compared with imported goods, due to the deflation of the dollar. That too is not a real economy. It's one based simply on the value of our dollar. How is that different from inflation, which is also a value-of-the-dollar measure?

Mr. Gordon Thiessen: But it is a very different one. What we're going through in this recent period is really the result of having the prices of the prime rate commodities we export go down substantially, basically by 20% when you measure it from the levels in early 1997 right through to the end of 1998, and our dollar is responding to that. What it's doing, basically, is encouraging resources and people to move out of the commodity sector, where prices are very low and uneconomical, into the manufacturing sector, where we can make up for the decline in our export receipts in the commodity sector. That's exactly what you want to happen. It helps to maintain employment and output in this country, and it is a very sensible outcome.

That's what a floating exchange rate does for you. You get hit by one of these nasty shocks, as we have in the commodity area, and it helps that adjustment whereby people, capital, and resources move out of those primary commodities and into the manufacturing sector.

Mr. Charles Freedman (Deputy Governor, Bank of Canada): Mr. Epp, perhaps I could add one word if you want to examine history. The best post-war period in Canada and the United States was the 1950s and early 1960s, which was a period of inflation of the sort we have seen in the last little while. We had high growth of productivity and low unemployment, and we had continuous growth throughout that whole period. The problems started to develop when we got this very boom-bust economy and we got inflation. One of the fascinating things about the U.S. is that since they have achieved a much lower rate of inflation, it looks as if they're going back to a higher productivity track and a lower unemployment track. When we talk about what we would like to see for our economy, that is a model we would love to be able to emulate.

Mr. Ken Epp: But in your report you say that you're expecting Canada's economy to have continued strength based on a strong export market. In fact, the last couple of years have demonstrated that your statement is basically true.

Internally, that doesn't do anything for us, though. Basically, what we're dealing with is a very low rate of inflation and wages going up very, very slowly in terms of any individuals. The economy, in my view, seems really to be somewhat sluggish. I'm just wondering what can be done to stimulate that economy so that it really takes off.

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Mr. Gordon Thiessen: I would suggest to you that we've done remarkably well considering that we've been hit by this nasty surprise coming from the Asian financial crisis. When you look at how we've been getting through this thing that hit us from outside, which we had no real control over, and the fact that we had an economy that grew last year at 3% and looks to us as if it's going to grow at more than 3% this year and next, that strikes me as being a pretty good outcome.

Now, I would suggest to you that in fact things are improving substantially from where we were last year and the year before and that our ability to export is really crucial to our economic performance. We are a small country. We're open to the world. We do have to be able to export.

But what we're also saying is that we see an increase in the amount of domestic spending in the next year or so. We see consumer spending picking up more, and we think that business investment spending is going to pick up, so that we should have a more balanced economy with both the export sector and the domestic support growing more rapidly than before. I think that's good news.

Mr. Ken Epp: Now, in your report you presented to us today you said on page 3 near the end of the first paragraph: “What we have in mind are such things as movements in inflation relative to expectations...”. This is providing pressure on the economy's production. Then you say “growth of money and credit”. I would like to know what your plans are in terms of increasing the money supply.

Also, to me, the increase in credit means an increased debt load, which I think most of us would recognize as being a ball and chain around our economy, because the more debt load you carry, the more interest you pay and the greater the hindrance to a growing economy.

Mr. Gordon Thiessen: A certain amount of debt is necessary in order for an economy to work. It's the way you basically transfer savings from the people who want to save to investors and borrowers who want to spend. So you want some of that.

What we're talking about here is monitoring rates of growth that start worrying us as being excessive and that might be advance indicators of inflation to come. That's what we're talking about here.

What we're talking about is that we're in a zone of uncertainty. We think the economy's going to get closer to full capacity next year, but we don't know exactly where that full capacity is. So we want to feel our way along here. We want to make sure that the economy has lots of room to reach its full potential, but we don't want to get ourselves back into the inflationary excesses of the 1970s and 1980s.

So what we're saying is that there are a lot of indicators you want to monitor, such as the growth of money and credit. If it looks as if they're getting excessive, that is one of those indicators that may just give you a little warning sign that maybe things are going a little too fast and a slightly slower expansion will be more sustainable.

Mr. Ken Epp: You have no intention at the present time of altering your goal with regard to the inflation rate.

Mr. Gordon Thiessen: No. We basically made an agreement with the Minister of Finance and the government to continue to follow the 1% to 3% target, and we're going to do so out to the end of 2001, at which point we will reassess that and ask ourselves whether we should do something different in the future.

The Chairman: Thank you, Mr. Epp.

[Translation]

Mr. Loubier.

Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ): Mr. Thiessen, it is always a pleasure to meet you, despite the fact that we can make the same criticism each year, this year more than ever. I have the impression that you are seeing the development of Canada's economy through rose-tinted glasses.

You said that by next year, they're probably won't be any margin of unused production capacity left and that there may be a problem with the figures. In any case, it seems we are moving towards what is called full production capacity. You say that you want to maintain low inflation, that is between 1 and 3%. But in order to achieve this, you will have to increase interest rates next year. If there is only a small margin of unused capacity, if indeed there is any, the result will be pressure on prices and you will have to respond by increasing interest rates. But in so doing, you'll compromise investment which is necessary to increase production capacity and to ensure full production and job growth potential.

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Every two or three years, we can hold the same thing against you: you want to kill the fly of inflation with a hammer. Mr. Freedman said that he would like to incorporate the American model into Canada, because in the US, productivity, investment and jobs are on the rise, but that's not the way to incorporate the American model.

In the United States, a certain level of inflation is acceptable, a higher level than Canada's, but, conversely, the ability to create jobs and to promote investment is much greater in the States than it is here. I would like to know what you think about this, because it's a little tiring to hear you repeat every year, each time you appear before the Committee, economic forecasts which seem accurate, but which your analysis belies and which ultimately impede the growth of our economy.

Mr. Gordon Thiessen: I don't agree with your explanation. I believe that there is not much of a difference between Canada and the United States. Inflation is currently 2.5% in the United States or, as the trend would indicate, 2.2%. There is not much difference between Canada and the United States.

Mr. Yvan Loubier: It's all a matter of numbers, Mr. Governor.

Mr. Gordon Thiessen: But there is a minor difference in the way both countries calculate the rate. I believe that the difference between Canada and the United States resides in the fact that commodities play a much bigger role for us than they do in the United States. We were hit hard by falling commodity prices. That's what distinguishes both economies.

Mr. Yvan Loubier: There is another difference, Mr. Governor. Our dollar is worth less than 7 cents and it has decreased on average one cent a year for the last 30 years. This indicates that there is a huge productivity problem in our private sector. Indeed, the Minister of Industry and even the Minister of Finance have recognized that Canada has a serious productivity problem. You're not going to improve Canada's production capacity by imposing drastic measures, especially since you yourself have admitted that our margin of unused productivity will be used up in the second quarter of next year. New investments are necessary, and we will have to invest more than what has been done in the United States because of our productivity lag.

Mr. Gordon Thiessen: I agree that it is very important for Canada to increase its investment rate. In the United States, they certainly invest more than we do. But I must say that our interest rates are lower than south of the border, which should spur investment in Canada. I believe we are on the right track to improve our productivity rate.

I also agree with the fact that it is very important to increase our rate of productivity, but you won't achieve that with higher inflation.

Mr. Yvan Loubier: Why do you think the United States outperform Canada in job creation? Compare the States' inflation and interest rates with Canada's. Two and a half years ago, you yourself told this very committee that our inflation rate policy may have gone too far to calm inflation, which ultimately did not materialize, in doing so, we may perhaps have compromised job creation. The Americans don't agree with unbridled inflation, but control it so it stays at an acceptable level. They also outperform us in job creation.

I feel that even if we discuss this subject for the next 200 years, you would still cling to your ideology. As was the case for your predecessor, the fight against inflation is a holy one which you will never relinquish. You would never admit that it may be a good idea, at a certain point, to loosen the reigns of inflation to create new jobs.

I would like to address another area. It was hard to understand your reaction when people started talking about the idea of a single currency for the three Americas. I did not quite understand why you outright rejected this idea by saying that the matter was not even up for discussion. Indeed, it seems that the Minister of Finance and you are birds of a feather because you're singing from the same songbook on the same day.

