[Recorded by Electronic Apparatus]

Tuesday, December 5, 1995

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[English]

The Chair: Order, please.

The finance committee is very pleased to have a group of distinguished economic experts and economists with us during our pre-budget investigations. We look forward to your presentations.

As I understand it, each of you will be starting off with a three-minute overview on where you think we should be going in terms of our next budget. Following that we will turn to questions from members. You will each have adequate opportunity to present the entirety of your views as well as an opportunity to sum up at the end.

In advance, I want to thank each one of you for being with us. We have with us from the Bank of Canada for Canadians Coalition, Jordan Grant; from the Canadian Centre for Policy Alternatives, Duncan Cameron; from Carleton University, Tom Rymes; from Informetrica, Michael McCracken; from the University of Ottawa, Gordon Boreham; from the University of Toronto, Tom Wilson; from the University of Western Ontario, David Laidler; from the National Anti-Poverty Organization, Lynne Toupin et François Dumaine; and also from the University of Toronto, John Grant and Edward Neufeld.

We welcome you.

Jordan Grant, perhaps we might ask you to start off.

Mr. Jordan B. Grant (Chairperson, Bank of Canada for Canadians Coalition): Thank you, Mr. Chairman.

The committee has received and is receiving a fair bit of conflicting advice last year and this year. I'm sort of awed to be here in the company of so many distinguished economists.

I've given you a handout about targets. When going around the country, the committee has asked people for certain targets with respect to the deficit. It has also set targets with respect to inflation control. The question that hasn't been asked explicitly by this government is what the appropriate targets for unemployment should be.

You'll see that in our chart we've suggested some very aggressive targets for both the deficit.... Incidentally, we would like to point out the difference between operating expenses and capital. The Auditor General recommended many years ago that the operating budget and the capital budget be distinguished from one another. While the operating budget should be balanced over the course of a business cycle, there's no reason why government should not be borrowing for capital expenditures, which have a much longer payback period.

We've also set targets the for current account deficit, It's probably the big problem that is not discussed in the Canadian economy right now. The target that's been dropped from public discussion is the percentage of GDP.

Internationally, Canada has been living beyond its means for almost twenty years. We've been borrowing from the rest of the world to finance our own consumption, yet at the same time we've been living below our means domestically. We've had high levels of unemployment. Essentially we've not been putting our full capacity to work.

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I submit that one of the major reasons for this is the adoption of our monetary policy that is focused exclusively on one target: inflation control.

The conventional economic advice you're receiving is based on a fundamental assumption that an unemployment rate, which they call the NAIRU, or natural rate of unemployment, of 8% to 9% is an acceptable, natural and unavoidable unemployment rate in Canada.

The reason that people aren't asking for targets for unemployment is that if you ask the proponents of the conventional wisdom around the table for their forecasting projections the unemployment rate would remain.... Certainly, the Bank of Canada's position is that the unemployment rate should remain within the 8% to 9% range. Essentially, they're prepared to live with that unemployment rate forever.

That's essentially the position that Kim Campbell took in the last federal election and you know where she is now.

However, there is another model. The reason we have this unemployment rate is that, in effect, unemployment is being used as the tool for containing inflation.

Over the course of years, the government has given up a number of other tools it used to have as a means of inflation control. I'm talking about a whole range, and later we could get into some of the specifics. But over the years we've given up almost all of those tools. The only tool the Bank of Canada has left is the very short short-term interest rate that it's able to push up. That in turn impacts directly on the exchange rate. It essentially moderates the economy by maintaining interest rates that are high enough to keep the unemployment rate between 8% and 9%. That is an unacceptable means of inflation control.

We have a hidden incomes policy. Let's be explicit about it. If we get that unemployment debate on the table, then we can take a look at whether this is the appropriate means for inflation control. Are there other means that would be less damaging to the economy and certainly less damaging to the federal budget?

I'll leave it at that at this point.

The Chair: Thank you, Mr. Grant. We'll come back to you later for more details.

Mr. John Grant, please.

Professor John Grant (Faculty of Management, University of Toronto): In my view, microeconomic policy must orient itself to three goals. One goal is the attainment of reasonable price stability, taking one year with another. If monetary policy is clearly oriented to maintaining price stability, it will also, by extension, be oriented to keeping the economy close to its potential.

With this as a working assumption, it seems to me that fiscal planners can set out confidently to undertake ambitious medium-term to long-term goals with the assurance that losses of output and employment due to short-term shifts in program expenditures or taxes will be minimized.

But for the most effective attainment of its aims, it's desirable that the government should set out clearly and well in advance its medium-term to long-term fiscal plan juxtaposed with the long-term monetary plan, so that private decision-makers will be able to distinguish in their minds between developments that will be shocks and those that will be the structural or cyclical developments policy-makers will reinforce.

Expectations are notoriously difficult to manage, but periodic restatement of structural and sustainability goals, widely debated and seen to be consistent with the best interests of the country, will have the best chance of generating private activity that's consistent with those goals and doesn't depend on invalid expectations.

I see monetary policy as taking primary responsibility for managing the economy as close as possible to its potential level of output in the context of price stability.

Fiscal policy, on the other hand, should be oriented primarily to maintaining an appropriate level of domestic saving with the aim of attaining the highest long-term real return on the country's wealth in the context of moving toward global sustainability.

So in this context I see monetary policy's role as managing the short-term to medium-term shocks and fluctuations of aggregate demand. Focusing on maintaining reasonable price stability is a good intermediate target for the bank, because it will give an appropriate lead to private decision-makers and ensure we stay as close to our potential as possible, as shocks and upsets will allow.

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So as I say, our fiscal plan should be fundamentally a long-range plan. Global population and GDP projections make it clear developing nations will be avid in rewarding users of this world supply of savings in the coming years. Canadians must expect lower rates of return on domestic investment than on diversified foreign investments, as developing countries build their infrastructures and converge upwards towards our levels of productivity.

The bank must contend with many expectational factors, many of them beyond its control. Its greatest influence will be wielded when, like the Bundesbank, it establishes a widespread conviction among world financial market participants that it will take whatever steps are required to maintain price stability.

So high standards are required of both fiscal and monetary decision-makers. What we lack at present is primarily a credible assessment of the country's potential in the medium to long term in the global context and a fiscal plan that's appropriate to that context.

The Chair: Thank you, Mr. Grant.

Mr. Cameron.

Mr. Duncan Cameron (President, Canadian Centre for Policy Alternatives): Merci, monsieur le président.

I've been interested in the impact of monetary policy on the economy, interested enough to write Mr. Thiessen and Mr. Martin. It's been clear to me for some time that the people who are unemployed in this country in a sense could be designated as ``inflation-fighters''; that the government has decided to keep a certain number of people, perhaps 1.5 million, 8% to 9% minimum, unemployed.

So I wrote both the governor and the Minister of Finance and said as welfare recipients are cut, and as UI benefits are cut, perhaps it should be pointed out that the Bank of Canada has already decided to have an unemployment rate of 8% or 9%. So this so-called ``voluntary unemployment'', people having fun on welfare and so on...by making those changes, you in fact are going to leave these people unemployed anyway, because that's the bank's policy.

They wrote back and said structural issues were involved. The reason was NAIRU. It was high because of high welfare payments, because of high UI benefits.

Because these have been changed, I would ask you to ask the governor, has NAIRU been moved down as a result of these structural changes? That's the first question I'd want to know.

The second thing that's concerned me and the Canadian Centre for Policy Alternatives has been the inevitable increase in the debt when interest rates are above the rate of growth in the economy. I'm interested in the question of what we can do with the bond market. I'd like to see the Bank of Canada ask why they are not intervening in the bond market, if necessary, at the short end or at the long end, to bring down interest rates. That is an option we've used in the past. It would require some dampening of credit creation by the banks, of course. But it would reduce the cost of credit to government, the cost of credit to the economy.

In short, I'd like to see a return to the art of central banking rather than a dogmatic fight against inflation.

Finally, I have one other point. When I started at the Department of Finance, there was really only one question you had to ask: is the economy expanding or contracting? At this time it's quite clear to me the economy is contracting. If it is, another tough budget, on top of the Ontario budget, is going to put us in a recession. If that's the case, then our deficit problems are going to be for real.

The Chair: Thank you, Mr. Cameron.

Mr. McCracken.

Mr. Michael McCracken (Chairman and Chief Executive Officer, Informetrica Limited): As I understand it, what you're interested in at this stage is a short statement about what the thrust of the budget should be. Then we'll come back to some of the other questions you raised.

To that end, I'd like to go to the last panel in the pink handout I've given you, which is the current outlook. At present the U.S. economy is slowing. The growth rate for 1996, from consensus forecasts in November, was 2.7%. This is down from 3.2% for 1995. Our forecasts for the Canadian economy for 1995 are 2.3% growth for real GDP, 1.6% in 1996. This excludes the precise effects of the UI reform or Harris economic statements, although we do have some judgments on those.

At the first cut, the Harris economic statement suggests it will lower real growth by about 0.6% - more in Ontario, but of course it won't be concentrated exclusively in Ontario. There's more to come in Quebec, in other provincial budgets, and probably in the next federal budget.

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There remains, however, a possibility of a tax cut in Ontario at some time in the future. Only time will tell. Some restraint was already anticipated in our latest forecast, but not to the degree that it's present in 1997 and beyond. We expect to be lowering our forecast by another two-tenths of a point in 1996 and below 2% for 1997.

What that will give you, then, are three years of below-potential growth, 1995, 1996, and 1997. We can go beyond that, but I think the key issue is that this is not an environment in which the economy will be helping the governments along as it did in 1995.

Whether we are in a recession at the moment, coming out, or about to enter a recession depends on which definition of ``recession'' one uses. But I think it's clear to almost everyone that we have not been growing rapidly in the last year by any measure.

