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STANDING COMMITTEE ON FINANCE
COMITÉ PERMANENT DES FINANCES
[Recorded by Electronic Apparatus]
Tuesday, May 16, 2000
The Chair (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I'd like to call the meeting to order and to welcome everyone here this morning.
As you know, the order of the day is pursuant to Standing Order 108(2), consideration of the Bank of Canada's Monetary Policy Report, May 2000.
We've the pleasure to have with us the Governor of the Bank of Canada, Gordon Thiessen, and Mr. Malcolm Knight. Welcome.
We always look forward to your visit, Governor. You know how this works. You have approximately 10 to 15 minutes to make your presentation. Thereafter, we'll engage in a question-and-answer session. Welcome.
Mr. Gordon Thiessen (Governor, Bank of Canada): Thank you very much, Mr. Chairman. I must say that it's always a pleasure to appear before this committee. Since other parliamentary business precluded my appearance before you last November, I'm pleased to have the opportunity to come on this occasion and to talk with you about the economic situation in Canada and the prospects for inflation.
Last week we released our 11th monetary policy report. Since our report in November, the Canadian economy has outperformed expectations. Bolstered by vigorous external and domestic demand, Canada's economic expansion strengthened in the second half of 1999 and into early 2000. The buoyant U.S. picture, combined with Canada's high levels of business investment and solid employment gains, augurs well, we believe, for continued strong growth in Canada. Given the strong momentum of demand, the Bank of Canada has raised its projection for economic growth in the year 2000 to a range of 4% to 4.5%.
The trend of inflation in Canada over the past six months has been lower than expected and is among the lowest in the industrial countries. Nevertheless, pressures on capacity will likely intensify through the year. Consequently, we expect the trend of inflation, as measured by the consumer price index excluding food, energy, and indirect taxes, to rise gradually to close to the middle of our 1 to 3% inflation-control target range. To keep this core rate of inflation steady near 2%, some deceleration in economic expansion or a more rapid increase in productivity and production capacity will be required during 2001.
When it comes to the production capacity of the economy, there is currently even more uncertainty than usual. The lower-than- expected rate of core inflation would suggest that conventional measures may be underestimating the economy's capacity to produce goods and services without adding to inflationary pressures. While the conditions that would permit an increase in productivity growth and in capacity have improved substantially in recent years, there has so far been no significant hard evidence of such an increase. This makes judging the balance between aggregate demand and supply in the economy an even greater challenge than usual for monetary policy.
The other main risks to Canada's economic outlook include the possibility that the momentum of aggregate demand from the U.S. economy will continue to be stronger than expected and the likelihood of a buildup of inflationary pressures in the United States spilling over into Canada. The U.S. economy has continued to steam ahead. There is a clear need for the pace of expansion in the United States to slow as we progress through this year and into 2001.
Mr. Chairman, prudent monetary management dictates that we in Canada should not underestimate the upside risks for inflation, especially given the strong growth of aggregate demand in Canada, the United States, and elsewhere. Because of the lag of some 18 to 24 months in the effect of monetary policy on prices, the bank is always trying to anticipate inflationary pressures one to two years ahead.
Finally, Mr. Chairman, I would like to emphasize that productivity growth is the only way to achieve long-term gains in incomes and living standards. The technological revolution that's currently sweeping the world provides us in Canada with a golden opportunity to improve our productivity. The best contribution that monetary policy can make to enhancing productivity is to provide a low inflationary environment. Low and stable inflation reduces uncertainty about future price movements, lowers the incidence of boom and bust cycles in the economy, and helps keep interest rates down. All of this helps to encourage investment in the equipment and software needed to take advantage of the new technology.
Canada's inflation control target and the bank's commitment to maintaining that target should ensure that monetary policy fosters a climate conducive to continued improvement in the performance of our economy.
Thank you very much, Mr. Chairman. Mr. Knight and I are open to your questions.
The Chair: Thank you, Governor.
Now we'll have the question-and-answer session. We'll start with a 10-minute round. Mr. Solberg.
Mr. Monte Solberg (Medicine Hat, Canadian Alliance): Thank you very much, Mr. Chairman.
Mr. Thiessen and Mr. Knight, welcome. First of all, I simply have to say congratulations to the governor on the announcement of his retirement. On behalf of the official opposition, I want to say thank you for your service. We'll hopefully have a chance to see you again before you actually leave your post, but I do want to say that.
I do want to say that I think you've achieved your primary goal, which is to keep inflation under control.
Having said that, I'm going to ask you some questions about that right now. You just mentioned in your remarks that the core rate of inflation is on the rise, around 2%. Overall we're looking at inflation getting close to the upper part of the band. I'm wondering if you could say a little bit about that and explain why we shouldn't be concerned about that, why the core is more important to focus on.
Mr. Gordon Thiessen: Yes, certainly.
What we find when we look at inflation is that there are some items in the consumer price index that have large fluctuations in them. It doesn't mean they're not important, but it means that if you're going to get a fix on what the underlying trend is, you have to try to look through those fluctuations. Two items that tend to have the greatest fluctuations in them are energy prices and food prices. These are very important prices. But if you're trying to get a fix on the trend, you want to look through those ups and downs.