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This issue is the focus of serious debate in Latin America. The President of Argentina has even talked about converting its country's currency to the dollar. Eight finance ministers from Central America will meet shortly to debate the possibility of having the same currency for all of Latin America, namely the US dollar. Mexico's two biggest employer associations are putting enormous pressure on President Zedillo to adopt the American dollar as the official currency so that Mexico can better withstand the repercussions of financial crises like the recent Asian crisis.

I wonder why you flatly rejected even analyzing this idea, especially since the Bank of Canada has the tools to do so. I know that there are many high-calibre financial analysts at the Bank. Why did you flatly reject even analyzing the opportunities which would come Canada's way if it started using the US dollar, when everybody else is seriously doing so?

Even the president of the US Federal Reserve did not outright reject the request made by the Government of Argentina. All he said is that the issue was worth studying. There are limits. Americans are being more open-minded. I can provide you with all the newspapers and communications we had with Latin America. I can assure you they are very open to the idea and willing to analyze the issue. But it seems we are totally closed-minded.

Mr. Gordon Thiessen: A lot of research has already been carried out on this matter. When Europe was discussing a single currency, we closely looked into the matter. We published our conclusions which anyone can read.

Mr. Yvan Loubier: Mr. Governor, since the last crisis, you have not given any thought to this issue. There is indeed a way to protect oneself from financial crises like the Asian financial crisis. We can reduce the margin of manoeuvre of speculators who held international economies by the throat by simply speculating on secondary currencies. Whether you agree or not, the Canadian dollar is a secondary currency; it doesn't count for much in the grand scheme of things. Speculators take advantage of secondary currencies throughout the world to make billions of dollars in a few days. As you well know, short-term capital represents 30 to 40 times the daily value of international trade in goods and services. That's a lot of money. These speculators take advantage of secondary currencies.

The best way to fight this situation is to gradually decrease the number of world currencies. The creation of the Euro led to the withdrawal of 11 currencies which are now beyond the reach of international speculators, who provoked the most recent Asian crisis. Why don't you analyze the idea of a single dollar or a single currency for the Americas?

Mr. Gordon Thiessen: As I indicated, we have already studied the issue and have concluded that the Canadian economy is very different from the American one, especially in view of the importance of commodities in our country. If commodity prices were to fall it would have huge repercussions for Canada but not for the States. We need some kind of buffer between both economies. A floating exchange rate could be a buffer, which would be very helpful.

Latin American countries have a hard time controlling inflation. Inflation had climbed so high that people don't trust their currencies anymore. That's why they want the credibility of the US dollar. We are in a completely different situation.

Mr. Yvan Loubier: But what are you going to do? You have to give your analysis some perspective. What are you proposing for the future? What will you do if every country in the three Americas, including all Latin American countries, agree on the common use of the US dollar and if Canada is the only one left to use the Canadian dollar? Canada is the main trading partner of the United States. If there were to be free trade between the three Americas, countries which use the common currency in an open market would have an advantage because they would not have to pay costs involved in transactions and exchange risks.

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Are you saying that Canada should remain isolated from the rest of the Americas, that it should continue to use the Canadian dollar and that our exporters should continue to pay the costs involved in transactions and exchange rate risks, when, in a few years, there will be open trading between all the other countries? It would be harder for us to compete because we are not using the common currency. How would you react? Would you still say the same thing and refuse to even think of Canada's participation in the common currency of the Americas?

Mr. Gordon Thiessen: You always have to look at a situation and determine what is best for Canada. If you look at the single exchange rate established by currency boards elsewhere, you will notice that the repercussions of crises like the one which hit Hong Kong or the one which is currently hitting Argentina are not the same as the ones affecting the United States. These financial crises have created huge problems and tensions within those countries' economies. I don't believe that a single exchange rate, a currency board and the dollarization of an economy are a silver bullet. I don't think the scenario you have described will become reality one day.

Mr. Charles Freedman: Mr. Loubier, I would like to add a few words because in the United States, Mr. Greenspan and Mr. Summers reached a certain conclusion. Argentina had asked that discussions take place on the possibility of the United States agreeing to share seigniorage and to act as a last resort lender, but the Americans refused, no discussion.

Mr. Yvan Loubier: I'm sorry, but they did not close the door.

Mr. Charles Freedman: Yes.

Mr. Yvan Loubier: No.

Mr. Charles Freedman: Any country can start with dollarization.

Mr. Yvan Loubier: Yes.

Mr. Charles Freedman: But Argentina also wants the US to share seigniorage and to be their lenders of last resort. The Americans have already refused and have indicated quite clearly that the objective of their monetary policy was to guard the interests of the American economy and that they would not make a decision regarding the situation Argentina now finds itself in.

[English]

The Chairman: Thank you, Mr. Freedman.

Mr. Nystrom.

Hon. Lorne Nystrom (Regina—Qu'Appelle, NDP): Thank you, Mr. Chairman.

Welcome, Mr. Thiessen, to the finance committee.

You were talking about the 1970s and the inflation rate being very high at that time. I remember very well being on the finance committee when John Crow was in this position and arguing for a very high interest rate policy. Could you take us into your confidence and reflect back so we could learn something from history? Were the interest rates too high at that time? Was he coming down too hard in terms of an inflation policy?

There's been a lot of criticism that the interest rates were much too high, slowing down the Canadian economy and throwing a lot of people out of work. The living standard of course between us and the United States is a lot wider now than it used to be 10 or 15 years ago.

Was your predecessor much too tough or the interest rates too high? Would you like to comment on that, and can we learn from that era? I'm sure you could tell us something; we wouldn't spread the word too widely.

Mr. Gordon Thiessen: Yes, I think we did learn something from that era, and it was that we waited too long to follow a tighten-up policy.

If you go back to the early 1970s when inflation took off, we were a little too slow off the mark. It wasn't a uniquely Canadian thing, it was true of quite a lot of countries that didn't see the kind of buildup of inflation pressures that were accumulating around the world in the early 1980s.

If I could do it over again, I would like the monetary policy to have been a good deal tighter there at that time. When we realized how serious this was by the mid-1970s, inflation was well and truly entrenched. Once it gets entrenched, it is so very difficult to turn around because people have been hurt by it and they want to protect themselves against it happening again. And so it gets to be very difficult to reverse it.

Exactly the same thing happened to us in the 1980s. I wish we would have been a little tighter earlier in the 1980s, because then we wouldn't have have had to be quite so tight later on. And we would have avoided that kind of buildup in inflation and speculative pressures and distortions that we saw at this period. That's what I'd like to do differently.

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Mr. Lorne Nystrom: In terms of the layman's language on main street in Broadview, Saskatchewan, the fact that the bank was too slow to act in those two cases and had to be tighter than they might have had to be later on, what did that mean in terms of slowing down the economy more than it should have been slowed down? What did it mean in terms of unemployment? Is there any way of putting any kind of specific figures on what was the situation where the bank was too slow to react, in your opinion? And how much higher do interest rates have to go because the bank was too slow to act?

Mr. Gordon Thiessen: That's very difficult to tell, I must say.

Mr. Lorne Nystrom: Can you quantify them a little bit for us and give us an idea of what the error cost us in terms of the mistake?

Mr. Gordon Thiessen: No, I don't think I can really do that. But what I can say is that getting into the kind of boom-and-bust scenarios that we and other countries got into during that period was certainly costly; and this is all of course with the benefit of hindsight, which is much easier to see. I have to tell you it would also have helped enormously if we'd had tighter fiscal policy through that period, so we weren't building up the deficits and the accumulating debt that we did from the mid-1970s right through to the mid-1990s, because that added to the problems we were having to cope with.

But I think there's no question that you can look back and with the benefit of hindsight you could have said, boy, we should have avoided that run-up in inflation because it's inevitably followed by a deep recession. And that's what we're trying to do now. Get the inflation rate down, keep it down, have people's expectations shift so that they expect it to stay low. Then you've a lot more room to manoeuvre.

The point we were trying to make in our opening statement here is that we're now getting close to what you might have expected with full capacity, but we don't really know because there are so many changes. But we now have the room to manoeuvre, to test, to check, that we didn't have during the previous 25 years. I think that's a very positive outlook for Canada.