The total employment increase in the last 12 months has been 33,000 - that's 0.24% - 9,000 full-time jobs and 24,000 part-time jobs. There has been a decline of 113,000 in public administration, offsetting increases of 146,000 in other sectors.

There has been no change in the labour force. This is an extraordinary event. Essentially, we're missing 180,000 to 200,000 people who normally would come into the labour force if we had a normal economy. Instead, with a falling participation rate, down to 64.4% from 65.3%, they have essentially kept the unemployment rate stable, rather than having it rise by 1 to 1.5 points.

The latest number we have on GDP on the year-over-year basis is 1.2% growth. That's total growth over that period.

Taking all this in line, looking at what we now have as a situation, it suggests that on a monetary side, which is not normally part of a budget statement, something needs to be done.

Certainly, real interest rates at the moment remain above growth in Canada, destabilizing fiscal balances and private debtors. We have growing fiscal restraint at all levels of government. Debt ratios are declining, and I suggest that at this stage there's plenty of room to stop putting the boot to the economy and to start stimulating and to seek aggressively a substantially easier monetary policy.

Let me stop at that point. Perhaps you can ask some questions on that later. Thank you.

The Chair: Thank you, Mr. McCracken.

Mr. Neufeld.

Dr. Edward Neufeld (Visiting Senior Research Fellow, Centre for International Studies, University of Toronto): Mr. Chairman, thank you very much for this opportunity of appearing before your committee.

I'll say just a word about the budget, and then I want to say a few things about monetary policy.

It's clear that the economy is growing less quickly and will grow less quickly next year. On the other hand, it is continuing to grow and certainly financial markets are saying that it is likely that it will continue to grow, if you watched even the markets yesterday and in the last several weeks. The markets aren't always right, of course, but at present it looks as if we're going to continue to have a growing economy, while at a slower pace, as Michael said.

The question, however, is, what is appropriate policy within the context of that environment? The concern I have about moving away from the government's track on fiscal policy is that I think it will do much more harm than good. There is a need to continue to build credibility in the public finances. Reduced credibility has a quick reaction in financial markets in terms of interest rates, what government has to pay, and general confidence in the country.

So in terms of fiscal policy, government should continue to build credibility, continue to do what it says it's going to do. I have no doubt that that will pay off in economic terms.

Let me say a word about monetary policy. There's an enormous tendency, including some comments today, to overestimate what the Bank of Canada can do to influence the economy. It's frequently thought, for example, that they can control interest rates. Well, anyone who has watched markets very closely over the last five years knows very well that there are enormous limitations to that statement.

What the bank can do is control the settlement balances of the 12 clearers that clear through it. This usually means that it can control the one-day rate, the overnight interest rate, and the band it has around them. Analysis shows that the relationship between what it can do there in the longer-term rates almost doesn't exist at all. Long-terms rates are not controlled by the Bank of Canada except in one very important way, and that is through controlling the rate of inflation.

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It's also the case that this has seen pay-offs. There's this question as to whether or not monetary policy has been helpful or harmful for fiscal policy or for the public finances. I think the policy taken in the long term has been helpful for fiscal policy. Today we have interest rates, short rates, that are at about 6%. Not very long ago, they were over 12%. We have long-term rates down to 8%. Not long ago, they were at 10%. Today we have a short rate that is only about 38 or 40 basis points away from the U.S. short rate, and the inflation rates between Canada and the U.S. now are not very different. They're very close together.

What we have seen is the Bank of Canada making a contribution that has generally been overlooked in terms of reducing the costs of carrying the debt. I would think the appropriate policy is for the bank to continue to make the biggest contribution it can make to both resolving, in the end, both the fiscal problem and the problem of inadequate growth. In my judgment, it can best do this by pursuing its primary goal, which is to ensure that there is continued confidence in the currency through price stability and, in the short run, to try to absorb the shocks in the system, whether they come from endless discussion over the Constitution and the crises that generates or whether they come from external shocks or whatever. It has to try to cushion those shocks on the economy. Those are its two big contributions.

The final point I would make is that I just do not believe at all that our fiscal problems can be solved by actions on the part of the central bank. Inflation means higher interest rates, and that costs the government. Inflation means exchange rate instability, which depresses confidence in the country. Inflation means higher costs for what government has to buy, and the negative impacts of that are very substantial indeed.

Sometimes it is argued that loosening up will depreciate the currency, which is good for exporters and good for the people who work in the export industry. What one forgets is the negative side of all this. Inflation reduces the real income of those people who have to buy imported goods. It reduces the purchasing power of Canadian businesses that have to buy imported capital goods. When you offset those things you get to a point at which, even in that sense, inflation is negative for the economy.

So my view is that we can't look to monetary policy to solve our fiscal problems. What we can look to is fiscal policy. In the end, that is the same as it's always been: action in terms of expenditure cuts, tax increases, or a combination of the two.

The Chair: Thank you, Mr. Neufeld.

Professor Boreham, please.

Professor Gordon Boreham (Professor Emeritus, Department of Economics, University of Ottawa): Thank you, Mr. Chairman.

When I received your invitation to appear before the committee in this letter by fax the other day, all I was aware of was that by and large you wanted to talk about the Bank of Canada.

The Chair: We are open to your suggestions as to what measures we should take - fiscal, monetary, whatever - for the next budget and succeeding budgets.

Prof. Boreham: That wasn't the impression I got from reading the letter, nor was I aware that the format would allow us two or three minutes to make our points. In fact, when you mentioned two or three minutes, I immediately felt like a mosquito in a nudist colony. I knew what I wanted to say, but I didn't know where to begin.

The Chair: We'll give you lots of chances to explore those other areas later.

Prof. Boreham: Let me just take a somewhat different approach from my colleagues who have spoken before me.

I came here because I wanted to talk about current monetary policy. In my opinion, the historical benchmark in the Bank of Canada's current approach to monetary management was John Crow's Hanson memorial lecture delivered at the University of Alberta back in January 1988. It was in that speech that Mr. Crow explicitly declared that the overriding objective of monetary policy in Canada was to control inflation and reach price stability over time.

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Incidentally, Alan Greenspan adopted a similar goal when he became chairman of the Federal Reserve System the year before.

The bank's absolute commitment to price stability was reaffirmed in its annual report for 1990. In February 1991 a joint declaration by the Bank of Canada and the federal government announced numerical inflation targets for the period ending in 1995. In December 1993 these targets were then extended to the end of 1998.

Incidentally, Governor Thiessen gave a speech in April at the University of Waterloo. He said that by adopting those numerical inflation targets, the Government of Canada was formally acknowledging price stability as the primary objective for monetary policy.

I recall being before this committee two years ago as a witness, when we were talking about whether or not we ought to change the preamble to the Bank of Canada Act. As you know, the preamble was left unchanged. In other words, the Bank of Canada presumably was still subject to a plurality of objectives as opposed to being accountable for only a single objective, namely price stability.

In March of this year, Governor Thiessen delivered the HERMES-Glendon lecture at York University. In this he restated the primary goal of monetary policy, but then he very skilfully outlined the transmission mechanism of monetary policy as viewed by the Bank of Canada.

The reason I'm prefacing my remarks with these points is because the new monetary policy, which I date from January 1988, has now been in place for eight years. It's time now to objectively assess the results of that policy. In the beginning there was conjecture as to whether or not this was or was not the appropriate route to follow. But reasonable men can disagree and wait for results to confirm their impressions. Eight years have now passed.

I've spent the last two days reading speeches by the Governor of the Bank of Canada over the last two years. I've carefully examined his assessment of the Bank of Canada's role over the last couple of years, and all I could find was that monetary policy has made four major contributions.

It has contributed to the achievement and maintenance of a low rate of inflation. Yes, since 1991 inflation has come down from 6% to 2%, but some would ask, at what cost? It has encouraged businesses, he said, to control their unit labour costs. It has provided a more predictable climate for making business decisions to invest in productivity enhancements. It has reduced the volatility of the Canadian dollar, thereby enabling businesses to improve their international competitiveness, as evidenced by the strong export performance of Canadian firms in the last couple of years.

These are the gains Governor Thiessen has said can be ascribable to monetary policy, but I think most of us expected more. Most of us did not expect that the policy that was pursued by the Bank of Canada between 1990 and 1993 could conceivably contribute to the most severe recession this country has ever had.

If you look at some of the other dimensions of the Canadian economy over the last several years, such as declining real family incomes, widening regional and income disparities, stagnant job creation, very little improvement in our balance of payments -

The Chair: Professor Boreham, could I ask you to sum up quickly?

Prof. Boreham: I'm going to make this last point.

The Chair: We'll come back to you. We'll give you lots of time. Please just sum up now.

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Prof. Boreham: I was hoping that this committee would in fact be prepared to consider the Bank of Canada's overall performance in the light of eight years of experience and pass some judgments as to whether or not, as you say in your letter -

The Chair: With your help, we're prepared to, Mr. Boreham. Thank you. We'll come back to you, sir.

Mr. Rymes.

Professor Tom Rymes (Economics Department, Carleton University): Thank you,Mr. Chairman. I have distributed to your clerk some written comments, which I will now quickly elaborate on.

Let me take a strong position at the beginning, not one I'm particularly agreeing with, but one that the Bank of Canada should take. The Bank of Canada has been pursuing a policy of price stability. If you accept their argument, then price stability has led to the highest rate of economic growth that the Bank of Canada can bring about, because the Bank of Canada believes that any other policy than price stability is inimical to economic growth. Their policy has led to the lowest rate of unemployment that the Bank of Canada is capable of producing because of the efficiency associated with zero inflation. That's fundamentally the Bank of Canada's view.

By pursuing that, the Bank of Canada thinks its doing the best that it can, and if correct, the Bank of Canada has contributed to the fiscal position of the Government of Canada in a favourable way. It has made in point of fact the revenue of the Department of Finance higher because the economy is growing faster, supposedly. It has made the revenue of the Government of Canada lower because the equilibrium rates of unemployment that the Bank of Canada is generating have been lower.