That's why we look at this core rate of inflation, which excludes energy prices, food prices, and the effect of changes in taxes, again because those can affect the CPI. When we look through all of those, we do see the core rate of inflation at 1.5%. But we see the economy growing rapidly enough that we think that's going to go up to 2% over the course of this year.
The real question we face is: is the momentum of demand in this economy likely to push that core rate even higher? That's the big question.
What we're seeing is demand in the United States that is very strong and is spilling across the border into Canada. The crucial thing we want to achieve here is to keep this expansion going. What we want to avoid is a repetition of the boom and bust that we had in the last two decades. That's why we look at this core rate.
Mr. Monte Solberg: In your remarks you mentioned productivity. In the recent report you issued, the monetary report, you suggested that demand had exceeded what was thought to be capacity. Obviously that's not quite the case. There have been, I gather, some revisions to what the capacity might be. In some ways that concerns me. I'm wondering if you could tell us why it's difficult to foresee what the capacity in the economy will be, and maybe also talk to us a little bit about whether you foresee productivity in Canada continuing to grow and whether as a country we're putting enough money into capital stock and that kind of thing.
Mr. Gordon Thiessen: The problem with capacity is that a large chunk of capacity is made up of machinery, equipment, technology, buildings, and so on, and it is very difficult to measure exactly what the stock of that is and what's happening to it. Has the machinery and equipment that was put in five years ago lost its efficiency or become obsolete? It's very difficult to get a fix on all of that. We make estimations and Statistics Canada makes estimations, but we all know there's a wide margin of uncertainty around that. That's why it's so important for us to monitor a range of indicators that give you some sense of whether we're pressing hard against capacity or not.
Our judgment in the monetary policy report is that as of the beginning of this year, while the traditional estimates would say that we had pushed right up hard against capacity and might be in an excess demand situation, the other indicators said to us, no, that's not the case.
So in the report we said it's our judgment that we have not pushed through the limits of capacity; we're not in an inflationary situation yet. But as we look forward, the question is, what's going to happen to productivity, and is that going to add to our capacity to produce? We think a lot of elements are in place for that to happen.
We have seen a pickup in investment over the course of the last four years, which is quite significant. But we also know from American experience that it takes a while for that investment in technology to really feed through into increased productivity. So we don't see the productivity in the overall numbers yet, but we do hear about it anecdotally and we see the technology being put in place. But until you actually see it happen, you want to be fairly cautious about it all.
Mr. Monte Solberg: What would be the impact on productivity, though, if we see a hike in interest rates, today for instance? Would the hike in interest rates dampen the increase in productivity to the point where it causes us problems, or will there be an offset there?
Mr. Gordon Thiessen: I think there's always a problem here. If we were to let demand really take off and inflation pressures build up, then we're looking at much higher interest rates down the track and an economy that's going into a boom and bust scenario. That's a highly uncertain scenario. Our past experience is that when that happens, you really do see investment drawing back.
We think it's far better to try to keep the economy on an even keel. That may mean slightly higher interest rates than before, but a smoothly expanding economy is a lot better for investment than a boom and bust scenario. We really do believe that is the best thing we can do to get this investment and get the productivity gains.
Mr. Monte Solberg: How much time do I have?
The Chair: You have four minutes.
Mr. Monte Solberg: I want to switch gears a little bit. This is an issue that we could probably talk about all day, but I think it's something that's certainly topical right now: the strength of the dollar.
We're in a situation now where commodity prices are actually fairly strong. Certainly oil prices are strong. Yet the dollar languishes. I wonder if you could reflect on that a little bit.
First of all, why is that? A lot of us have been led to believe the dollar should be much stronger than it is today. I don't pretend to understand why that is. Does it have something to do with the fact that our economy isn't as productive, for instance, as the United States economy? I appreciate that we've appreciated against, for instance, the Euro, but we've traditionally measured ourselves against the U.S.
I think it's of concern to just about everybody. So maybe you could reflect on that, say a little bit about that.
Mr. Gordon Thiessen: Certainly. I think there's no question that we would all like to see a stronger currency, partly because what that does is reflect an even stronger economy. But we do need to remind ourselves all the time that there are two sides to an exchange rate. You're always comparing two currencies, and each currency reflects what's going on in the economy.
In the case of the Canadian dollar compared to the U.S. dollar, what you're always doing is comparing developments in the Canadian and U.S. economies. There's no question that the U.S. economy continues to burgeon ahead. It's pushing hard against the limits of capacity, and as you mention, they have been getting very good productivity gains, better than anybody else in the world. That gets reflected in their currency, and as a consequence, the U.S. dollar is strong against everybody. So to a certain extent, what we're seeing these days is more the strength of the U.S. dollar than a particular comment on the Canadian dollar.
But that being said, as we look forward, I certainly hope that as we start getting those productivity gains, as our economy starts growing at capacity, we are going to see that reflected in our currency.
Mr. Monte Solberg: So I guess the way to strength in the dollar lies on the fiscal side of the equation, not necessarily through monetary policy.