Mr. Lorne Nystrom: Many central bankers do not have inflation targets. I don't think the United States Federal Reserve Board has. You have. What evidence is there that targets are helpful in terms of controlling the inflation rate?

Mr. Gordon Thiessen: Quite a number of countries have them now. New Zealand was the first. We were second. The British, the Swedes—

Mr. Charles Freedman: The Finns.

Mr. Gordon Thiessen: —the Finns. There are a number of them. The new European Central Bank has them as well. They aren't absolutely crucial, but they sure do help if you've had a history of relatively high inflation. So most of those, certainly New Zealand—I forgot Australia—Australia, the U.K., Sweden and us, are all countries with a relatively high experience of inflation during the 1970s and 1980s. The Americans always did a bit better than we did through that period, and so it's less crucial for them. It's also hugely helpful to be the international currency. It does give you a little more room to manoeuvre than if you are a smaller, open economy.

But if you listen to the discussions both among economists and central bankers, I think you would find that the bulk of opinion would be in favour of inflation targets, that they allow you basically lower interest rates on average and a better performing economy than you would otherwise get.

Mr. Lorne Nystrom: Do you have any empirical study, where it's really made a difference in terms of the five or six countries that use the targets compared to the five or six countries of comparable size and economic strength that do not use the targets? Do you have any data, Mr. Freedman or Mr. Thiessen, as to whether or not there's actually any...?

Mr. Gordon Thiessen: There have been a number of conferences. Unfortunately, the run of data tends not to be long enough. In the social sciences, if you're going to do empirical work you really need a longer run of data than what we have to date, and that gets in the way of making those hard comparisons, I'm afraid.

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Mr. Lorne Nystrom: I wanted to switch the question to the issue of the so-called Tobin tax, the tax on international currency speculation.

On the March 23, Parliament passed a motion endorsing the principle of the Tobin tax by a vote of 164 to 83, making us the first country in the world to have a Parliament endorse the principle of the Tobin tax, working in concert of course with the world community. You've criticized that in your testimony before the Senate. I'm wondering why you, as the central banker, would not express support for the will of Parliament?

Mr. Gordon Thiessen: I think that as a central banker, and because central banks are set up to be somewhat separate from government, it is important that we express our view about things that have an implication for monetary policy and for our exchange rate. A tax on international financial transactions is of that character.

I must tell you, Mr. Nystrom, that I expressed my view about the Tobin tax quite a few years ago and well before Parliament had taken its vote. Most people would find it unacceptable for me to suddenly change my view if I didn't have a good reason to.

Mr. Lorne Nystrom: If you're separate from the government, then maybe you would be somewhat supportive of the Tobin tax as well.

Mr. Gordon Thiessen: I must say I don't—

Mr. Lorne Nystrom: The vote was 2 to 1, it wasn't exactly a close vote in Parliament. It had members of all parties supporting it, including the Reform Party and the Conservative Party.

Mr. Scott Brison (Kings—Hants, PC): No.

Mr. Lorne Nystrom: One Conservative.

Mr. Scott Brison: No, the Conservative Party did not support it.

Mr. Lorne Nystrom: Members of.

The Chairman: Mr. Brison.

Mr. Scott Brison: Parliament's support of the Tobin tax proves that politics can be the natural enemy of good public policy.

Welcome, Mr. Thiessen and Mr. Freedman. It's great to have you here with us today.

My first question is relative to the situation in the U.S. For some time we've seen U.S. economic growth that has been exceptional and confounding inflation numbers. In fact, in the U.S. the unemployment for some time has been actually below the non-accelerating inflation rate of unemployment.

Recently, in the May 14 numbers from the Department of Labour, we've seen a jump in inflation, and there are some signs that we will see a tightening bias with the fed. If that were to occur, what would your response be?

Mr. Gordon Thiessen: We'd very much have to look at what the circumstances were when it happened. What happens to the U.S. economy and in U.S. financial markets is very important to us. So if the Americans—I hesitate to get into all these hypotheticals—were responding to an economy that was growing even more rapidly than before, that would likely have some spillover effects to Canada and mean that the Canadian economy was growing even more rapidly than before.

That's the kind of situation we would have to examine and we would have to say to ourselves, does that look like it's sustainable or isn't it? On that basis we would make a decision.

What I must emphasize is that what happens in international financial markets will always have an impact on Canadian interest rates. That's true of every country in the world. There's no such thing as completely independent national interest rates. They are all affected by what goes on internationally and they're certainly affected by what goes on in the largest economy of the world. So if the Americans raise interest rates, that's going to have an effect on market interest rates in Canada no matter what the Bank of Canada does.

What we then have to decide is, given then what's going on in the U.S., what are the implications for Canada and what would we do? I can't tell you in advance what we would do. It would have to depend on the circumstances.

Mr. Scott Brison: Given the importance and the impact of U.S. monetary policy on Canadian monetary policy, and you've observed it closely, what do you think the response of the fed will be?

Mr. Gordon Thiessen: I think it's too soon to say right now. What they've done is they've basically fired a warning shot. They've said, it looks to us like there are some inflation pressures building up here.

Are they actually going to have to raise interest rates? At this stage we don't really know. It's going to depend to some extent on whether the relative strength in the U.S. dollar and the increase in medium- and longer-term interest rates in the U.S. are sufficient to just damp that economy down. If that were to happen, the fed might not have to move, but you cannot be sure of that at this stage.

• 1620

Mr. Scott Brison: With the monetary policy having about a two- or, some say, three-year lag in terms of its impact on the economy, once the fed determines that they will tighten policy, wouldn't it be too late? Isn't that the risk now? Or do you agree with these new paradigmers who believe the global economy and changes in labour and technology mean that inflation isn't the risk any more?

Mr. Gordon Thiessen: No, I certainly don't believe that, and Alan Greenspan doesn't believe that either.

But the real question is that you have to look forward, and the fed is looking forward. They're looking at the information that comes in. You want to look forward one to two years—that's basically the lag—and ask yourself, does it look like those pressures are building up to the point where we're going to have an inflationary outbreak? This is not easy stuff to do, but they're going to have to make a judgment. All they're saying now is that on balance they're biased in favour of the interest rate increase, but they haven't done it yet.

Mr. Scott Brison: We talked about inflation. There's another risk about which some economists, in fact a large number of economists, have been speaking—the risk in recent months of deflation, that we have a global asset bubble that is precariously overvalued. In fact, if you look at price-earnings ratios on the equities markets, for instance, it hasn't been as high since just before the crash in 1929, I believe, on average, for the Dow Jones industrial average, for instance.

I've asked you your opinion on inflation. I'd appreciate your opinion on some of the reports and opinions on the risk of deflation.

Mr. Gordon Thiessen: We need to be very careful of what we're talking about when we're talking about inflation and deflation. When we're talking about inflation, we are typically talking about the rising prices of consumer goods and services, not about equity prices, asset prices.

Frequently when people talk about deflation, they are talking about asset prices, not consumer prices, whereas consumer prices are what really matter. What an economy is all about is to provide consumers with the goods and services they need and they want. The prices of those are what you want to keep as stable as you possibly can. So I don't believe there is very great risk that we're going to have persistent declines in the prices of consumer goods and services in the world.

The Chairman: Mr. Brison, this is your final question.

Mr. Scott Brison: May I have a comment prior to the final question?

I would argue that the degree to which market participation has grown significantly would mean that if market prices dropped or the equities markets fall significantly, they would have a greater impact then, maybe.

But for my final question, you've indicated that a low dollar in fact helps in terms of our economic growth in Canada because of the fact that we export a lot. I would argue that the logical corollary of this argument—or the Prime Minister's, that a low dollar helped tourism—would be that if we lowered our dollar to zero and gave everything away, we'd be the greatest export nation in the world. But that's obviously not the case.

Doesn't a low dollar have a perverse effect on productivity in that it increases the price of equipment—for instance, software that is often purchased from other countries—needed to improve productivity, and at the same time it reduces the incentives for Canadian companies to purchase that equipment and to improve productivity, because they can hide behind the low dollar, at least in the short term?