If you take the Bank of Canada's position, the goal of monetary policy should be price stability, and on no account should one think of solving fiscal problems by monetary policy. On no account should monetary policy accommodate fiscal policy in any way whatsoever. The Bank of Canada has an excellent, theoretically powerful position that should be examined very carefully by this committee. In my written comments, and now with you very briefly, I'm trying to provide a counter to that argument.

The counter to that argument is elaborated on in my written remarks, but it makes the point that Professor Neufeld has picked up, namely that the bank operates on the economic system by means of positive and settlement balances with the direct clearers or the bank. Fundamentally, what the Bank of Canada is always operating on is the relative costs of the direct clearers in providing financial and intermediation transaction services.

The argument I developed at some length in my written remarks is that what the Bank of Canada's anti-inflationary policy has done since 1988 is in point of fact raise the relative costs of the transactions and financial intermediation services that the banks and the quasi-banks in Canada have been providing, and the consequence of that has been that the rate of growth has been lower than it could have otherwise been, and the rate of unemployment is higher than it otherwise could have been.

On the comments about the effects on real interest rates, I'm very ambivalent, because I don't think the argument really hinges on whether or not the Bank of Canada can affect long-term interest rates. I think the argument hinges on whether or not the Bank of Canada can affect the costliness of the provision of financial services by the banks and other financial intermediaries in the Canadian economy.

Thank you, Mr. Chairman.

The Chair: Thank you, Mr. Rymes.

Mr. Tom Wilson, please.

Professor Tom A. Wilson (Director of the Policy and Economic Analysis Program, Institute for Policy Analysis, University of Toronto): Thank you, Mr. Chairman.

I was expecting to have an overhead here for some slides, but it hasn't arrived yet, so I'll defer those and use the opportunity to respond to questions.

The Chair: Thank you.

Prof. Wilson: In the few minutes I have, I would like to focus on the interaction of monetary policy with other policies. In the letter I received, the fourth question was whether monetary policy should accommodate fiscal policy. I am interpreting that as not meaning the way we used to think of it at the end of World War II, which is maintaining interest rates and funding the deficit, but rather accommodation in the sense that fiscal policy moves in the direction of restraint. Then it is very appropriate, and indeed essential under current circumstances, that monetary policy move in the direction of these in an attempt to maintain real aggregate demand unchanged in the face of the additional fiscal restraints.

When the machine arrives, I will show you some experiments we've done with our model to demonstrate the importance of that. We start from the assumption that you are trying to reduce the deficit-to-GDP ratio by a certain amount; we have a base case projection with relatively modest fiscal restraints, essentially carrying forward the fiscal restraints of last year's budget with the debt-to-GDP declining to 3% next year, as is the target, and then 2.1%, 1.5%, 0.5%. So in the fiscal year 2000-2001 there is still a public accounts deficit, although I might add that this is consistent with a cash balance and so the government would no longer be borrowing.

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We have done some experiments where we say, let's move to a tighter fiscal stance - which I think personally would be appropriate - wherein the deficit targets would be 3%, 2%, 1%, 0% on the public accounts basis, and then examine what are the magnitude of the expenditure cuts that are required under alternative monetary policy responses. You get quite a difference. Clearly, if monetary policy acts to neutralize the real demand effects, the necessary expenditure cuts are considerably smaller. If there's no monetary policy response at all, the expenditure cuts are much larger. The intermediate case, where the bank treats it literally that all it has to do is neutralize the price level effect, is in the middle. I'll defer some of the numbers until we have the overheads here.

The other two issues I want to comment on briefly are the interaction of monetary and fiscal and debt management policy and the interaction of what I would call the fiscal mix and monetary policy in obtaining objectives.

On the debt management side, as I indicated last year, it seems to me our debt management policy is fundamentally inconsistent with the fiscal strategy and with the monetary policy of maintaining inflation in a 1% to 3% range. We are paying very high nominal interest rates, in real terms, on long-term debt, and I think it would be appropriate for the government to issue additional index debt. That may require some redesign of some of the index debt to make it more attractive to be held outside tax-exempt funds.

The other area I think is worth discussing is the interaction of certain tax policy moves with the attainment of the deficit targets. Here I would point out that there are some tax cuts that really do have significant supply side effects. Number one would be payroll tax cuts. We've done some experiments with additional UI rate cuts, which indicate that a combination of cutting UI contribution taxes coupled with expenditure restraints can actually enable us to attain deficit reduction targets with positive effects on the real economy. There are other tax cuts that can do this as well; GST cuts would be another example.

The thing I think we should be looking at on the tax side is that there should be an attempt to make any revenue increases generated by tax changes what we call inframarginal. Things like taxing employee benefits, or taxing capital gains on small business and farms, are largely inframarginal. Let's try to avoid raising effective marginal rates.

My view of the Ontario tax cut is that it's inappropriate because it's such a broad-based cut. True, it's cutting marginal rates, but it's also cutting a lot of inframarginal rates. Probably you could have had a lot of the stimulus from these cuts by focusing on reducing marginal rates rather than having these large, very expensive, inframarginal cuts.

Thank you.

The Chair: Thank you, Mr. Wilson.

Lastly, Mr. Laidler.

Professor David Laidler (Department of Economics, University of Western Ontario): Thank you, Mr. Chairman. I too prepared brief written answers to the questions that were faxed to me. Let me speak briefly to the budget question and then briefly to some of my answers.

I liked last year's budget. What I liked best about it was the very conservative assumptions that went into the deficit projections that made it likely they would be exceeded by the end of 1997. I would like more of the same. It seems to me there is a good chance Quebec will separate from this country three years hence. That will be accompanied by a fiscal crisis of an enormous order, and I believe the Government of Canada owes it to the inhabitants of all of Canada, including Quebec, to put the fiscal house as far in order as is possible so as to minimize the fiscal consequences of what must be a fairly high probability of Quebec separating.

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Now let me turn to monetary policy. The first two questions were about the past. I've answered those in writing. Let's talk about the future.

I still believe the right goal for monetary policy is a target range for inflation within which the inflation rate should be. I borrow the adjective from Bennett McCallum: ``negligible''.

I think the boundaries of the range should be rather widely set and the period over which it is averaged should be rather long, so there is a built-in cushion against real shocks that might otherwise have adverse effects on real income and employment.

I would not recommend gearing monetary policy to any further short-run fine-tuning.

When it comes to solving fiscal problems by monetary policy, I would say two things. Fiscal problems are not the kind of problems you solve; they're the kind of problems you cope with. There are a number of ways you might cope with them by monetary policy.

Inflation is a tax, and you could raise revenue that way, with all the adverse side-effects. I am not very optimistic about using expansionary monetary policy to try to lower the cost of outstanding debt. For one reason, I don't think it'll work. The best the Bank of Canada can do to get nominal interest rates down is to establish the credibility of negligible inflation. We've seen some progress in that over the last year.

I dare say a really vigorous monetary expansion could shove real rates of interest at the long end down for a few months. It would also shove inflation expectations up. I don't know what would happen to nominal interest rates, net, even in the short run. In the long run I'm as sure as I can be about anything in economic life that they would go up and the policy would be self-defeating. Of course, the Bank of Canada's credibility would be destroyed as well.

The final question is should monetary policy accommodate fiscal policy. I think that's badly phrased. When I think of monetary policy accommodating fiscal policy, I think of monetary policy going in the same direction. As deficits are cut, I do not want interest rates to be kept up and the exchange rate to be propped up by the Bank of Canada. If the Bank of Canada is pursuing negligible inflation in the medium term, the automatic response of markets to contractionary fiscal policy will be an easing of interest rates, and perhaps an easing of the exchange rate. I would like that to be permitted to happen. I would perhaps like it to be encouraged.

I would pull just one thing from the answer to the first question sent to me. I am very uneasy about the tactical framework within which the Bank of Canada operates. I do not like the monetary conditions index as an operating target. I think it makes the bank too reluctant to allow the exchange rate to fall when markets want to take it down.

I don't like the second step in that line of causation either, because I think it focuses too much attention on the unemployment rate as a variable that's intermediate between what the Bank of Canada controls and the inflation rate. I'm therefore still unrepentant in thinking monetary aggregates have a larger role to play in the tactic of monetary policy.

The Chair: I guess we were hoping for unanimous views from all of you. We remain unsurprised that there's very little unanimity around this table. We've seen a couple of major views, ones basically supporting a reasonably tight monetary policy, others saying what the Bank of Canada's done in the past and is doing today is totally harmful to our current situation.

Do any of you want to discuss this among yourselves before we turn to questions from the members?

Mr. McCracken.

Mr. McCracken: I was trying to keep score. Would the persons who think the Bank of Canada should be tighter than it currently is please identify themselves?

The Chair: Or tight. I would say Mr. Neufeld was basically supporting the view of where the Bank of Canada is today. He wasn't criticizing it for having gone too far, I'm sure.

Dr. Neufeld: Mr. Chairman, you're right in what you said, which is not saying they should be tighter. In fact, I think the present position is, as I mentioned before, that there is a mere 38-basis-point difference between Canadian and U.S. interest rates in the area the Bank of Canada in fact controls. So not just because of its action but also because of market action, the bank has gone a long way toward easing.

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From here on in - and this is a point that has not yet been made - for the bank to move rates further, it requires that the markets agree that it is a desirable move. If the markets these days tend to push rates lower, I would say the bank should in no way prevent that from happening. It should be pleased this is happening. But to go beyond that and to move Canadian short rates to levels that the market thinks are totally unsustainable will result in what happened in January 1990, when the bank tried to move the bands down by just one-quarter of one percent, no more. The market didn't agree with that, and within a week we had a mini exchange crisis on our hands. Interest rates turned out to be higher than they were before the bank tried to lower them.