Mr. Gordon Thiessen: I certainly think monetary policy can really only focus on one thing at a time. We really do believe the best thing we can do is to keep inflation low, because that adds a degree of stability to the economy and keeps interest rates lower than it otherwise would. It's really when you get the productivity gains that you tend to get the persistent acceleration in a currency, and that's what the Americans are seeing.
The Chair: Thank you, Mr. Solberg.
Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ): Governor, welcome to the Finance Committee. I wish you good luck in your new career.
Governor, I have a very simple question to ask you. This afternoon, the American federal bank, in view of the overheating in the U.S., is getting ready to raise the American interest rate by about half a point.
What does the Bank of Canada plan to do? Does it simply intend to increase the Canadian interest rates by half a point too, the way it usually does, because, in my opinion, the Canadian monetary policy is not autonomous, or are you going to take into account the fact that the Canadian economy has not reached its full potential and that we are not in an overheated situation, and adopt a distinct attitude towards that and not a follower's attitude like the one you had during the first three or four years, particularly during the worst phase of the Asian crisis?
Mr. Gordon Thiessen: In Canada, you must always look at what is happening in the U.S. because this country is our biggest partner for foreign trade. When the demand increases at a very high rate, as is happening in the U.S., that has an effect on Canada, particularly its exports. So, when the federal reserve increases its interest rates, this is a very important piece of information for us.
Sometimes we follow the U.S., sometimes we decide not to follow, because the situation in Canada is different. The most important thing for us is to look at the future and to see whether, in a year or two, inflation will be on the rise. That is the big question we ask ourselves. What happens in the U.S. is important and we always have to take account of the American situation.
Mr. Yvan Loubier: What should Quebeckers and Canadians expect tomorrow morning? Should they expect the interest rates, starting with the Bank of Canada rate, to increase in a situation in which it may not be opportune because economic growth has not achieved its full potential? Should they expect you to have a distinct policy and not to follow the American policy exactly, as you did in September 1998, at the worst of the Asian crisis? At that time, there was some doubt about your autonomy regarding American monetary policy. Should they expect you to let the Canadian dollar fall, for instance? What is your view in this regard? There is talk of short-term rates. Of course, a long-term view is required, but given the decision of the American federal bank this afternoon, I would like to know what your real intentions are for tomorrow. What should we expect?
Mr. Gordon Thiessen: It is hard for me to answer you question. We have to await the American decision and we will then have to evaluate the situation in the U.S. and decide what the implications of this decision are for Canada. We will make our decision on the basis of this information. I cannot give you an opinion right now.
It's not possible for me to say now what we're going to do.
Mr. Yvan Loubier: Even though you are retiring, you do not want to leave us with a present like that?
Voices: Oh, oh!
Mr. Richard Marceau (Charlesbourg, BQ): In the debate about the independence of Canadian policy, most of the experts agree that, if the U.S. Federal Reserve raises its short-term interest rates by half a point, or 50 basis points, it is quite possible, indeed almost certain, that the Bank of Canada will keep step by deciding on an increase of 25 or 50 basis points. This is a trend that has been observed for several years and it raises the entire question of the independence of Canada's monetary policy in relation to U.S. monetary policy.
You realize that there is a debate going on here, in Canada, about the future of the Canadian dollar in relation to American currency or a common currency for North America. It is possible that one day the political decision-makers will make this decision because, basically, this is a decision for the political decision- makers.
Given that this is a possibility, do you not think that an organization like the Bank of Canada should go to its drawing board and say to itself that, in case such a decision is made one day, it should at least have a blueprint for what would happen then? In your opinion, should the Bank of Canada not do this in case such a decision were made?
Mr. Gordon Thiessen: I think it is up to Parliament, to the people who make political decisions to decide that this would be a good idea. We have to work with the exchange rate system we have now, which is a floating exchange rate. We have examined all the arguments on both sides and done research in this area, and our point of view is that the floating exchange rate, the flexible exchange rate is the best one for Canada.
Mr. Richard Marceau: I understand that. Moreover, you are one of the keenest advocates of the flexible exchange rate. This being said, I ask the question again: do you not have, somewhere in your boxes, some studies or an action plan on how you would go about it if such a decision were made?
Mr. Gordon Thiessen: I do not think this is our responsibility. If the House of Commons decides that this must be examined by the Bank of Canada, we will do so, but we have to work with the system in place at the present time.
Mr. Richard Marceau: Just a minute. I do not understand. It is repeated to us ad nauseam that the Bank of Canada is a completely independent body, not only from the Government of Canada but also from the House of Commons. You tell me that you would examine this subject if you were asked to do so by the House of Commons.
Mr. Gordon Thiessen: As you said, any decision concerning the exchange rate system must be made by the government, by Parliament. In such a case, the Bank of Canada would conduct studies. For the time being, the system in place is a flexible exchange rate system, and it is the system with which the Bank of Canada must work.
Mr. Richard Marceau: You have taken part in many conferences on the monetary future of Canada and everywhere you have been a keen advocate of a flexible exchange rate policy, on the basis that a flexible exchange rate could absorb shocks.