Mr. Gordon Thiessen: I certainly would never advocate pushing down your currency to stimulate your exports. What we're seeing here is the response to a major shock that has hit the Canadian economy, and that's the shock in commodity prices that I keep mentioning. It's terribly important. Sometimes living in Ontario you don't always appreciate it, but I tell you, if you go anywhere else in Canada, you do appreciate it. It's important, and it has been a very difficult thing for the Canadian economy to adjust to.

• 1625

But the reason for the lower dollar and the reason I think it was appropriate in these circumstances is that it helps the process of adjusting to that shock. It helps the process of moving the Canadian economy out of producing primary commodities, where the prices aren't very good these days, and into producing manufactured products, where the prices are much better. So it's helping us get through that difficult period, and that is what I think is reasonable.

You are right that a lot of the machinery and equipment that we use in Canada is imported, and so there's no question that a low Canadian dollar gets in the way of that. But I guess the question is what's the alternative? What if we had pegged the Canadian dollar at 75¢ before this shock hit us? Do you think that would have encouraged investment in the manufacturing sector? I don't think so.

The Chairman: Thank you, Mr. Brison.

Mr. Szabo.

Mr. Paul Szabo (Mississauga South, Lib.): Thank you.

Governor, the last time you were before us I presented some statistics about what has happened over the last five decades—the 1950s, 1960s, 1970s, 1980s, and 1990s. In each case, at the end of the decade in North America, both Canada and the U.S. were either entering or just in the middle of a recession. The symmetry was uncanny.

If I were to take the average of what occurred there in terms of the shift in the fundamentals and plot it, the inflation rate would rise to just under 2%, which is exactly what has happened. So it seems that the symmetry continues, and if it should continue, obviously you would expect that we are going to enter into a potential recession, starting on or during the end of this decade.

Basically I want to ask you about something that Mr. Brison raised. It has to do with the excess capacity. Is there an appropriate or target level of excess capacity within the system, and if there is, where are we relative to that excess capacity? If it's our expectation that the spending projections are going to utilize that, how quickly do we have to work to mitigate the negative consequences of exhausting our capacity? Can we simply rely on monetary policies such as interest rate movements, or do we have to have partners in this to address the capacity requirements or the ideal capacity levels?

Mr. Gordon Thiessen: I accept that you can certainly find two cycles at the end of two decades, but I really don't see the same kind of accumulation of problems that one saw in the late 1970s and the late 1980s.

At that time there was, encouraged by inflation, a degree of speculative activity and an accumulation of debt levels that were much higher than anything we're seeing now. I think it was indeed a kind of situation that was ripe to go into economic bust. I don't see the same thing. One exception is the U.S. stock market, which looks to be rather overvalued. I think that's the one area where you can worry about it. But if you went back to the periods in the late 1970s and 1980s, it was far more worldwide, which made it a more worrisome problem as well. So I just don't see the same seeds of recession now that were there then.

With respect to excess capacity, what you really want to do is run at full capacity. That doesn't mean every single company is going to be going flat out, but what it means is that, on average, most companies across the country will be running at a degree that really stretches them a little bit. That's what we've been seeing in the United States for the past few years. That's where we'd like to get to. So I don't think you want to target excess capacity; you really do want to run at full capacity.

As to how quickly you have to act, when you have your inflation rate low and people expect it to stay low, the situation in Canada and in the United States is that you have a little more room to manoeuvre. It's quite different from what it was like in the 1970s and the 1980s where, as you pressed on the limits of full capacity, everybody became worried there would be another outbreak of inflation. They ran for cover. Prices, wages and interest rates were pushed up as everyone sought to protect themselves.

• 1630

We don't see that same kind of behaviour, or likely behaviour, in either the U.S. or Canada, so we have a little more room to manoeuvre. But we're saying we have to monitor that. That was the message in our opening presentation to you.

There is a whole host of things we need to monitor because we are not absolutely sure where full capacity really is, so we have to feel our way here. But if we see an accumulation of signs of problems, we will indeed have to act.

But I have to tell you, I don't see very much of that in the near future at all. I think we have more capacity than we realize. That is certainly the American experience.

Mr. Paul Szabo: All right. I have just a very brief point, because I know my other colleagues have questions.

Of the costs of operating a business, two-thirds to three-quarters have to do with human resources costs. Wage settlements seem to be on the rise. There are pressures, at least, for higher wage settlements. To a great extent, unless they can be translated into higher productivity, they will put even more pressure on the inflationary scenario. What are you seeing in the public and private sectors in terms of the validity of the wage settlement levels?

Mr. Gordon Thiessen: We're seeing that most of the pressure, and where there is strike activity of some sort or another, has typically been in the public and the parapublic sectors. Of course, in a number of those sectors there were wage freezes for long periods of time, so now there's that awkward business of readjusting wages to something a little more competitive.

When we look at the private sector, the wages have been running at just around 2%. By and large that's been leading to a kind of small increase in unit labour costs, roughly in the order of 1% to 1.5%, which is our inflation rate. So there's nothing very special there. If we were to get some improvements in productivity as we got to full capacity, you would probably see those unit labour costs go down, which has been the recent American experience. Then there's a little more room for some larger wage gains in response to that.

Mr. Charles Freedman: I have the numbers in front of me. I know there have been some highly publicized contracts, but overall for the total public sector in 1998 on average it was 1.5%, and for the first quarter of 1999 it was 1.3%. So it's in the 1.5% range. In the private sector it was a little higher and has been higher throughout, running at just under 2%. The last quarter was 2.2%, and that kind of range. There are obviously some exceptional ones where there are special factors, but there's very little sign at the moment of any kind of breakout there.

Mr. Paul Szabo: Thank you, Mr. Chairman.

The Chairman: I have a follow-up question in reference to the report, where you suggest potential output may be larger than was previously thought to be the case. You attribute this to some of the changes that have occurred, like market deregulation, employment insurance reform and others. I'm just wondering if these policies have benefited the Canadian economy. Is there anything else we should perhaps be doing? What other policy areas should we be working on, so we can achieve those ends?

Mr. Gordon Thiessen: I think what you always want in an economy is as much flexibility as you can get, because the world is a very changeable place. What strikes you about the U.S. is the flexibility of entrepreneurs, workers and the population in general to adjust to these shocks. I think that's been one of the secrets of their success.

By comparison, if you look at Europe, where there seems to be less flexibility, they seem to have had more difficulty responding to that changing world economic environment. So anything that encourages flexibility ends up being helpful in this regard.

• 1635

The Chairman: Governor, some of the points you made speak to attitudinal change. The American economy has always promoted the whole notion of entrepreneurship. They tend to take greater risks. An American entrepreneur is not one who thinks he's going to have 100% success. He knows that failure may in fact be part of getting into business. How do you change that attitude in Canada, or should we?

Mr. Gordon Thiessen: I don't think you can set out to change attitudes. I'd like to think that attitudes change with success. When you see successful entrepreneurs I think that tends to change attitudes. It's one of the remarkable things about the high-tech industry that's very dramatic in the U.S., but also in Canada, where entrepreneurs in that sector have frequently done very well. I think there is something of an attitudinal shift that's occurring. It's a small segment of the population, yes, but nonetheless there are people seeing the possibilities.

I think one of the important changes in attitudes that I've seen over the course of the 1990s in Canada is a greater realization that there is a big international economy out there and we need to be competitive if we really want to have a very successful Canadian economic performance. I think it's quite remarkable what's happened over the course of the last nine years. I think the attitudes in Canada have changed a lot. I think there's a realization that you have to keep up with the best practices and that you have to look to those international markets to benchmark yourself to see how good you are. I think that's a big change, and a very positive change, I must say.

The Chairman: You spoke about the whole notion of rewarding success and reducing taxes, talking about personal taxes in the short term, but in the short to medium term also talking about corporate taxation in Canada. If in fact people get to keep more of the money they make, would this help to change the attitude of Canadians?

Mr. Gordon Thiessen: I always hesitate to get into the discussion about taxes, because it has a large element of political choice about it—small “p” political choice—about what arrangements society wants to choose for itself. I'm always a bit nervous, as a central banker, getting into that.