So this is a very sensitive area in which I think one should recognize that the bank has enormous limitations in how it can move interest rates around.

The Chair: With due respect, Duncan Cameron said the Bank of Canada should never have been in the bond market to get rates down.

Mr. Cameron.

Mr. Cameron: If you look at the historical gap in the real rate of interest in Canada from 1981-94, it was 6% short-term; we've had a 6% average in real interest rates. That compares with 1% in the period from 1950-80, so obviously there's been a major shift. Our interest rate is high on the bond market because we're expecting high inflation. Well, inflation has been very low and people have reason to believe it will continue to be low because we're in a deflationary situation.

I think the expectation in the bond market is based on the expectation of tight money policy. If you change the tight money policy, you would in fact get money flowing into that long-term end of the market, which would bring down interest rates naturally.

I think the government should indicate that it's concerned about the cost of credit to Canadians; that it's concerned about the cost of financing government debt and that this is an issue; that it's concerned about the rate of unemployment and what it does to the rate of economic growth; that it's concerned about the cost of the high unemployment rate that we have today, which we estimate at about $100 billion a year.

The government's policy now is to lower wages. That is the policy -

The Chair: I'm sorry, we were just dealing with the Bank of Canada.

Mr. Cameron: But that lowering of wages is a result of what the Bank of Canada has identified as the structural problem of NAIRU. If the government is moving in response to the Bank of Canada's argument that NAIRU keeps unemployment up, what I'm going to argue is that the government should go back to the Bank of Canada and say that it did what the bank told it to do, that it's going to lower wages in Canada and wants to see interest rates come down.

The Chair: Mr. Laidler.

Prof. Laidler: Here are just a couple of facts. The real return bond is now yielding a little over 4.5%. The nominal bond that's the closest thing to it in terms of maturity is, I think, yielding just over 3% more per annum. So long-term inflation expectations in the bond market offer an inflation rate of about 3% until 2021, the top end of the current target range even if you don't allow for an insurance premium to be in that.

From these numbers, I would go on simply to second what Tom Wilson said. I think there's everything to be said for the government issuing more indexed debt if it's worried about cutting its financing costs.

The Chair: Thank you.

Mr. Boreham, you certainly don't like what the Bank of Canada has done over the past eight years.

Prof. Boreham: The reason I made the points in the way I did was that I've been teaching economics now for nearly forty years. When you start in a money and banking course or in a macroeconomic course, you usually start off with Canada's macroeconomic objectives, dating from the preambles of the Bank of Canada Act in 1934 through the 1945 white paper on employment and income. I thought it was generally well accepted by this time that Canada's macroeconomic objectives were economic growth, a high and stable level of employment, reasonable price stability, a viable balance of international payments, and equitable distribution of rising incomes. I wasn't aware that the Government of Canada had changed these macroeconomic objectives, although over time we perhaps gave different emphasis to these goals. Can we not expect the Bank of Canada to respect these goals, to give us a balanced approach?

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The Chair: Thank you.

Mr. Jordan Grant, you had your hand up.

Mr. Jordan Grant: The question has been raised as to whether the Bank of Canada can affect interest rates or not. We submitted last year, a little too late for the committee to see it, a paper, of which I've given you just a copy of the summary page today. I've resubmitted the whole paper to the clerk. It talks about that issue.

When we talk about that issue, we have to look at the short term and the long term. But first of all, let's talk about where interest rates should be. Never mind about how we get them, but where they should be.

I think there would be a broad consensus that for the financial system to be sustainable and for deficits to be sustainable, the average interest rate should be somewhat less than the potential rate of growth in the economy. During the period from the 1940s to the mid-1970s, short-term real interest rates were about 1% and long-term rates were about 3%. We had a higher rate of growth in the economy. We had a sustainable system. Debts didn't grow faster than the economy.

As an objective, we should be looking at how to get interest rates down to a sustainable level.

The Chair: How do we get them there fast?

Mr. Jordan Grant: We can't get them there fast.

The Chair: How do we get them there?

Mr. Jordan Grant: In the short term, the Bank of Canada can very well adopt a very similar strategy to what it adopted in 1993. In 1993, we had a relatively loose monetary policy. The implication of that loose monetary policy was that we had a declining value of the dollar. Our financial markets are so interlinked -

The Chair: Can you just tell us quickly how we get them there?

Mr. Jordan Grant: In the short run, the Bank of Canada can narrow the spread between the Canadian and the U.S. rates down to zero, or possibly slightly negative. That's not the nominal rate.

The Chair: Okay. We heard that.

Mr. Jordan Grant: In the longer term, the only way the Bank of Canada can affect long-term interest rates is by being a bigger player in the debt markets.

The Chair: Thank you.

Tom Wilson, do you agree with that?

Prof. Wilson: Mr. Chairman, I was outside. What was the question that was being discussed?

The Chair: I'll explain. In the short term the Bank of Canada should intervene to get our rates down to the U.S. rate or below it, and in the longer term we will have the opportunity to get our rates down as well, through the Bank of Canada.

Prof. Wilson: I would favour some easing of monetary policy under current conditions. The outlook isn't that strong. There's a fair amount of slack in the economy.

I thought our principal focus today was on the interaction of monetary and fiscal policy, not on monetary policy itself. It seems to me that in the context of additional fiscal restraints, we're seeing them in Ontario now. We at the centre of the table feel this cut very deeply. I'd say they're coming from additional restraints at the federal level. I think it's perfectly appropriate for monetary policy to be taking those factors into account, and I would say try to maintain the growth of nominal aggregate demand.

I don't think there's a risk that we're going to move up above the 3% limit within the 1% to 3% range. With reference to some of the comments that have been made, I don't think the Bank of Canada can control the difference between the real interest rate and the potential growth rate. All over the world, this has happened.

Around 1980, there was a fundamental change. Before that time, real interest rates tended to be lower than trend real growth rates. After that time, with the exception of the really high growth in far east Asian countries, real interest rates have been above real growth rates. That's really changed the arithmetic for fiscal policy, as you're well aware. I don't think the Bank of Canada can reverse that.

The Chair: Tom Rymes.

Prof. Rymes: Very briefly, the point of my interjection was to claim that the Bank of Canada may be unable to affect real interest rates. I think there's good evidence for that. What the Bank of Canada can do is affect the cost of banking. That's how the Bank of Canada is operating its monetary policy now. By putting the banks into positive or negative settlement balance positions, they affect the spread of interest rates, and it's the spread of interest rates that is the price of banking services.

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So the Bank of Canada can affect the rate of growth of the output of banks in the Canadian economy, financial intermediation in general, and that feeds as intermediate inputs into the output of the economy as a whole.

I would focus on what effect the Bank of Canada can have on the real rate of growth of the banking system as a primary objective of monetary policy today.

The Chair: John Grant, with whom do you agree?

Prof. John Grant: My assessment is that worldwide real interest rates are high partly because there are perceived high returns to productive investment globally, and that's a good, constructive reason.

The other reason is a bad one, that we have huge fiscal deficits in Canada and the U.S. in particular, which are straining the willingness of fund managers to hold increasing amounts of our debt.

Given those situations, neither of which the bank can directly influence, I think that attempts to reduce short-term real interest rates in Canada can be manipulated, but at the price that the real exchange rate would then fall quickly as well.

The bank may feel more tender about its ability to manage the resulting monetary conditions than might later turn out to be the case, but I personally would defer to their technical expertise in this area.

Trying to manage aggregate demand as a whole means that you can't focus only on easing real short-term rates. You've always got to be concerned about what will happen to the real change rate as a result.

[Translation]

Mr. Loubier (Saint-Hyacinthe - Bagot): When the Governor of the Bank of Canada tabled his most recent report, he said that if the Bank of Canada had been able to estimate the extent of the slowdown in the economy and job creation that we experienced last winter and this spring, it would probably have managed its monetary policy differently.

I have been listening to you for the last little while; half the economists here say that the Bank of Canada has no power over the current situation. How does one explain that the Governor of the Bank of Canada himself says that he would have acted otherwise if he had foreseen the slowdown that occurred last winter and in the spring, when you say that the Bank of Canada has no influence on the current situation or job creation? That is my first question, Mr. Chairman.

[English]

Prof. Laidler: I certainly wouldn't say that the Bank of Canada has no influence on the real economy or on job creation.

I would say that the Bank of Canada's control over those matters is subject to sufficient time lags and quantitative uncertainties that it cannot, as a practical matter, be used to the good; but if the Bank of Canada makes a mistake, then the Bank of Canada certainly can do harm.

When I was here at about this time last year, I warned that the behaviour of the rate of growth of the M1 aggregate was signalling a slow-down in the economy and that I was a bit worried that the Bank of Canada was making a tactical error in monetary policy.

I believe the Bank of Canada did make a tactical error in monetary policy, and I believe it did so because it paid too much attention to the exchange rate and not enough attention to the monetary aggregates.

[Translation]

Mr. Cameron: Mr. Loubier, like you, I have followed the changes in the Bank of Canada's monetary policy. I too was surprised by the fact that the Bank had, to all practical purposes, abandoned the basic control over the money supply that it used to exercise through the mandatory reserves held by banks, and that it had in effect said to the commercial banks that they were no longer required to make these deposits. This is a kind of present to the banking system.

When I asked Mr. Bernard Bonin how the interest rates were to be controlled, he told me that they have all the means necessary to control short-term interest rates through the mechanism that Mr. Neufeld referred to. Every day at 5:00 p.m., they establish the level of federal government deposits with the banking system. Then they change the rate at which they lend to the financial markets. With its influence on the sales of weekly issues, if the Bank of Canada decides to acquire Government of Canada instruments...