Do you not think that, insofar as the daily flows of funds are huge, this flexibility, instead of absorbing shocks, will on the contrary amplify them? Do you not think that what perhaps was an advantage a few years ago or even a few months ago may have become exactly the opposite, with the result that it is practically impossible? Last Thursday, we were told about fund flows of some $2,000 billion daily. How can a relatively small bank like the Bank of Canada believe that a flexible exchange rate can absorb economic shocks, which are sometimes asymmetrical?
Mr. Gordon Thiessen: It is very interesting to study the experience of the Asian countries affected by the financial shock of 1997-1998. These countries then had fixed exchange rates. With a very large outflow of funds, they found it very difficult to keep their fixed rates of exchange. Finally, there were financial crises in these countries. I think that most of the people who now observe the international situation think that it is better for these countries to have a flexible exchange rate. It is easier to manage the international flow of funds when you have a flexible exchange rate, because a flexible exchange rate works a bit like a shock absorber when there are flows of funds and real economic shocks. In either case, it is very useful to have a sort of cushion or buffer between your country and the rest of the world.
The Chair: Thank you, Mr. Marceau.
Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you, Mr. Chairman.
Welcome, Mr. Thiessen. Thank you for appearing before us. I always look forward to every time you appear before us, and seeing what I'm going to do as a businessman and where I'm going to be investing. So I'm going to be asking some of the same questions.
Mr. Thiessen, I've been quite a follower of yours and what has happened to our interest rates and the value of our dollar. But as a businessman today, if I was looking to invest, what would I be looking at in the future? Last year, of course, it didn't seem that interest rates were going to be going up too much. We looked forward to possibly between 0.5% and 1%, the way our economy was going, but now we've seen a total of four consecutive rises of the interest rates of the United States and we have followed suit. There's another one coming from the United States, and of course we might possibly follow suit.
My question is quite simple. I know they say the long-term interest rates have been right around 8% in the last decade, but in the short term, where it's been up and down, of course, we have taken, especially in the last five or six years, a role where our short-term interest rates have been lower than those of the United States, which was unprecedented, and it may be the reason for the low value of our dollar. I take a look and say that once you get your house in order by balanced budgets, by having surpluses, by paying down the debt, the value of our dollar will go up, interest rates will be more stabilized. But really I don't see too much in terms of that. Yes, the interest rates have still continued to rise and the value of our dollar has continued to lower.
Mr. Thiessen, how many more injections will there be from the United States treasury, and the governors of their bank and ours, until we can really believe that in terms of our interest rates in the long term, let's say within the next few years, that trend, the spiral going up, will really slow down and stop?
As a business person, I start to feel a little bit jittery right now. I've heard over the last two years that, yes, it's going to be stable, don't worry about it, keep investing and keep growing, it will find its place. At the moment as I see four rises, one after the other, in the United States, and ours to follow. Where do you see in your crystal ball that really we'll eventually stop this spiral of interest rates going up and coming to an end, and maybe start going down again?
The Chair: Thank you, Mr. Pillitteri.
Mr. Gordon Thiessen: I can't tell you precisely. What I can tell you, though, is if the concern you and others feel is that we could go back to the kind of interest rate increases we had at the end of the 1970s, the early 1980s, or at the end of the 1980s, the early 1990s, the answer is absolutely not. Remember that at those times we had high inflation rates. We're sitting here with inflation down near 2%. Our aim is to keep it there.
This really means you don't need huge increases in interest rates to keep things on the straight and narrow. That's one of the great advantages of keeping your inflation rate low. When you look out along the rest of the yield curve to interest rates from one month out to 30 years, what you see is that they're staying relatively low. They are indeed staying lower than the American rates all the way out.
The interest rates that we affect directly are the very short-term ones. Our job is to make sure this inflation rate isn't going to get away, because if we keep it stable we're going to keep those low interest rates. Yes, indeed, the short-term rates may have to go up somewhat, but they're never going to go up the way they did during that inflationary period. If the markets believe we're going to be successful, what you'll see is further out. You won't see any big movements in interest rates. You will see the investors and savers saying, the central banks look to have this under control, so as I look at an interest rate for five years or ten years, I'm quite content to see an interest rate of 6% or less, for example.
The Chair: Thank you, Mr. Pillitteri.
Mrs. Karen Redman (Kitchener Centre, Lib.): Thank you, Mr. Chairperson.
Thank you, Mr. Thiessen. It's nice to see you again.
On page 9 of the report, I read with interest the way the bank explains rising oil prices and how they affect inflation. It's certainly something that's got a lot of media attention over the past year. The bank makes a distinction between first-round effects and second-round effects that result from increases in crude oil prices, and I'm wondering if you can explain the difference of these two rounds of effects and what the bank's projections are for oil prices, both in the short and medium term?
Mr. Gordon Thiessen: Certainly. When we talk about first-round effects, what we're really talking about is the price of gasoline, heating oil, and natural gas, which are part of what consumers have to spend part of their incomes on, hitting the consumer price index directly.
When we talk about second-round effects, what we're talking about is, say, an increase in the price of gasoline leading to an increase in transportation costs, leading to an increase in the cost of groceries or whatever. Or the increase in energy costs relating to an increase in air fares, for example, or perhaps an increase in hotel room rates because the cost of heating has gone up. Those are the kinds of second-round effects we're talking about.