But I think there's no question that over time incentives are important, and you want to make sure that you set the incentives for the kinds of economic performance you want to get. Taxes are important, but it's not just taxes. What you have to do is decide what kind of basket of public goods you think is best for your country, and then what kinds of taxes you need to finance those public goods. So you have to look at the two sides of that picture, and those involve an awful lot of political choice for Parliament and the general public. It's not one that I think you can give a highly objective economic answer to, so I'm always a bit hesitant to wade in too deeply.

The Chairman: I often find many Canadians refer to the American economy as a vibrant, dynamic economy that is doing very well, and they praise the American economy for its economic benefits, for its low unemployment and greater mobility. Canadians also have to understand that you can't have it both ways. You can't have a Canadian economy being an American one. But is there a change in attitude in Canada where we are viewing ourselves as Canadians first and foremost, but are beginning to finally think in North American terms?

Mr. Gordon Thiessen: I find that hard to answer. But I think what certainly strikes you is the extent to which Canadians are drawing comparisons with the U.S. and expressing a certain amount of distress that our economic performance hasn't been comparable. So to that extent Canadians do seem to be looking more carefully at what factors have led to that U.S. performance and whether we can replicate that here.

But I'd like to add this. I know you probably all get tired of listening to me talk about that commodity price shock, but if the Asian financial crisis hadn't hit us, the Canadian economy I think would be operating at full capacity right now. It would be pressing the limits of the labour market. We might be getting the same kind of investment as the Americans are getting, which added to labour productivity. So I'm a bit hesitant to say that somehow you need this absolutely major shift to get some of that U.S. performance. Whether we perform as well as the U.S. in all of that I simply can't tell you. I don't know.

• 1640

The Chairman: Thank you.

Mr. Gallaway.

Mr. Roger Gallaway (Sarnia—Lambton, Lib.): I have a couple of questions, Mr. Thiessen.

As of yesterday, I understand that the TSE 300 was off, and I think the number is 10.8% over the past 12 months. It has declined that amount. I'm trying to understand. If the TSE 300 is declining, the value of companies in this country is declining almost 11%, where is inflationary pressure coming from? I have to assume these companies are making less or they're going to be more competitive in the marketplace. Where is the inflationary pressure coming from?

Mr. Gordon Thiessen: There isn't a great deal of inflationary pressure, which is why we tend to be nearer the bottom of our target range for inflation. And as I was explaining earlier, part of this is the fact that we've been hit with a shock.

Part of the reason the TSE is off is because all those resource companies have been hit by a major decline in their prices and profits, and the Canadian economy has been similarly hit, so that by and large inflation has tended to be on the low side in this period.

Mr. Roger Gallaway: I have one other question. If we compare the TSE 300 to the Standard & Poor's 500, which in the same period has increased about 17.5%.... This is a rather open-ended question, but we have this great disparity then between Canada and the United States, with a 17.5% climb in the U.S. What's going right there? Yes, it's a bigger economy; yes, there's more confidence in some currencies. But what are they doing right or what are we doing wrong to explain this kind of gap in 12 months? It's 28%, and to boot, our currency in the same period dropped about 1% to the American dollar. So you can add another percent to all of that.

Mr. Gordon Thiessen: One of the differences is that they are a commodity importer rather than an exporter, so they have benefited from the lower prices of commodities, whereas it has had a net negative impact on us. That's certainly one of the differences. But the U.S. economy has been performing better than any other economy in the world. You can't find another one. The Australians may come close, but there's nobody who's been performing as well as the U.S. has, and I think that's a longer-term factor.

What strikes me as I look back is that during the 1980s, when it looked like Japan was going to dominate the world and Japan was going to buy up all those American companies, what you had was a reaction in the United States among companies to become more globally competitive in ways that we didn't hear an awful lot about. But as we got into the 1990s it paid off big time for them, and all of a sudden you shifted from worrying, as people did in the mid-1980s, that the U.S. was in secular decline to seeing the U.S. as the strongest economy in the world. Part of it was some of the investments in new technologies, some of the changes in processes that started to occur in the mid-1980s earlier than anywhere else in the world, effectively. That's paying off for them right now.

Mr. Roger Gallaway: Okay. Thank you.

The Chairman: Thank you, Mr. Gallaway.

Mr. Pillitteri.

Mr. Gary Pillitteri (Niagara Falls, Lib.): Thanks very much, Mr. Chairman.

It's good to see you again, Mr. Thiessen. I'm going to ask slightly different questions from some of my colleagues.

I was listening with great interest about using the common currency, and I read something about how the Europeans have come up with the Eurodollar and of course these countries had to peg their currencies to that Eurodollar. Their economies are more, relatively to scale, compatible. Specifically four or five of the larger ones are more compatible, and their own currencies are being pegged to the Eurodollar.

• 1645

I see my colleague talking here about using the American dollar. If we were to do the same thing in scale of size, comparing ourselves to the United States, I would hate to think—I just want your opinion—what would happen to some of the economies after free trade. For some of our companies the simple difference of one or two cents keeps the manufacture here in Canada, especially in the agrifood industry, where we've lost so many. Wouldn't the government have to be more intrusive if they wanted to maintain some of those economies here in Canada? If they were pegged to the dollar, to one common currency, wouldn't the government actually have to be more forceful and more intrusive in the currency per se in order to maintain the growing Canadian economy?

Mr. Gordon Thiessen: No, I think in fact it would be quite the reverse. I think you would basically have to encourage companies to become far more flexible in their operations, in the wages they charge, until they got to be competitive. That's basically the only way you can do well. If you're sitting in that common currency, there's no other adjustment factor. Then if you're in an industry that's not doing very well, you have to adjust your prices and wages downward until you can compete. There's nothing much government can do to protect you from that.

Mr. Gary Pillitteri: Thank you, Mr. Thiessen. I just wanted to follow up on that. For the first time, you answered a question that I asked through the back door, and you answered the question I wanted you to answer, which is that actually, as far as being competitive is concerned, we had to be more effective than the Americans or any large economy, because in actuality government could not be intrusive, so we had to scale down to their level, especially their standard of living.

But I want to go to another line of questioning, Mr. Thiessen. I want you always, as you look into the crystal ball.... As a businessman, when I was looking for loans and interest, I went for loans with long-term rates rather than short-term rates in the 1970s, the 1980s, and the late 1960s. I've found that in the last five years, as a businessman, I've done quite well in the short term...from 3% or more in the short-term loans being lower. How does it look in the future? In advising some of my friends, would I be looking at staying with the short term, or is it time to look at long-term interest rates?

Mr. Gordon Thiessen: I think what low inflation should give you is far more confidence in the long term. One of the very sad things that happened during the 1970s and the 1980s is that a whole lot of long-term contracts disappeared—25-year mortgages disappeared, long-term bonds disappeared—because there's so much uncertainty in that inflationary environment.

So in the period of low inflation that we're in now, which is very similar, as Chuck was saying earlier, to where we were in the 1950s and 1960s, I think we should see some of those longer-term instruments coming back. Of course, the great advantage of them is that they lock things in. You can sleep at night knowing what your interest costs are going to be next year and the year after and the year after that, and I think that tends to make for better decisions.

What you really want to do is match the borrowing term with the length of the asset. So if you're buying a piece of machinery that you think is going to last ten years, you really want to finance it with a ten-year instrument. That's the best way to do it, whereas through much of the inflationary period people were financing ten-year assets with three-month money. That can be a way to absolute disaster, and it was in many cases.

The Chairman: Thank you, Mr. Pillitteri.

Are there any further questions? Ms. Redman.

• 1650

Mrs. Karen Redman (Kitchener Centre, Lib.): Mr. Chairman, I have just a couple of quick questions, because I know my colleague also has one.

On page 3, when you talk about the range of indicators to assess the degree of pressure on the economy's production capacity, the way I read that is that some of our instruments may be outdated and we're moving to something that may look a little bit more subjective. I'm taking it that's because of the growth of the entrepreneur within our economy and the shift in the economy. I'm wondering how that compares to how other G-8 countries are dealing with this issue.

Mr. Gordon Thiessen: I think this is probably closer to what the Americans are doing than anybody else, because nobody else is in quite the same circumstances.

Chuck, you may think, as I'm talking, about the U.K. situation. But certainly there's nobody else in quite the same circumstances.