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At present, the Bank of Canada has decided to grant no credit to the provincial government, which it is mandated to do and used to do, or to the federal government. It finances solely the circulation of bank notes, nothing else.

So, the total of the debt held by the Bank of Canada has fallen from 25% of the total to about 4% or 5%.

The Chair: Thank you Mr. Cameron for your suggestion.

Mr. Neufeld: Mr. Loubier, I agree with what Professor Laidler said. Of course the Bank of Canada is not powerless, but in what area does it have power? For controlling inflation, but not for controlling the long-term money supply. This power can contribute enormously to controlling long-term interest rates because they follow the inflation rate.

There have surely been times where the Bank of Canada has made mistakes, but it's not easy. I think that there is not a single economist at this table who has never made a mistake in economic forecasting.

The Chair: That's true.

Mr. Loubier: I remember.

Mr. Neufeld: Yes, and when a mistake is made in a forecast, a mistake is certainly made in applying monetary policy. Maybe it can be rectified quickly, but it is impossible to believe that the Bank of Canada will never make a mistake.

Mr. Loubier: Returning to what you just said, Mr. Neufeld, and what Mr. Laidler said earlier, that it could be dangerous for the Bank of Canada to take certain action. But could it be that the Bank of Canada, in the past eight years, that is to say the time frame proposed by Mr. Boreham earlier, has adopted an attitude that is dangerous considering the state of the Canadian economy, the job market in particular? Could it be that it is somewhat responsible for the situation that we have been experiencing in Canada for the past three quarters, zero net job creation?

I would like to return to what Mr. Thiessen said in his report. He said that, if he had been able to better forecast the extent of the slowdown that occurred last winter and spring, he would have acted otherwise. Could it be that, in its obsessive, if not compulsive, and excessive fight against inflation, based on real short-term interest rates, the Bank of Canada has contributed to blocking economic recovery? There is danger either way: if you take action in one direction, there are risks, because there are always risks, but if you fail to act in the opposite direction, there are risks that economic recovery will be weaker than it should have been for the past three and a half years or so.

Mr. Neufeld: I think, Mr. Loubier, that the Bank of Canada has not given too much importance to controlling inflation. After all, the present inflation rate is between 1% and 3%, the target rate agreed on by the Government of Canada and the Bank of Canada. However it is true that when the Bank of Canada makes a mistake, and it made one several months ago, it is a mistake regarding what needs to be done to reach the targeted objectives. For several months, monetary policy was too tight. Then the Bank of Canada corrected the situation. It corrected it because its inaccurate forecasts would have created problems related to the inflation rate.

[English]

The Chair: Mr. Grant.

Prof. John Grant: I think in retrospect we can see that all of us make mistakes. The private sector makes them, the bank makes them, and fiscal policy doesn't get it right either.

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I think the lesson from that should be that on the one hand we need longer-term oriented planning where monetary and fiscal measures are deliberately juxtaposed and made consistent at least ex ante so that when the shocks and the inevitable results of mistaken expectations are identified, there's a rolling plan into which to fold the response.

I think in retrospect that the sad history of the 1980s reflects as much mistaken expectations on the part of fiscal managers as it does on the part of the monetary managers. Indeed, the private sector blew itself up in the late 1980s with its expectations of asset price changes and inflation rates that never came to pass.

So, again, I think what monetary and fiscal policy can do may have more to do with setting a grand strategy for the medium to longer term and making it clear to the private sector what is reasonable to expect.

Mr. Grubel (Capilano - Howe Sound): I'm sorry I was late, but I had to be in the House.

I have a feeling that the people who believe that the Bank of Canada has great freedom to adjust monetary policy have missed two fundamental developments since the 1980s. One of them is the total integration of the international capital market.

There are trillions of dollars floating around the world. If one country suddenly decides that it would like to offer people who are lending money to them a significantly lower rate than anybody else, why should any of those sharp-pencilled managers in today's global market be willing to lend any money to these people? I don't understand this. This may have been possible in the 1960s and 1970s, but how can it be in 1995? I really don't understand.

The second thing I missed from the analysis of those who believe they can manipulate monetary policy and interest rates as in the 1950s and 1960s is that we now have a shortage of capital. I think that in the long run, in a flow sense, the demand for savings and the supply of savings is what determines the interest rate.

What we have in this world today, like we never had before, certainly since the Second World War, is a demand for savings from the general public by governments that has to be met somehow and rationed somehow, and it's being cut off by high interest rates in order to choke off the private demand. Therefore, I would suggest that these people who believe that these factors don't matter, that the Bank of Canada can just go beyond them...I really don't understand how that is possible.

My last comment is that I would suggest that according to the model I have presented, we are unable to change anything in the long-term interest rates, which are important for investments, except the spread that we as a nation have relative to that amorphous concept of the world interest rate, and that is, of course, the risk premium that has been attached by investors who believe that in fact a government may come into power that follows the siren song of those who say all you have to do in order to get out of trouble is to push the easy monetary button, let inflation go wherever it wants and let the exchange rate go.

Now, that's where we can help. That's where I think this government can do something, namely, get its fiscal house in order and get that spread down, and for the rest, hope the Americans, the Japanese and the Germans do the same thing. Then we get back to perhaps what we had in the 1970s.

This was a general statement, and I invite your comments, please.

The Chair: I know that Duncan Cameron does not agree with you.

Mr. Cameron: When I started doing my doctoral thesis on the international monetary system, one of the first books I read was your Penguin book on the subject. I was kind of surprised to see the change in your views that has occurred.

Mr. Grubel: No change whatever, I'm afraid.

Mr. Cameron: The globalization argument - it's because we decided to get out of line with interest rates in the rest of the world. It's because we raised our interest rates 5 to 6 points above U.S. interest rates that we attracted money from all over the world.

Wynne Plumtre looked at the Canadian economy in the 1930s and said, there's one rule: don't get your credit out of line with international credit conditions. So when we decided to do that to fight inflation, we got ourselves into a financial problem.

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What we're arguing is we should bring the interest rate down to a band between 1% above or below U.S. interest rates on a short-term basis; to realign ourselves with world rates, not step out of line from world rates. That would produce a significant change in our interest rate structure.

The second point you make is about the rate of savings. Well, perhaps Tom Wilson can address whether Keynesians still say the rate of savings depends on the rate of investment. If you look at the rate of investment in this country, you'll see from my remarks that Canadians, to the extent that they've been investing, have been investing abroad. One of the reasons they've been doing that is high interest rates.

If you're a monetarist like Brother Laidler and you look at the figures for M2, you will see in 1992 we were growing at about 5%, down to 3.8%, down to 2.2%. So we are restricting monetary policy. I'm not sure what the lag will be, but we're setting ourselves up for a recession somewhere down the line, if you're a monetarist. If you're a Keynesian, by cutting government spending and trying to balance the budget in a recession, we're also setting ourselves up for some economic difficulty. So I think there's more unanimity here amongst economists than you might expect.

The Chair: Mike McCracken.

Mr. McCracken: I have a couple of observations.

I think one can take this notion of the integration of capital markets too far, particularly when you add the notion that there will be exchange risk in those movements. There will also be potential illiquidities. Tax treatments may be different.

Today, whether you look in nominal or real terms, there is a wide variety of interest rates out there. Canada is at the higher end of the real interest rates. Japan is at the very low end. If in fact, as you portray it, it was somehow a risk premium difference, one would think with a financial system about to melt down, with no effective government, Japan would have a much higher risk premium than currently exists.

So we do have a lot more latitude to move. Always implicit in the comments people make about the impotence of some group, or the inability to change from the current situation, is a sort of self-serving additional footnote that rarely appears, that we can't change anything without changing something else. For example, it's implicit that we can't interest rates without the exchange rate changing, or without having to give up on some other objective someone has.

But we can change interest rates. We have done it numerous times in this country on a week-by-week basis. We can change long rates if we wish to operate in the long market. We can change real rates if we wish to operate in the real market. The issue is: are we or are not going to do it? We certainly have seen movements in these rates, and we've seen them triggered by policy as well as by external shocks.

So I don't think we should take it that somehow there is a market out there that is functioning perfectly and sending out the appropriate signal at all points and times and monetary policy is totally impotent to do that. If you really believe your world, then you should, of course, be lobbying strongly for Canada to adopt the U.S. currency -

Mr. Grubel: I am.

Mr. McCracken: Oh, are you? Good. Well, then, you might as well jump on that band wagon. So you like their monetary policy compared with ours, presumably. It would be a more sensible policy, from your viewpoint. That direction is another way of getting the interest rates down -

Mr. Grubel: If we're going to -

Mr. McCracken: It would make your job a lot easier, too. You could just adopt the U.S. dollar.

Mr. Grubel: In this integrated world that I think we live in, we might as well have a voice on the board of governors instead of just tagging along the way we are. But that's a separate issue.

Mr. McCracken: A federal reserve district, possibly.

Mr. Grubel: Let's not get sidetracked on this. This is a very personal view. It has nothing to do with my party. I have to be very careful on this. I want to assert it has nothing to do with my party.

Mr. McCracken: It's based on an analytical framework, though.

Mr. Grubel: But Michael, you say it's not integrated. There's some reason for why we are at the current level. Let's assume the Bank of Canada tomorrow not only acts but says it is now prepared to lower the interest by increasing M1 and ensuring the interest rate will be lower.

Now, you are a fund manager for Oppenheimer or whoever it may be, with trillions of dollars at your disposal. You have some money in Canadian money; and it was just the right interest rate that kept you in Canadian money. The news is that as of tomorrow the Bank of Canada will lower the rate it will give you on those Canadian funds. Are you going to be saying to this fund manager, ``Just hold on, because in the long run it doesn't matter''? Or will that fund manager say, ``No, I'm not going to keep that Canadian bond, which now yields less, and I'm going to go into a German or Japanese bond'' or whatever it is? Explain that to me.