Sometimes in the past when the price of oil went up and it caused people to worry about inflation, you saw prices generally starting to push up. Then you can get yourself into something of a spiral. That's what we want to avoid.
But I must tell you that until now we have not seen any serious second-round effects whatsoever. With the price of crude oil stabilizing to some extent—it's been pushing up a little bit in the last few days, but it's not pushing ahead the way it was—what we really expect is that we're going to see the total consumer price index and our so-called core rate that I talked about earlier converging, probably towards 2%. The price of oil that we have in our forecast right now is basically $25 a barrel, on international markets, in U.S. dollars, plus or minus a couple of dollars. However, currently I think we're a little above that, at $29.
Mrs. Karen Redman: Is there anything magical about arriving at that price?
Mr. Gordon Thiessen: Not really. That's just our view, looking at the international supply of oil and international demand for oil. This is, I have to tell you, a bit of a rough-and-ready calculation. But it is on the basis of that and on the basis of talking to some large international oil producers that we've come to the view that $25 looks to be a price that would stabilize supply and demand in the international oil market.
Mrs. Karen Redman: Thank you.
May I ask another, if I have time?
The Chair: Sure.
Mrs. Karen Redman: I don't envy you your job. I was really interested. I said to my colleague Sophia Leung that if you were able to directly answer Mr. Pillitteri's question, we should write it down. I'm sure everybody would love to have a window on your crystal ball.
On page 24 of the report, you talk about a survey that the bank regularly uses, the Conference Board's index of business confidence, to approximate inflation expectations. And based on this survey, the majority of respondents expected the price increases would be less than 2% or 3% and they would fall sharply, I believe.
Do you find this result worrying? And how reliable is this index?
Mr. Gordon Thiessen: You don't want to put too much emphasis on it. And that's why we tend to look at a series of measures of expectations of inflation. I think the crucial thing for us is to see that most of the survey participants continue to see inflation somewhere around the middle of our target range. That's what's really important to us.
I think when some of this survey was taken we might have been in the situation where oil prices were pushing up and pushing the total consumer price index up, and what we've seen subsequently is that there's been some reversal of that. I suspect that if we took this survey today we would find that a lot more participants would be very close in to the 2% range. That's what we really would expect.
And that's what we think setting targets for inflation and keeping to them should do. What we really want is for all those people who have to make decisions about the future to make them on the basis that inflation is going to be roughly 2%.
So if you're a business person and you have to make an investment decision, you have to make some judgment of what is going to happen to prices over the length of that investment. Similarly, if you're an individual and you want to decide whether you're going to invest your money in a five-year GIC, you want a sense of what's going to happen to inflation. And we want to persuade all of those people, count on 2%.
Mrs. Karen Redman: Thank you.
The Chair: Mr. Knight.
Mr. Malcolm Knight (Senior Deputy Governor, Bank of Canada): As the governor indicated, crude oil prices rose very sharply starting in February of last year, and that did push the overall consumer price index up. So the rate of inflation as measured by the overall consumer price index reached a year-on-year rate of growth of 3% in March.
But it looks now like that sharp rise in oil prices has stopped. Production of OPEC is a little bit higher than it was last year and stocks are rising somewhat.
All we are saying here on prices is that if petroleum prices, rather than rising further, remain in their current range or start to decline, we'll see fairly soon a slowing down in the rate of overall inflation to that core rate, which is in the range of 1.5% to 2% right now. But it is very important for us to be looking always at expectations of future inflation, because we don't affect the inflation rate today when we change interest rates; we affect the inflation rate going out a year and a half to two years.
So it's very important what businessmen and housewives, and other workers of all sorts, think about what's going on in the future. And that's the tendency of inflation that we're trying to keep low and stable.
Mrs. Karen Redman: I can't resist. There are businesswomen out there too.
Mr. Malcolm Knight: That's why I said other types of workers.
The Chair: Ms. Leung.
Ms. Sophia Leung (Vancouver Kingsway, Lib.): Thank you, Mr. Chair.
It is very good to see you, Mr. Thiessen. I hope you come back again before your retirement.
Mr. Gordon Thiessen: I'm bound to.
Ms. Sophia Leung: On page 23 of your book you talk about productivity in Canada compared to U.S. experiences. That's very interesting. Here are recited three different reasons, and all that sounds very sound. I wonder if you would like to comment. We know our Canadian productivity is always lagging behind. Do you think a reason may be lack of investment funding in our...? We have a lot of very educated high-tech expertise here, but we've heard a lot about the lack of venture capital or risk funding. So venture capital is not available, one.
Also, again I think the amount of income is a factor between the two countries. We know there is such a difference.
Then the third factor I hate to say, but there's always discussion about the tax.
I'd like you to comment. Do you find those three factors are causal factors for our Canadian productivity lagging behind?
Mr. Gordon Thiessen: Well, I have to admit to you that productivity is one of those areas.... Economists have just found it very difficult to get a really good fix on what gets you higher productivity. If we'd been able to figure that out, we would have done something about it a long time ago.
What we see, however, is that we have this period over the last four years or so in the U.S. when their productivity has spurted ahead. Nobody else has really managed that. So what we're doing now, I think all of us, is looking at that and asking what's caused that. What we see is their rate of investment in new machinery, equipment, and technology is very high and has gone up very sharply, basically starting in around 1992 and continuing right through until now. That seems to be one factor.