You don't see the same degree of investment in technological change, for example, in continental Europe as you see here, and we in turn are running a bit behind the Americans in all of this. But what that means is that there has been so much investment in machinery and equipment, new technology, restructured companies, and a more flexible labour force in such a way that you just aren't sure what full capacity is. That's why you have to follow all these other things. This is very close to what the Americans have done, and it's why, when their unemployment rate got down to 6%, they just basically followed it down ever so gently to see what was happening, and when they didn't see the pressures building up, they just let it go.

Mr. Charles Freedman: I think I would just add that the U.K. case is a very similar kind of thing. They have many models. They also use all the information they can get to try to assess what pressures are out there on inflation.

One of the things we mentioned in the governor's opening statement was the information provided to our regional representatives from their business contacts. In the last few years...we now have five regional offices, and our people in those offices are spread out across the country and spend a lot of time talking to businesses, business associations, and so on. That's a very useful piece of information, because of course you're looking at a world with a degree of uncertainty. You're trying to bring together all the information you can. And what we're finding is that it's very interesting and useful to bring together that information with all our analytic assessments, with the money and credit, all the pieces we can glue together, and then make this judgment.

One thing, for example, is that they go out and say, what do you expect prices to be, what do you expect growth to be and sales to be, and it's always very interesting to see that as a cross-check. That way it gives us an extra degree of confidence in how we're viewing the system.

Mrs. Karen Redman: It was an interesting sidebar that came out when we had our productivity conversations, because I come from Kitchener—Waterloo and there's very high growth in the high-tech sector, yet that doesn't seem to be translating to our productivity statistics.

The only other question I had was.... Everybody talks about the Asian crisis, and you quite rightly talked about the commodity hit that we had here. When I was in Taiwan earlier this year, one of the things that came out was the fact that they had weathered that Asian crisis very well, and when we talked to people there, one of the things they attributed their weathering that storm to was the makeup of their economic sector and the fact that the small and medium-size enterprise was the backbone of their economy.

I'm just wondering if that translates in any way to the Canadian economy, and where we should be looking to direct our growth.

Mr. Gordon Thiessen: I think in their case, of course, they aren't a major commodity producer, which certainly does help in these matters. But they didn't get themselves into some of the problems that Thailand, Indonesia, and South Korea got into, and I think that certainly helped them through this piece. They ended up with.... They have a better-developed financial sector.

In these other countries, the financial sector was not in good shape. Even now, a country like Thailand, even though things are turning around for them, is still struggling with a financial sector that is not in good shape. It needs a lot of reform.

Mrs. Karen Redman: Thank you.

The Chairman: Mr. Discepola.

Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.): Thank you, Chair.

Governor, you seem to be adopting the Minister of Finance's method of giving yourself targets. But I look at that and I say, well, between 1% and 3%, that's a 300% fudge factor in there. I'm just wondering why you're asking that large a manoeuvring space. Is it beneficial for Canadians in general that we give you that latitude? Should we be focusing on narrowing the target? My concern is that if we give you that large a latitude, is there not a danger that interest rates will go up, which would then be more detrimental to Canadians?

In your opening remarks—and you said it last week also, I believe, when you made your statement on television—you said we should be happy. I know in my riding I've never seen higher confidence, and I come from a Quebec riding. It's great news for Canadians.

• 1655

You allude to the fact that our economy is doing well, and it's doing well in large part because of our low dollar and we're an exporting nation. But that worries me again. How do you develop policy based on the fluctuating exchange rates possible over the next year or two? If it's going well and the economy is chugging well, are there any downsides possible either in inflation, interest rates, or the dollar performance?

Mr. Gordon Thiessen: On the wider target, that's really the result of a lot of work that we've done about which fluctuations in inflation are just unpredictable—you know, they go up and they go down—which aren't long-lasting, and you don't want to be running after all of them. So if inflation's going to go up for a few months and then it's going to come down for a few months, you don't want to be raising interest rates when it goes up for a few months when you know full well it's going to come down again. So you want to leave yourself enough margin to cover what are almost random fluctuations in inflation. You really want to focus on the underlying trend. You want to see through those ups and downs.

We think the band that we have of plus or minus 1% roughly covers that, and that is the sole reason it's there. So I think what that leads us to is a more stable interest rate policy than we otherwise would have.

Mr. Nick Discepola: There won't be a temptation to increase interest rates when you see inflation going maybe three months or four months?

Mr. Gordon Thiessen: No. What we really care about is.... If that trend looks as though it's going to go through the top end of our band, 3%, then, yes, we are going to tighten, and we should, because it means we're in an unsustainable situation and we could get back into the boom and bust that we want to avoid.

No, we focus on the trend. I don't think the wide band gets you into a problem like that. Indeed, I think by and large it leads to smoother policy than it otherwise would.

Mr. Charles Freedman: Perhaps I'll mention that of course we take both the top and the bottom of the band very seriously. As the governor mentioned, if we were getting up towards 3% and the trend was looking to push through, we would be tightening. As we were moving down towards the bottom of that band, of course we've had a couple of reductions in interest rates, which are related to the fact that.... Given the fact that the world financial situation was calming, we were able to turn our attention back to acting in order to ensure that we were going to be comfortably back within the range, as opposed to where we were before, which was sitting at or below the 1%.

So we take both the top and the bottom quite seriously.

Mr. Gordon Thiessen: With respect to the future, I keep wanting to go back and emphasize that this is not a low-dollar policy, absolutely not. You don't want that kind of policy. What you really want ideally is a strong currency. The way you get a strong currency is with a strong economy. But when you get hit with the kind of commodity price shock that we got hit with, the currency is going to go down temporarily, and it helps you adjust to that. We shouldn't count on it permanently. We shouldn't count on somehow or other having this weak and undervalued currency for a long time because that's somehow going to stimulate our exports; we have to be internationally competitive. Our businesses have to look at what their international competitors are doing, and they have to benchmark themselves against that. That's what they have to do.

What the undervalued dollar currently is doing is encouraging some of our manufacturers to expand, to test their luck in the international markets because our dollar is low, and hopefully get a sound footing that will allow them to compete when our dollar recovers. In the process of doing so, we are transferring part of our economic activity away from commodity industries, where the prices are bad, into the manufacturing sector, where the prices are good. That's exactly what you want to happen.

But I cannot just sit there when someone talks about a low-dollar policy, because that's not what we have and we don't want that.

The Chairman: Thank you, Mr. Discepola.

Mr. Hubbard.

• 1700

Mr. Charles Hubbard (Miramichi, Lib.): Thank you, Mr. Chairman.

First of all, I'd like to compliment the governor and deputy governor. Your work has been very good, and as politicians and members, we certainly appreciate the fact that we don't have you in the press everyday being challenged to go up or down, and things seem to be operating quite well across the country.

I'd like to comment on just a couple of concerns that went through my mind when I listened to your talk this afternoon.

There was mention of regionalism, and of course in Canada we have various regions that have serious economic problems, even though the centre has been doing very well.

The second comment is in terms of gold, which was the magic for so many years in terms of banking, but today of course some of the lustre is lost. But we do hear concerns about what might happen if we pay off a lot of the third world debt with international gold. Will that affect our system here in Canada, other than the fact that we do know it may affect our natural resource industries?

A third area I'm concerned about is banks and some of our financial institutions that are involved in various very major sorts of economic activity overseas. In fact, some of our big banks are making more money internationally than they are back here in our own country. As a Canadian, I wonder if these banks are in any jeopardy as a result of what they're doing. We've seen some of the British banks taking major hits with that.

Finally, I'd like to comment on inventory—because we find that manufacturing inventory has changed radically in the last five to ten years—and how it might affect the future of commodity prices. And of course, with commodity prices, there is the basic concept of international problems with natural resources, where there seems to be a great amount of backlog of inventory at low prices that has affected our Canadian wheat, our Canadian mines, and many of our Canadian industries.

I'd like you to comment on a few of those topics I just mentioned.

Mr. Gordon Thiessen: All right.

Certainly the proposal to basically forgive the debt of some very poor and very highly indebted countries has been discussed for a number of years, and nobody seems to know where you can find the money to do that. So the recent proposal has been for the fund to sell off some of its gold holdings and use that to finance this, not completely but partially.