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Mr. McCracken: But Herb, you know better; you know that's not the way it works. The way it works is that the rate drops, you now are sitting there with your funds in Canadian dollars, saying what the hell do I do now? The issue is, are they going to drop further - in which case you get out. If they've already dropped, you say, well, I might as well hold onto them because the only way they can go is up. I'm not suggesting we advertise or take out goddamned ads in The Wall Street Journal saying we're going to lower interest rates in this country. But sure as hell we can do it.

Mr. Grubel: But we do it only to the investors -

Mr. McCracken: If the people up there at the bank don't know how to do it, I'd be more than pleased to show them how to do it.

Mr. Grubel: We do it only to Canadian investors, not foreign investors. We keep it separate.

Mr. McCracken: Anyone can move interest rates around. They're holding Canadian instruments.

The Chair: I think Mr. Neufeld, Mr. Wilson and Mr. Laidler wanted brief comments on this whole thing.

Prof. Wilson: I have what we call a two-handed intervention here. All of this discussion ignores the fact that if you're a bond holder and interest rates go down, you're very happy if you're holding, because you get a capital gain on it. You might be able to factor that in.

The Chair: And then the capital gains taxes - you pay on that.

Ed Neufeld.

A voice: No, no one pays that any more, though. You know that.

Dr. Neufeld: I think the argument here is one of just how in fact markets will react. This isn't even a theoretical discussion. I think if you want to know how markets react you should look at markets and sit on the trading desks for awhile. For the last period of my professional career I was quite close to that kind of world.

There have been two or three instances that have shown conclusively that if the Bank of Canada wishes to lower rates, first of all it can't be hidden - those traders know everything that goes on from minute to minute, so trying to hide what the Bank of Canada is doing is not possible. If the bank tries to lower a rate that the market fundamentally feels goes against its view of the future in terms of economic conditions, in terms of political uncertainty, in terms of the risk to the country's credit rating - you name it - then the action of the Bank of Canada to try to lower rates will have exactly the opposite reaction along the whole spectrum of interest rates.

This is not a theoretical discussion; this is a discussion of observation of how markets today operate. It goes back to that part of Mr. Grubel's comment about integration of financial markets. Markets are very integrated. As for intervening in the long-term bond market, any amount of bonds that the Bank of Canada can throw into that market is a drop in the bucket in terms of the holdings of bonds by the private sector, not just in Canada but abroad. We've seen it time and time again - the bank moves stuff at the short end; nothing happens at the long end because the bank does not control the long end except through what it eventually produces in terms of protecting the real value of the currency.

The Chair: I think Mr. Jordan Grant disagreed with you earlier on that point.

Mr. Jordan Grant: First of all, let's look at the context. With the long-term rates set on the international market they're not looking just at nominal rates, they're also looking at expectations of where the dollar is going to be as probably the most important thing, because these traders are moving in and out every day. Whether the rate is 9% or 8%, their money is going to be made on whether the dollar moves up or down. They're not hanging in there for a year, they're not making their 1% difference by holding on.

If, as Mr. McCracken said, short-term rates move down, yes, the natural reaction is that the markets sell off. There's an immediate adjustment in the value of the Canadian dollar and that adjustment continues until such point as the markets perceive that the Canadian dollar is undervalued.

Right now the markets perceive that the dollar is overvalued. We've got people like Friedberg who are saying that the dollar's real value is 65¢, and we've got people like Laidler for the C.D. Howe Institute who are saying the real value is about 70¢. The fact of the matter is that we're still running a current account deficit of $20 billion per year. When in 1993 the rates went down, we peaked out at a current account deficit of about $30 billion per year. The moving down of the interest rate and the exchange rate helped that current account deficit situation by about $10 billion.

The policy of maintaining high interest rates in order to continue to attract inflows of foreign capital is a policy designed to continuing the descent into foreign indebtedness in perpetuity. The objective of the government should be to be reducing our levels of foreign indebtedness in the long run. That means setting interest rates that are appropriate for the Canadian economy and allowing the markets to establish a reasonable level for the dollar, which is whatever level will establish a current account balance.

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The Chair: Don't worry about interest rates; get them down; drop the dollar. It doesn't matter where the dollar goes.

David Laidler, your name has been taken in vain lately.

Prof. Laidler: I must thank Duncan Cameron for a salutation that I haven't heard since my student socialist days.

Just for the record, M2 seems to me to be growing quite healthily at the moment, and so does M1. I think monetary policy is basically on track.

I want to come back to what I said at the outset. There's a very high probability that three years hence this country will either divide or go through a radical reconfederation. That is going to be accompanied by enormous uncertainty in international capital markets. We are going to need all the credibility we can get in order to get through that with minimum damage to Canadians in Quebec and outside of Quebec.

It's unbelievable that people are advocating taking risks with the credibility of the Bank of Canada at the moment on theoretical positions that, frankly, seem to me to be very ill established.

In the current political and fiscal situation in this country, one must err on the side of conservatism. We'll be in a terribly dangerous position over the next three years.

The Chair: Mr. Campbell.

Mr. Campbell (St. Paul's): We've heard from many witnesses in this round of prebudget consultations, and all of us appreciate how difficult is this issue of monetary policy and the role and ability of the Bank of the Canada.

It has been said before this committee and on the road as we travelled the country that high interest rates are responsible for the tremendous debt and deficit of this country. I've heard that statement being made as boldly as that: it's all the fault of those high interest rates.

Yet when you look at the evolution of the federal deficit over the last 25 years, it's clear to me - and I wonder if anyone disagrees - that while the high interest rates might have coincided with us running deficits in certain years, might have added to the burden, we clearly ran deficits for most of those years from the mid-1970s through the early 1990s. Therefore we have to lay the blame for our existing situation - I'm not talking about how we may solve it - on our spending, not on high interest rates.

I wonder if anyone wants to react to that. Mr. Neufeld?

Dr. Neufeld: I certainly do not believe that our fiscal problems have been either caused or aggravated by the general direction of monetary policy. This abstracts from some of the short-term mistakes to which Mr. Loubier referred earlier.

The impact of monetary policy on the fiscal situation has three elements: inflation, interest rates, and real growth. You have to go down the list to say what impact monetary policy has had on each of those and how each of those affects the fiscal balance. I've tried to do that.

For example, when I look at inflation, the simple view is that if a country gets into trouble, all you have to do is deflate the currency. You pay back in cheap dollars and it doesn't cost you so much.

There are two or three problems with that. One of them is that we now have a very short-term debt. Interest rates go up overnight when you try to inflate the currency. So I don't think there'll be any joy at all for the federal government in getting inflation to wipe out the problem of the deficit.

Inflation also costs the government more. It's wages go up; the stuff it buys goes up. Certainly its tax revenues go up as well; however, indexation reduces - not eliminates - the amount of the tax revenues it gets.

So my conclusion has been - and I'm summarizing - that inflation will in fact not improve the fiscal balance.

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What about interest rates for this kind of policy? If you have a market and a debt that's short and interest rates go up very quickly, clearly inflation won't help you on the interest rate front. Low inflation will, as I mentioned before. We've seen our short rates go from 12% or 14% down to where they are today, 6%. That's an enormous savings to the Government of Canada, as is the downward move in long-term rates. It's not as great, but it dropped from over 10% to about 7.5% at present.

What about real growth? This is the big debate. There are some people who say inflation encourages growth. I don't agree with that, and I don't see the statistical evidence that leads me to believe inflation leads to higher growth and therefore doesn't lead to higher tax revenues from the real output of the country. Whether I look at inflation, interest rates or real growth - the three things that you think might emerge from a monetary policy - I see no case for saying that will help solve the fiscal problem.

Mr. Campbell: Mr. Chairman, others wanted to respond to my statement.

Prof. Wilson: In the long run, I don't think monetary policy can affect real interest rates. I don't think the rate of inflation has that big an effect on the government's balance. In the short run, however, there are effects, and I thought your question was really focusing on the past rather than looking ahead.

Mr. Campbell: There is no question of looking ahead. I am looking at the past right now.

Prof. Wilson: There's no question in my mind that the transition from an environment in which the expected rate of inflation was running at 4% or 5% to an environment in which the expected rate of inflation is, say, 2%, has had transitional effects that have added to our fiscal problems.

One transitional effect was that during the tightening, the recession was deeper and more prolonged. That had a negative effect on the government's budget and made the deficit higher. Another transitional effect was that long-term bond holders were happily gobbling up federal debt at very high nominal rates, and when inflation came down there were, of course, windfall gains that these bond holders received. Those were windfall gains for the bond holders but windfall losses for the taxpayers. If those bond holders are overseas, of course the windfall gain for them is a windfall loss for the country. So the transitional period does have some negative effects on fiscal policy.

I agree with Ed Neufeld, on the other hand. We should not reverse all that and try to inflate because we had some other reasons for wanting to come down. We want a lower inflation environment. I think we should be focusing on.... I won't change the subject right now, but I really wish we would come back to the issue of the monetary-fiscal policy interaction. I think there are -

Mr. Campbell: I have another question, Mr. Chairman, but I think Mr. Cameron also was anxious to respond to what I said.

Mr. Cameron: In my presentation notes, the national debt increased from $330 billion in 1988-89 to $508 billion by 1993-94. In that period, tax revenues exceeded spending. There was an operating surplus of $21 billion.

Mr. Campbell: I was talking about operating deficits and I went back to the mid-1970s, when it was clearly all in deficit, Mr. Cameron.

Mr. Cameron: The $300 billion that was inflated by interest rates, and nothing else, was created by a - I hesitate to say it in this company, of course - Liberal government that introduced a series of tax expenditures that led to a number of leakages on the revenue side. Those tax expenditures, for instance, give us a -

Mr. Campbell: I wasn't debating the source of the operating deficit. I was making a comment about the fact of an operating deficit in those years beginning in the mid-1970s through to the late 1980s, and the extent to which debt accumulated because of those operating deficits. We can debate how we got into deficit, but that's a different question.