The other factor seems to have been a remarkable degree of flexibility in providing financing to the high-tech industries, and some of it is self-generating. For every successful entrepreneur in the high-tech industry, you see someone who's been willing to invest more in the industry, then in turn you see venture capital funds attaching themselves to these so-called angels, and then you see more traditional financial institutions attaching themselves to the venture capital firms.
We don't see anything quite that dramatic in Canada, but the anecdotal evidence is that some of that's happening here as well. So as the high-tech industry here has become more successful, we hear stories quite similar to what's going on in the U.S.
The other thing is, investment in machinery, equipment, and new technology in Canada has also started to pick up, but it only basically started around 1996. So we're essentially running about four years behind the U.S. But if you look at a chart and if you look at this investment compared to the size of our economy, you see a path that is parallel. We're still running a few years behind, but it means a lot of the things that are needed seem to be put in place.
That's why I said in my opening statement it really looks as if some of the preconditions are there. Whether it's all going to come off, we don't know at this stage. Nobody really predicted the U.S. productivity growth. But it does seem to us lots of things are in place.
But there's no question that what you want over a long period is a system of taxation and expenditures that provides the best set of incentives and a balance between safety net considerations and incentive considerations. You also want to make sure you have training educational arrangements in place that really provide you with people who can respond quickly to the new knowledge information that's required in this rapidly changing society.
I don't see anything in Canada that says “Impossible. Can't do it.”
The Chair: Thank you, Ms. Leung.
Ms. Sophia Leung: Thank you.
The Chair: If I could just follow up on that question, what changes have you made to your conventional techniques to predict future trends, given the fact that there's immense technological change, and in fact some of the productivity gains may be a result of that?
Mr. Gordon Thiessen: It's very difficult to do. So much of economics looks at the past, looks at the relationships that prevailed in the past, and says if those relationships are maintained, this is what the future is going to look like. But when you're in a period of rapid change, the way we are now, that becomes more and more difficult to do.
That's why you'll notice that in some of the things we say, we spend a lot more time talking about our regional representatives going out and talking to business people, asking, “What's happening? Are you investing in technology? What do you think the payoff is going to be? Do you feel you're pressing the limits of capacity? Are you having difficulty getting skilled workers? If you are having difficulty getting skilled workers, what are you doing about it? Are you engaged in more in-house training?” That's the range of things we find ourselves having to look at now.
You just have to be a little more agnostic about what's going on with the supply capacity of the economy, as I was saying earlier in answer to a question.
The Chair: So what does that say? For example, we receive a monetary policy report, and we give it the weight it deserves, with the caveat that there are those concerns you just cited. Will the Bank of Canada engage in reviewing the types of techniques it uses?
Mr. Gordon Thiessen: Oh, absolutely. We have to. Again, that's one of the things we've been learning from our American counterparts. You can't just rely on all the traditional relationships that are there. You'd better look at all new pieces of information that are possibly there.
One of the things we have seen, for example, is that some of the inflation pressures one might have expected in the U.S. were a little slow to come by. That's telling you there's something special going on. Similarly, in Canada the recent inflation numbers are a little better than we expected—by that I mean lower. That caused us to say, if you look at those traditional estimates, you might think we were at or beyond full capacity. Our judgment is that we're not, because there's enough other information that would deny that.
That's the kind of thing we're doing, and that's what we have to continue to do, because there's no question that, as you and your committee, Mr. Chairman, have said, productivity gains matter a lot. That's what gives you income growth and standard of living improvements. We want to ensure monetary policy accommodates and encourages that. That's why we're watching it so carefully.
The Chair: Thank you.
Mr. Paul Szabo (Mississauga South, Lib.): Thank you.
Welcome, Governor. The last time you appeared before us, I pulled out a chart that showed the condition of North America over the last six decades, and one of the patterns there was that at the end of each decade, in 1950, 1960, 1970, 1980, and 1990, not only Canada but the U.S. was in recession at least within one quarter of the decade end. I asked you whether or not the pattern was going to repeat.
Here we are, past the first quarter of the new millennium, and it has not happened, and you said it wouldn't happen, because you saw no indications. Of course at each of those decade ends we saw the pattern of rising inflation and rising interest rates. They're the classic pre-recession indicators.
Yesterday we heard anecdotal evidence that Denny's Restaurant from the U.S.—Maryland, I believe it was—was recruiting people in New Brunswick for $12 an hour. It made me think of the case of Nortel, which was paying engineering students significantly higher salaries in the U.S. than they were in Canada for the same job. These two examples seem to indicate to me that even if we were to change taxation policy drastically, we couldn't make up the variance in base salary being offered, the differential between Canada and the U.S.
So the question is, do you believe those examples—and if there are others—are indicative of an economy in the U.S. that is primed for high inflation, and possibly we have to be on guard with regard to higher interest rates in the U.S. and not be drawn by it, as opposed to trying to defend ourselves? Or could we see the Bank of Canada again drop below the line of the U.S. rate, simply because we've had a better handle on the economic fundamentals in terms of our economy?