I must say we're not talking about a lot of gold sales here, and I think the amount would be really small relative to the size of that gold market. I don't think that would be a big deal. I think some of the sales of gold from some of the larger central banks and the threat of that is probably having a bigger impact on the gold market. But even there, I must tell you I think it's overstated, quite frankly.

One of the reasons gold is at a relatively low level is that it used to be a hedge against inflation, and the inflation outlook just is very low and stable. So some of that attraction of gold has disappeared.

As for your question about Canadian financial institutions operating overseas, what you want of course is for them to operate efficiently, effectively and prudently. If they do that and they're making money, that's just as good as if you have a Canadian manufacturer such as Bombardier selling airplanes overseas. Both of them are just good exports. So if they're doing a good job, no one should be worried about it, quite frankly.

Now, there have been times in the past when banks have got into making loans in third world countries that were not as soundly based as they should have been, and that leaves everybody feeling a little nervous about it. But some of the activities of our banks are a little different now. They are getting involved far more with local banks in partnerships, or maybe they own them, as opposed to simply making loans. This business where you get into the local market, you buy into a bank, you set up a strategic partnership with a local bank, does strike me as having a sounder basis, perhaps, and therefore being less risky than were some of the third world loans that we saw in the 1980s.

Finally, about inventories, I don't really have a good fix—I don't know whether you do, Chuck—on the extent of those commodity inventories out there and the extent to which that basically means that prices are going to stay low for a long time, that every time there's a little bit of an uptick in the price somebody's going to unload some of that inventory.

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I would have thought the markets would have taken that all into account, so the current price of commodities would reflect any large inventories that were out there. I wouldn't have thought that would be an issue.

Chuck.

Mr. Charles Freedman: I don't have any feel for the inventories as such, but what really drives the price of commodities in the medium to longer term is the demand-supply situation. It's interesting that in the last little while, when there was the beginning of a feeling of a recovery in Southeast Asia and things weren't quite as bad in Latin America as people had thought, there was something of a slowdown. First there was a slowdown in the decline of commodity prices and then a bit of a recovery, just in anticipation of a pickup in the world economy and continuing growth in the U.S.

So you have two or three things going on. One, of course, in the last little while was the concern that Russia and some of the other countries that were going through a lot of difficulty would just dump a lot of their commodities on the world markets. That was a concern for some period of time. It turned out that their capacity to produce and transport wasn't as great as a lot of people had thought. And of course, to the extent that you get new, cheaper mines coming on, that puts downward pressure on prices.

But in the last couple of years, the really driving force has been the weakness in Southeast Asia and the world economy. To the extent we start seeing a recovery there and a pickup in some of those countries, that should be good news for commodity prices.

We've already seen a little bit of that, but our own expectation is that we will get a gradual improvement over the next while. We're not expecting a sharp rebound, at least until the world economy starts picking up, but it's looking better than it was before, certainly compared to the last couple of years when we just saw continuous declines. It's much better.

Mr. Charles Hubbard: Thank you.

The Chairman: Thank you.

The final question is from Mr. Solberg.

Mr. Monte Solberg (Medicine Hat, Ref.): Thank you very much, Mr. Chairman. It's a pleasure to have the governor and deputy governor here again.

I just want to follow up on earlier remarks with respect to the productive capacity of the economy. From your perspective it's important, I would think, to see that curve always moving outward to stay ahead of inflation, because price stability is a key goal of the bank. It occurs to me, just following up on what was said, that technology is a very important way to continue to improve the productive capacity of the economy.

The question to me is how do we get more of that technology in Canada and how do we make better use of it? I suppose one of the things we need is the ability to form capital to do that. This brings us ultimately to the question of how we do that. I come back to the tax cut issue again. I would think that would be one way of doing it. To some degree, it would help us improve the productive capacity of the economy.

If that's the case, what are the best taxes to cut? Second, is there room in the economy, given that you're saying we may be moving toward hitting that curve already, for tax relief of a substantial nature?

Mr. Gordon Thiessen: If Parliament decides to reduce taxes, I hope they do so for long-term incentive reasons rather than short-term demand stimulus reasons, because I think that's where it matters. As I said before, what you really have to get right here is the package of public goods that makes your economy work well and the tax level you need to finance that. I should add a third one here, as I still think our debt-to-GDP ratio is too high.

I think we have to worry about that in the short run as well, to get that down. That's what one has to balance off here.

Mr. Monte Solberg: Is there enough capacity in the economy right now for a substantial tax relief?

Mr. Gordon Thiessen: It depends how you structure it. If you spread it over time, I don't think there is an issue. We don't really know exactly how much capacity there is. That's why we're much inclined to sort of feel our way along here. At this stage of the game, you don't want to say you just happen to know and you'll aim at it, because you don't. The great success of the Americans was feeling their way along there.

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Mr. Monte Solberg: Okay.

Mr. Charles Freedman: One other thing that's worth reminding people is that economists do not know what the driving forces behind productivity growth are. It is still a matter of debate as to why the productivity growth in the world economy sharply declined in 1973-74. There have been hundreds of articles written on it, and no conclusive results.

We may be seeing now—and people are hoping—that we're getting back to something of a trend increase. There was a very interesting piece written by Dick Lipsey, one of Canada's best economists, a few years ago. He talked about the fact that it's very hard to predict how long it will take major technological changes of the sort we have seen in this country recently to feed into productivity growth. We may be seeing another one of those long lags.

We had a whole lot of changes over the last ten years, and one might have thought we would have already seen the productivity pick up. It's taking longer. But one of the points of Professor Lipsey's study is that when you've had these basic revolutions in technology, you don't see the results immediately. It takes a lot of time for the economy to adjust itself to those kinds of changes.

Mr. Monte Solberg: I'm curious about capital gains taxes. Your counterpart in the U.S. has said that's a good tax to cut, presumably because it leads to capital formation and that kind of thing. What's your opinion on that?

Mr. Gordon Thiessen: I don't know. I'm not sure. I don't think it's quite as straightforward as all of that. The evidence just isn't as certain as that, so I'd be far more hesitant to express a view about that.

Mr. Monte Solberg: May I ask a couple of specific questions here?

The Chairman: Of course.

Mr. Monte Solberg: Thank you, Mr. Chairman.

The first is with respect to the credibility of the bank. Obviously it's important that the bank be credible in what it says and maintain the respect of the investment community. I just want to take you back to earlier in the year, when I think you, Mr. Thiessen, were saying the expectation was that the economy would be quite strong and would probably grow at the upper end of the projections. Then on March 31 you cut the bank rate by a quarter point, which surprised a lot of people. I wonder if you could explain why that happened. That did look like a bit of a contradiction.

Mr. Gordon Thiessen: I don't think it was that much of a contradiction. The people in the financial markets who follow things very carefully were not surprised. Last fall, when we made our projections, we were still trying to extract ourselves from the Asian financial crisis. That had turned into a bit of a financial crisis in the U.S. There was talk about a credit crunch. So at that time there was quite a lot of apprehension about what the future had to hold.

As that credit crunch has disappeared and the Asian countries have recovered, the outcome has been better. At the time I said we would certainly be at the high end of that range and we would revise our projections upward when the time came to issue our Monetary Policy Report. But at the same time, through that piece, the inflation rate was at the bottom end of our target range and tending to stay below it. That tells you there's lots of room for the economy to grow. Even though it's growing faster, it's not pressing the limits of capacity, and therefore there's still a margin of excess capacity. That's putting downward pressure on inflation.

So the two are perfectly consistent. I think most of the people who follow these things closely understood that.

Mr. Monte Solberg: Recently in the House we passed a motion in support of a Tobin tax. Given all the debate we've had in the world about these flows of capital, this hot money and all that sort of thing, does the bank have an opinion on the Tobin tax? Is there a problem with these hot flows of capital? If the Tobin tax isn't the answer to them, what is?

Mr. Gordon Thiessen: I expressed a view about that a number of years ago in a speech I gave to an international conference in Montreal. The point I tried to make was that any kind of relatively small tax, as one is talking about in looking at the Tobin tax, would like discourage some of the beneficial flows of capital, the kinds of flows that help to stabilize your currency. You can have big inflows and outflows of exports and imports, which could cause your currency to bob up and down. What we have are stabilizing capital flows, which basically stabilize your currency and make it easier for people to transact business internationally.