Mr. Cameron: But the reason it accumulated was that interest rates were higher than the rate of economic growth. If you look at Martin's projections, we're going to need an operating surplus of $60 billion. Do you know what that's going to do to this economy - the deflation and job losses that are going to result - if you do this?

Mr. Campbell: Let me ask a short question that will probably lead to a number of interventions now, or perhaps in the wrap-up if we run out of time.

Another thing that's been said to this committee by witnesses last year and again this year is.... I understand that people are looking for an easy way out of this solution. We ran up aggregate debt and we ran deficits, and now people want to find magic solutions and ways to resolve the problem - maybe creative ways that haven't been tried in any other country.

We're talking about the Bank of Canada to a great extent here this afternoon. One of the suggestions that has been consistently made to us is that the answer really lies in the Bank of Canada holding more Government of Canada debt. We can talk about how that would be achieved and I have much concern about how that would be achieved, but my question really concerns what impact that would have on the very issues we're talking about here, the value of the dollar and interest rates. There have been comments on the viability of the Bank of Canada somehow holding substantially more Canadian debt than it currently does, how that would happen, and the impact of it.

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The Chair: That was suggested by Duncan Cameron, so let's let him respond quickly in three sentences.

Mr. Cameron: When we came out of the war the debt per capita was double what it is today and the Bank of Canada financed a good portion of the Second World War. If we think unemployment is a problem, if we think regional development is a problem, we can undertake the risk of having the Bank of Canada hold more credit and having the private banking system create less.

Mr. Campbell: How does it do it? What's the impact on the dollar and interest rates in the end?

Mr. Cameron: Well, it would undoubtedly have an impact in the short term on the value of the dollar.

Mr. Campbell: In which direction, up or down?

Mr. Cameron: Down.

Mr. Campbell: How far down?

Mr. Cameron: Until somebody thought it was undervalued.

Mr. Campbell: What would be the impact on interest rates as the result of a dollar at that level?

Mr. Cameron: If the Government of Canada through the Bank of Canada were buying bonds in the market and picking those up, the effect would be mitigated. In fact, it would be reversed, if you're willing to do it. My preferred method would be to have the government, through the Bank of Canada, be lending at zero interest to the provinces.

My second point is the one on accommodation. If you are going to cut expenditures, which I don't agree with, you have to accommodate a monetary policy.

The Chair: Thank you.

David Laidler.

Prof. Laidler: There are two things that can happen. The Bank of Canada has to buy this government debt with something, and that's going to be money that it prints. Since the liability side of the Bank of Canada's balance sheet is a little smaller than one year's federal deficit, that's going to have an enormous impact on the inflation rate. You're talking about a monetary expansion that could give you an inflation rate of 100% per annum if you monetized the whole deficit. I presume nobody is advocating that.

The kind of proposals I've seen instead are that reserve requirements be imposed upon chartered banks and clearers and that they be forced to hold government debt at low interest rates. All I can say in that case is I'm very glad I'm not a small business man going to a chartered bank for a loan, because if the credit is being force-fed to the government, it has to come from some other borrower's source of funds, and that's going to be the small business community, consumers, and all the rest of it. There is no way of making debt disappear through the financial system.

The Chair: Jordan Grant.

Mr. Jordan Grant: First of all, the way it would be done is the way it's done in almost every country in the world except for Canada, Switzerland and Great Britain, which is first of all by reimposing the reserve requirement. Canada had reserve requirements up until the 1991 Bank Act change.

Mr. Grubel: How much? Was it 100%, 50%?

Mr. Jordan Grant: It was about 10% or 12% on chequing deposits, and I believe 3% is the most recent reserve requirement on savings deposits. The banks didn't like this reserve requirement because it is in effect an interest-free loan to the government on which the banks are earning no interest. This is essentially money that the reserves -

Mr. Campbell: What would it have to be to have enough to buy back the debt?

Mr. Jordan Grant: Well, I don't think you would buy the total debt. If you take a look at the situation in the 1930s - and Mr. Grubel's comment reminded me that David Frum said essentially the same thing, that history never repeats itself - we had an unemployment rate obviously higher than we have now. We had global finance; in fact, the percentage of the federal debt held by non-residents was about 33%, and now it's about 25%. The interest cost as a percentage of federal revenue was 47%; today it's just under 30%. Funded federal debt as a percentage of GDP -

The Chair: I'm sorry. What are you advocating?

Mr. Jordan Grant: What the Bank of Canada did during the 1940s in order to fund the war.

The Chair: What are you advocating for today?

Mr. Jordan Grant: A similar strategy, except less drastic, which is essentially to reimpose the reserve requirement, gradually phase it in over time -

Mr. Campbell: Beginning at what level to what level?

Mr. Jordan Grant: You'd have to start at 1%. You'd have to gradually phase it up.

Mr. Campbell: Up to where?

Mr. Jordan Grant: Probably to the range of 10%, which would be similar to other countries. At the same time as you're raising the reserve requirement, you'd feed those reserves into the system so that it doesn't have a contractual or expansionary effect.

It would have exactly the same effect as what happened when the reserves were phased out in 1991. As the requirement was phased out, the banks had excess reserves. What the banks did with that excess money was buy federal bonds. Their holdings of federal debt in the chartered banks in Canada went from $20 billion to $75 billion over the course of three years.

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This was monetization of debt. The only difference between the Bank of Canada doing it and the chartered banks doing it is who gets the interest. It wasn't inflationary when the chartered banks did it. Provided the reserve is used to ensure the new reserves aren't used to create multiple expansion of deposits, it would not be inflationary.

The Chair: Thanks, Mr. Grant.

Mr. Rymes.

Prof. Rymes: I don't agree with this business of going back to non-interest-bearing reserves for the banks. I think that's just a mistake. The Bank of Canada is to be congratulated, in my view, for going to a zero reserve base, because that really improves the efficiency of the banking system.

It does not mean the Bank of Canada has in any way lost control of the output of the banking system. The Bank of Canada does control the output of the banking system. I think that's the real variable the Bank of Canada controls, and that's the real variable I was focusing on in my remarks.

Dr. Neufeld: Mr. Rymes is absolutely right that going to zero reserves, for all kinds of efficiency and operational reasons, was a very good thing to do.

About the basic question at issue, it is worth while to call a spade a spade. Really, these schemes of required reserves and so on are schemes of compulsory lending to government. If that's the issue, whether we want to have compulsory lending to government, then let's get that on the table, because there may be ten other ways that would be better than this one if that's what you want to do. I don't think compulsory lending to government is a good idea.

The final point. A lot of what we're talking about now about magnitude is arithmetic. In an hour anyone can figure it out.

About how much money you could actually raise by required reserves, the average cash ratio in the closing days was around 3% or 4%, I think, not even 12% or 8%, because there were a lot of deposits that didn't attract those reserves any more. Just take the quantitative impact of that. Even if it was a good idea, which it is not...even if you did, you wouldn't begin to make a dent on financing the debt.

This is not a theoretical discussion. This is basically arithmetic.

The Chair: Mr. Grubel, you had one brief comment you wanted to make.

Mr. Grubel: Just a quick comment.

Even our hero Mr. Tobin recommended that interest be paid on required reserves, which is about the same thing as eliminating them. If you impose reserve requirements, the banks, if they want to attract capital, need some revenue source; so the increase is spread between the lending and borrowing rates. That is exactly why the Euro-currency markets moved abroad, and our lending and borrowing moved abroad. That is why the Bank of Canada eliminated it.

It is foolish to believe you could somehow impose a tax on the banks, keep the money in the banking sector, when there are other alternatives and the whole thing would just be absorbed.

The Chair: Ms Stewart.

Mrs. Stewart (Brant): Thank you. It's been a fascinating discussion.

I've been trying to work through my mind all the bits and pieces here, the challenges and the suggestions. I think of Mr. Boreham talking about his forty years in the business of economics and how there used to be a time when the Bank of Canada did more than one thing; it did a whole bunch of things. That was great. And I hear Mr. McCracken and Mr. Cameron saying the same sort of thing: we can finesse and hide our activities from the market.

But then it was Mr. Neufeld who said the bottom line in this is really how the markets operate. The markets operate, I guess, differently today from how they did five years ago - certainly from how than they did ten years ago. The reality of all this is that you can't hide anything, and everybody is standing there watching everything ticker by them, responding to every little jump and jiggle.

By golly, I think of what Professor Laidler is saying. The impact on a day-to-day basis is phenomenal, in the ups and downs of what we do in this place and any other place across the country.

Somebody said they'd love to see the art of banking return, the art of monetary policy return. I just would say, given all this mélange and the discussion here, is the art of the 21st century just plain simplicity? Is it to confound the markets with stability? Is it to absolutely bore them to death with everything we do, focusing on one thing, not eight things, which is the one issue of stability?

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I just wonder if technology and change have brought us to that point. While we'd love to do all these other things and work the market in 16 different ways, we just can't any more.

Prof. Boreham: May I respond to that?

The Chair: Sure. Mr. Boreham, please.

Prof. Boreham: If Herb Grubel and Ed Neufeld are correct that the Bank of Canada has virtually no influence over long-term interest rates.... I suspect you know that -

Dr. Neufeld: I didn't say that.

Prof. Boreham: Not quite that, Ed?

Dr. Neufeld: No, I said it can't do it through influencing the rate of inflation.

Prof. Boreham: Okay, I'll remove your name, Ed.

If, as is sometimes suggested, the Bank of Canada has virtually no influence over long-term interest rates, then why don't we just abolish the Bank of Canada and establish a currency board?

Mr. Grubel: A lot of people are recommending that.

Prof. Boreham: That would be a lot cheaper and would simplify many things. It would bring us to a very simple environment.