Mr. Gordon Thiessen: As we point out in the report, there are certainly some risks in the U.S. That economy is very tight. As I've said, it's bursting at the seams. You can see it in the labour markets, as you were just suggesting. Labour markets are very tight. The last piece of information on wages and other benefits showed a very sharp increase in the United States. There's no question that this has led to a lot of concerns.
Up till now, the U.S. Federal Reserve has done a very good job. I think the best forecast for the future has to be that they will continue to do a good job. But there is a risk there. It is a very tight economy, one that may well be overheated. There's no question that the Federal Reserve has to slow that down.
If, sadly, they make a mistake and the U.S. inflation rate takes off and ours does not, then you should expect to see that reflected in circumstances in Canada. You would eventually see that reflected in a stronger Canadian dollar and in lower interest rates in Canada than in the U.S. because inflation was lower. That is certainly a possibility.
I must tell you that I still think the best forecast is to say that the Americans will get those pressures under control and you will have what commentators call a soft landing in the United States. That would be very welcome news for Canada.
Mr. Paul Szabo: I have one last little question. I understand from Finance officials that the annual growth rate of the high-tech sector in the U.S. is approximately 12%. Canada is lagging in terms of the growth of that sector. There are many consequences, but one is that we are not able to have parity with the U.S. in many ways, simply because of not having the stimulus of that sector to the same extent, as well as having, on a per capita basis, a higher debt load to service in Canada, which is also our cross to bear.
It leads from what you just said: that sector is growing phenomenally. Have you satisfied yourself that the growth is sustainable or healthy growth and won't in fact lead to a cycle where we build it up to a crescendo and then it has to correct itself and come crashing down and we run into a severe economic climate?
Mr. Gordon Thiessen: I must say that one of the things that I think have been helpful is the stock market correction in the U.S. recently, where some of the high-technology stocks have come off their peaks. That has caused a lot of people to reassess the future earnings of a number of high-technology companies. In some cases people have taken a rather more cautious view about the future. To that extent, some of the enthusiasm has dissipated there, and that's probably a good thing.
It's very difficult for someone to come in and make a judgment as to whether or not a rapidly changing technology is being exaggerated or is a source of excessive exuberance. It's very difficult. The famous Alan Greenspan phrase is not that he thought there was excessive exuberance; he said, “How will we know?” It's very difficult to know.
I think it's not possible for central banks to make a judgment saying that it's gone too far and they have to step in and do something about that. What you have to do, however, is look at the effect of all that enthusiasm on willingness to spend in your economy and ask yourself whether that is pressing too hard against capacity. Those are the crucial questions. If you get that right and keep inflation low, then you're going to keep the economy going, and that's what really matters in the end.
Mr. Malcolm Knight: I would just add one point to what the governor said. Even with this very rapid growth in the high-technology sector in the United States, one big difference between Canada and the United States is that demand is growing very much more rapidly in the United States than output is growing. As a result of that, the U.S. current account is in a deficit. It's quite a large deficit, in the order of 4% of GDP. So it's crucial for demand growth to slow down even with this much higher growth of supply in the United States if things are to remain stable.
What we're looking to achieve in Canada, where we have a different situation with a balanced current account, is to ensure that we can sustain growth with low inflation. In the longer term, that is what's going to encourage investment and industry, including the high-technology sector. The U.S. is certainly the leader all over the world in that area, but relative to many other countries, Canada should be very well placed in information and communications technology.
The Chair: Thank you, Mr. Knight.
Mr. Lorne Nystrom (Regina—Qu'Appelle, NDP): Thank you, Mr. Chair.
Welcome, Mr. Thiessen. Like the others around the committee, I wish you a very fruitful retirement when it happens. I hope you don't come back as a senator someday to be around this committee in some other capacity. Anyway, I wish you the best. I think if you did a public opinion poll out there, you'd be much more popular than your predecessor. I hope that trend will continue in terms of the Bank of Canada.
I wanted to ask you, in the immortal words of Alan Greenspan, how will we know? There's a danger, of course, that the U.S. economy is overheating, as you've said already, and that Greenspan will increase the interest rates once again. The Canadian economy is not overheating like the American economy, and there's a chance that we could get caught up in the backdraft. The Americans get a fever and we catch the cold, in other words.
How much independence do you have, as the Bank of Canada, to be different and distinct in terms of monetary policy and rate hike increase in the United States? In other words, how will we know whether we should hold the line on the interest rates in this country? How will we know whether we should be increasing them? How much independence do you have, how much flexibility? I realize that's a very simple question.
Mr. Gordon Thiessen: Well, that's what we have to do. That's what monetary policy has to do in Canada. It has to say, what are the pressures in the Canadian economy? But of course what happens in the U.S. has a great deal to do with the pressures in our economy. If you look at the period over the last six to nine months, what you see is very strong export growth. A lot of that is this overheated U.S. economy spilling across our borders and leading to a really rapid expansion in the Canadian economy.
So yes, monetary policy in Canada can be oriented to the Canadian economy, but we can never ignore what happens in the U.S. It just matters so much to us. That's a judgment we always have to make. We have followed the U.S. increases in interest rates the last few times, but we didn't follow them the previous few times and we moved on our own a few times before that.