• 1715

The kinds of speculative flows that one doesn't like is where somebody's taking a bet that your economic policy is dead wrong and you're going to have to change it.

Mr. Monte Solberg: Right.

Mr. Gordon Thiessen: Those kinds of speculative flows usually are anticipating huge capital gains. So there's no tax of a Tobin nature that I've ever seen that would discourage those. The problem is that that kind of tax, the way I have seen it configured, I think discourages the stabilizing flows and tends not to discourage the big speculative movements.

Mr. Monte Solberg: I still have a question on the speculative movements. People often disparage this speculation, but I really wonder if it's as bad as all that. Don't these people in fact take on risk for other people who aren't prepared to bear the risk? Ultimately, sometimes these people lose. So aren't they taking some of the risk out of the economy for all the other small investors who simply don't want to have to face that?

Mr. Gordon Thiessen: Well, that can be sometimes, but more often than not the kind of thing we are talking about is when you have a pegged exchange rate somewhere, and one of these speculative institutions decides that it is just not sustainable and basically tries to push it hard enough to cause the government to go off its pegged exchange rate. That in turn can have a huge destabilizing effect in the region around.

That was the kind of thing that everybody worried about in Brazil, for example, where they were trying to maintain that pegged exchange rate. There were strong pressures against them and they finally had to float it. In that case it came out pretty well, because the government reacted to fix up a budgetary problem they had, and everything calmed down after that. So the underlying situation was not too terrible. Sometimes with a smaller country these things can be destabilizing.

But I think the response to it is not a tax. I think the best response is the kind of thing that's now going on in the international community, where there's an attempt to get more transparency, more information. So we know more about what's going on in the country that we're talking about. We know something about its exchange reserves, how large they are;i we know to what extent it has borrowed short-term and foreign currency, what kind of risk that is. We also are trying to improve the quality of the financial systems in those countries. Recently, there's been an announcement that the International Monetary Fund is going to be looking at the nature of financial systems when it does its regular article 4 examinations, to try to bring them up to international standards.

Those are the sorts of things that I think can help enormously.

Mr. Monte Solberg: Thank you.

The Chairman: Mr. Freedman, you touched upon the issue of productivity. We were conducting a few round tables on this particular issue, and you're right when you say there is all sorts of confusion about measurements, the definition of productivity, and all that. But you know sometimes you just have to get down to some common sense, right? In the sense that while economists may be debating the issue, departments may come up with different numbers, and the OECD may revise numbers, the reality is that we have to improve the standard of living for Canadians, and that's what matters at the end of the day. And benchmarking I guess is important, but also up to a point.

Quite frankly, I don't care how we're doing in relation to other countries. What I care about is the fact that we put our energies—if we're doing well—to doing even better. I think that's the focus. Matching the Americans isn't really what we should be doing. We should be trying to do better than the Americans, and so on.

But there are some fundamental issues, like the tax policy. Reducing taxes, personal and others, I think that enhances productivity, does it not?

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Mr. Charles Freedman: But I think, as I said, it really is not totally clear what the driving forces are. In fact, as you know, the most recent data suggest that our growth rate of productivity, not our level of productivity but the growth rate of productivity, in Canada has been pretty much the same that in as the United States for the last 10 years. We have countries that have high taxes and high productivity, and we have countries with high taxes and low productivity. It may be a factor; I certainly wouldn't dismiss it as a factor. But it's far from being the only factor.

To come back to what the governor mentioned, I think it's a crucial thing when we view what is relevant here that we also compare both sides of it. I think part of the frustration with the high taxes in Canada is the perception that we're not getting value. If people believe that they're paying high taxes and they're not getting the services they want, whether they be medical or whatever, they get very frustrated. There are countries that have high taxes and high services, and they're very comfortable with it. Other countries have chosen to go the other way. So I think that's a crucial thing one always has to remember.

Some of the things in productivity are what economists call exogenous. They're driven by things over which we have very little control. The invention of the transistor, the growth of the Internet; these are not things that are driven by government. There are certainly inventions that have come out of the private sector, and in some cases nobody realized when the invention came that it was going to have this major effect.

On the other side, we do know that the overall stability of the framework we're offering can be important. That's why some people think that high inflation—the high and unstable inflation rate—was detrimental to productivity growth. A lot of people in 1973 and post-1973 said it was the high oil prices. Undoubtedly that was an important factor, but oil prices came down and down and down, and we didn't see the pickup in productivity. I think one of the things we're seeing now in the United States, and hopefully in Canada, is the result.... We will see higher productivity resulting from all the things we did that should act in that direction—the free trade agreement, the deregulation, and then of course we had NAFTA. Low inflation itself should be helpful in that respect. We did a lot of things that we would have expected to increase our productivity.

I guess the one thing, if you wanted to come back to my own personal views, is that I'm very skeptical about is the ability of governments to choose winners and losers in terms of industry. I don't think there's any evidence that suggests government should be trying to pinpoint that this will be the winning sector in the future and this will be the losing sector. I think that's been shown to be a kind of power and ability that governments don't really have.

The Chairman: But there are many things we can do on the issue of taxation. You talked about deregulation, privatization, and all these issues that—

Mr. Charles Freedman: Absolutely. Flexibility of markets and so on. All that is very much to the good—

The Chairman: The concern I have, quite frankly, is that because this debate has been going on for a while, what happens sometimes is that until you get to the perfect answer, people paralyze. And I think we can't allow ourselves to do that. I think there are going to be some choices about whether we aggressively reduce taxes, we privatize everything the government has, or other issues that we're going to deal with. If we don't move on certain issues quickly, you're going to.... To delay is to deny other opportunities, basically.

Mr. Charles Freedman: Well, there are some things that are, to me, almost self-evident, for example, increasing the internal free trade that we have in this country. As you know, there are barriers to trade. We've been trying to get them down. That to me is just one obvious way of trying to improve the performance of the economy.

The Chairman: We don't have to wait for further studies to determine that.

Mr. Monte Solberg: Could I just ask a follow-up question along this line? It's an interesting line of questioning.

With Canada's economy, with the size of the government consuming about 45% of the economy here, compared to the U.S. where it's, say, 36%, when you tie up that amount of the economy in the public sector, that must have an impact on productivity as well. Obviously there are some things government should do, for instance, supply infrastructure. But then there are soft costs where it's questionable whether that has an impact on productivity, and we would perhaps be a lot more productive if that money were still in the private sector doing the things that business does with it.

• 1725

I'm wondering if there is a correlation between size of government and productivity.

Mr. Gordon Thiessen: I think when you get to extremes it's easier to find. Where you've seen countries with a huge government sector, it's quite clear. When you get down to something that is large but not abnormal, it gets a little tougher.

The crucial thing, however, is how good a job does government do? If the government is providing the public services that make people work more effectively and efficiently, whether it's education, health, or social safety nets that are required, if it's being done perfectly, it can be a help to the economy. If you're doing it badly, it's certainly going to undermine productivity.

Mr. Monte Solberg: The key would be, if we assume that the private sector generally does things more efficiently than the public sector does, to try to emulate the private sector examples in the public sector in those areas where you've decided or you need to have the public sector involved.

Mr. Gordon Thiessen: I certainly think you always want to benchmark very carefully. You want to make sure that in your public areas you are doing as good a job in this as you could in the private sector.

Mr. Monte Solberg: Typically what happens, though, is that a lot of times when government gets big, it ends up doing a lot of things that would be happening in the private sector in any event. In that case, would you concede that probably we're going to be less productive than we would be otherwise?

Mr. Gordon Thiessen: I think there are certainly examples where governments have become more and more intrusive, in the sense of controlling the economy, and there's no question that you see a decline in productivity. All the socialist experiments tell you that.

Mr. Monte Solberg: Okay.

The Chairman: Are there any further questions?

Governor and deputy governor, thank you so much. It's always a pleasure to have you here. I must say your comments about the economy were quite optimistic, which will make Canadians quite happy.

Thank you.

Mr. Gordon Thiessen: Thank you, Chairman. It's always a pleasure to come.

The Chairman: The meeting is adjourned.