Professor Laidler mentioned that he wasn't too keen about the index of monetary conditions. I would like to propose that the Bank of Canada should abolish that index of monetary conditions and adopt an index of economic welfare. That's a proposal I would like to make.

I would also like to argue that if it's true that the Bank of Canada is interested in maximizing our welfare - that's the big title page in the current annual report: ``Maximizing the Welfare of Canadians'' - then the Bank of Canada cannot do that by ignoring the short-run effects of monetary policy on output and employment, which it continually seems to do. Therefore, I would argue that the Bank of Canada in fact should be concerned about short-run stabilization.

The Chair: Professor Laidler.

Prof. Laidler: The reason we don't have a currency board is that we have a flexible exchange rate. It's as simple as that.

The Art of Central Banking was of course a book written by Ralph Hawtrey about the conduct of monetary policy under the gold standard. That is, of course, where the mandate of the Bank of Canada came from. The primary aim of monetary policy and the mandate of the Bank of Canada Act is the maintenance of the external value of the currency, which meant maintaining a fixed exchange rate.

If you would like a fixed exchange rate on the United States, we can talk about that and we can then talk about how much scope for monetary policy within Canada there would actually be if we had that overriding goal.

Or we can talk about having a flexible exchange rate and about the Bank of Canada doing what is possible within the powers of monetary policy in a rather small, open economy with no capital controls. That's basically pursuing a negligible inflation rate, which is the flexible exchange rate equivalent of maintaining a fixed exchange rate under the gold standard.

So I don't understand all these comments about going back to the art of central banking.

The Chair: Mike McCracken.

Mr. McCracken: I'll make some quick remarks.

I guess some are mesmerised by markets, but I guess those who are must then accept the market outcomes for the unemployment rate, inflation, the exchange rate, growth, and regional development. It's certainly possible to do that. You could keep your hands off and let the crap shoot go on without limit. Some countries run it that way, such as Hong Kong, at the moment.

If that's the case, then we don't need hearings or the central bank. We certainly don't need the central bank lecturing to us. We don't need targets, and we don't even need budgets. Presumably, just do what you want, and let the markets take care of it.

Just as an aside, there's a saying in a current cabinet in Ontario. When asked how many it takes to change a light bulb, the answer is that it takes no one, as the market will take care of it. So you can abandon everything to the market.

But one of the reasons some economists and governments exist is because they say there's a market failure in some areas, or there's an outcome in which they would like to make some balance or choice. Either the market choice is not what they want, or it's when the markets don't seem to do a type of job that political people for whom we're voting want as an outcome.

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So when we have Mr. Laidler telling us that we have a flexible exchange rate but we don't follow it, we don't follow that market outcome, we don't let the rate be flexible and we let it move around a little bit, and when every time it moves a lot we get upset and try to move against it to maintain it at above an equilibrium rate, then it seems to me that at least in that area it's okay to interfere with the market as long as you like that outcome preferable to, for example, the market outcome on the unemployment rate, where we seem to be saying we have to take the outcome whether that is 9%, 10%, 11% or 12%.

So I guess the point is that there's a debate about markets, but if we're going to open up that can of worms I think we ought to also talk about whether the market outcomes are the only thing we have. Can we improve on the markets? Are the markets efficient? Do the markets in fact function with a long-term view or are they very short-term? Do they bring in environmental concerns? Do they bring in a number of other societal concerns?

I guess the sense is that probably since the darkest days of the 1930s markets don't do very well. There's no sense that they've improved. Indeed, if anything, they've just gotten into a quicker movement and a broader set of orgy players in this globalization of financial institutions.

The Chair: Tom Wilson.

Prof. Wilson: Mr. Chairman, I have to leave fairly shortly to catch a flight, and I just wanted to take -

The Chair: Tom, I'm just going to intervene in the market and not let you leave.

Some hon. members: Oh, oh!

Prof. Wilson: Are the doors locked?

The Chair: In that case, perhaps we could give you a little extra time to put a few other things on the record before you go.

We have a vote at 5:15 p.m.

Prof. Wilson: I wanted to very briefly tell you what's in this handout.

On the first graph we're looking at a fiscal policy designed to reduce the debt-to-GDP ratio by a full percentage point by the fiscal year 1999-2000. Then the other graphs show -

Mr. McCracken: [Inaudible - Editor] deficit reduction.

Prof. Wilson: No. Sorry. Yes, it's the deficit, which means that of course it's starting to decline even next year after the 3% target is reached.

The other charts show the consequences of alternative monetary policy targets, so that really underlines the importance of monetary policy accommodating, in the sense of trying to maintain demand growth in the face of the fiscal restraints. It makes the job of fiscal policy easier. The cost is a transitory impact on the price level. I would certainly favour that kind of action. I think some of the discussion today about difficulties of forecasting with monetary policy and so on are correct, but when we have two policies and when we know fiscal's going to go in at this juncture we know that's the time to offset with monetary.

Thank you.

The Chair: The chair feels a little bit under pressure right now because we have to leave very shortly. We do have the option of coming back after about 15 minutes and wrapping up then. I need your advice as to whether we do that or try to finish up before 5:30 p.m.

A voice: We'll finish up.

The Chair: We'll finish up before 5:30 p.m. In that case I am going to give each of you.... Is there anybody who hasn't had a chance to put his full theory before us? I'll give you each a couple of minutes and then we'll go into your summaries.

Mr. Wilson, you have to leave. Thank you very much for being with us. I appreciate it.

Prof. Wilson: Thank you. I have to leave unless anyone has very brief questions about that.

The Chair: Are there any questions on what Mr. Wilson said?

Mr. Neufeld, you have a comment.

Dr. Neufeld: Yes. This is not a question of just blindly accepting the results of the market. What we were discussing is what one can expect from monetary policy. The point we were making is that with one instrument, controlling settlement balances, the Bank of Canada can basically pursue only one objective. The best objective is relative price stability because it's the best way to encourage wealth creation and so on.

This is not to say to you, accept the results of the market. It's to say that if you have only one instrument, you can do only one thing at a time. Fiscal policy can do all of those things. And environment policy and labour policy - all those things can do all those things. But let's not kid ourselves that those kinds of objectives can be achieved through monetary policy.

The Chair: Thanks, Mr. Neufeld.

Mr. Cameron.

Mr. Cameron: The point of the art of central banking, the art of fiscal policy, was indeed stability. That was the whole point of it. But it was stability, not only stability of prices. It was stability of growth, of employment, and of other objectives.

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What the zero inflation target meant was destabilizing the economy, destabilizing people's lives, destroying the value of capital, destroying the capacity of the government to finance its own activities.

It was a destabilizing attack, and what we would call for is some moderation in its dealings with -

The Chair: Thanks, Mr. Cameron.

I'm sorry, I'm going to have to give each of you 30 seconds to sum up very briefly. I apologize for having to abridge our time.

Mr. Grant.

Mr. Jordan Grant: We have a number of economic instruments: monetary policy, fiscal policy, microeconomic policies. Each of them has impacts on more than one area of the economy.

We're heading into a period of very tight fiscal restraint that's going to have an impact on employment. If we're going to make up for the difference in order to offset that impact of fiscal policy, then we need to use some of the other instruments available to us, including monetary policy, to help to mitigate that impact.

The Chair: Mr. John Grant.

Prof. John Grant: I think all of us are learnedly skeptical about governments' intentions, central banks' intentions, and the rest of our intentions.

The best contribution government and central bankers can make is to lay out their plans and make clear that they're consistent with each other and have been organized to form a unity in a medium- to long-term context. In that way we can anchor private expectations as best we can.

The Chair: Mr. Duncan Cameron.

Mr. Cameron: There's only one test for government policy: are you making things better for the majority of people or are you making things worse?

The paper the Centre for Policy Alternatives released prior to this budget states that half of the decline of the Canadian economy in the second quarter of the year was caused by the kicking in of the Martin budget. we have another stiff budget without an accommodation of monetary policy, then things are going to get a lot worse in Canada.

The Chair: Michael McCracken.

Mr. McCracken: High interest rates in the 1989-95 period hurt the economy. That wasMr. Campbell's earlier question. In our estimation, it raised the government debt-to-GDP ratio by some 18 percentage points and led to a lower gross domestic product or a higher unemployment rate.

A whole series of simulations will be made public under the term ``monetary reasonableness''.

Basically, keeping interest rates in line with U.S. interest rates would have given you a much better path, and it's never too late to change.

The Chair: Mr. Neufeld.

Dr. Neufeld: Mr. Chairman, you gave me permission to speak at the start, so I will forgo my final comment.

The Chair: Thank you.

Mr. Boreham.

Prof. Boreham: The new monetary policy practised by the Bank of Canada has now been in vogue for eight years. My question is this: is the Bank of Canada's goal of price stability more credible with the general public today than it was eight years ago? I think not.

The Chair: Tom Rymes.

Prof. Rymes: I have two points.

I think the bank has had an adverse effect on the growth of financial intermediation in Canada, the real output of that, but I come back to David Laidler's point.

This committee should deal with David Laidler's point. If Quebec separates, there should be a clear statement from this committee as to what fraction of the debt Quebec would absorb. That has to be enforced, and there should be some discussion of the possibility of a capital levy to solve the sovereign risk problem if the country splits up.

The Chair: David Laidler.

Prof. Laidler: Very briefly, another stiff budget, please, with expenditure cuts and/or tax increases, and monetary policy that allows the exchange rate and the interest rate to move in order to offset the disinflationary consequences of that.

The Chair: We've heard a lot of ideas. We've heard very differing concepts, firstly as to what monetary policy can do and secondly as to what it should do.

We have benefited from each of you being here. I must say that if we listen to every one of you, our task does not become much easier. On behalf of all members, I thank you for an excellent contribution to our deliberations.

We stand adjourned until tomorrow.