Are the two economies moving in tandem to some extent because the U.S. is putting a lot of pressure on us, or are they not? That's the question. As long as the two economies are going together, it's hard to tell whether monetary policy in Canada is geared to the Canadian economy, because we seem to be going together. As long as those two economies are moving along together, what happens in the U.S. will matter to us.
The other thing is that people do tend to focus on the recent changes. I do remind you that we continue to have our very short-term target rates at three-quarters of a percentage point below the Americans', and we've done that through the piece.
Mr. Lorne Nystrom: In terms of the next few days, are we moving in tandem? How will we know whether that rate should increase in this country or whether it should hold the line compared to two or three months ago?
Mr. Gordon Thiessen: That's the judgment we have to make. We have to ask ourselves how much pressure there is in this Canadian economy. It looks like it's going ahead really smartly. I know there have been a few statistics recently that don't look as strong, but today's numbers on manufacturers' shipments and orders are very strong. They say, once again, that there's quite a momentum in the Canadian economy.
I can assure you that if it looks like the Canadian economy is not showing prospective inflation pressures as we go into the future, you will see that reflected in monetary policy.
Mr. Lorne Nystrom: If we promise to keep it a secret, can you elaborate a little bit more?
Mr. Gordon Thiessen: Well, I certainly can't tell you what we're likely to do in the period ahead.
Mr. Lorne Nystrom: I'll give you a few numbers and see how you respond to these.
Statistics Canada has said very recently, for example, that economic growth might not be quite as robust as we previously expected. For example, the gross domestic product in February fell for the first time in quite some time. It fell by 0.4%.
The other interesting thing is that the unemployment rate in this country now has remained at 6.8% for the fifth consecutive month, unfortunately. In April, the help wanted index decreased by 2.3%, the first monthly decrease since March 1996, which is also another interesting statistic.
Also, on May 8 of this year it was announced that department store sales fell for the second consecutive month to $1.48 billion.
So we have a number of indications here showing that there might be a little bit of a slowdown in terms of the growth of the economy. Can you give us an idea what impact those numbers might have in terms of possible rate increases in this country, regardless of what might happen in the United States?
Mr. Gordon Thiessen: I think the first thing to remember is that Canada is a medium-sized economy and very open. So what you have is a lot more fluctuation month to month in our data than you do in the data of the United States, for example, or of a country as large as Germany. You have to see through those. Just as I was saying with the consumer price index, you have to look through the fluctuations in energy, food prices, and taxes and see what the underlying trend is.
So while there was a decline in monthly GDP, I must say we expect there to be a very sharp rise in March. We got numbers today for manufacturers' orders and shipments for March, and they were up very substantially. That says it's very likely that dip in February is going to be compensated by an increase in March.
On the unemployment side, one of the things that appears to be happening now is that a lot more people are being drawn back into the labour force. What you're seeing is the so-called participation rate, the proportion of people of working age who are going back into the labour force looking for jobs, getting jobs. So in the period ahead we don't know, as employment grows, to what extent that's going to draw more people into the labour force or to what extent it's going to reduce the unemployment rate. But I think we do expect to see ongoing, fairly rapid growth in employment, and exactly how it affects the unemployment rate is hard to tell.
I have an answer for everything, I have to tell you. With respect to the help wanted index and the Internet, the number of people who are now looking for jobs on the Internet has gone up enormously. There is a real question about whether the help wanted index is a useful indicator any more.
And finally, the department store sales reflect the demise of Eatons.
Mr. Lorne Nystrom: Okay. I thank you for your answers. It's the Saskatchewan background that does that, Mr. Chair.
I wanted to ask you this. When you are looking at the possibility of increasing interest rates, I assume you take into account the fact that we almost have two economies there. We have people who are doing very well, and we have speculators who are driving the economy in some ways that turn to inflation. But then you also have the ordinary folks, and household debt in this country has gone up in the last decade. Real salaries have certainly not increased in the last decade. I just want to know what balance you put on those two.
The other part of the question, Mr. Thiessen, is that I think when the interest rate goes up by about 1%, the interest on our national debt, which is large, goes up by about $5 billion or $6 billion, or certainly figures that are in that range. I wonder if you could just speculate out loud again to us as to how you balance these things.
What's the import of the ordinary guy in Moosomin or Kamsack, Saskatchewan, whose income has really gone down and whose household debt has gone up, to the so-called young guy in red suspenders on Bay Street who is making all kinds of money, driving a very fancy car, and inflating the economy?
Mr. Gordon Thiessen: Well, we always look at the overall economy. It's the only way you can operate. You have to look at the total economy. You have to look at it from one end of the country to the other.
Mr. Lorne Nystrom: It's the consequences, though. The consequences are different for different people.
Mr. Gordon Thiessen: They are, but that's what you have to look at. What we're trying to do is keep this economy expanding, and that's in the interest of everybody. It is in the interest of almost no one for us to have boom and bust.
What we know from past experience is whenever you get the inflation rate growing, then you do have a speculative boom, and it's followed by a severe recession. That's what we have to avoid on this occasion. And that means looking at the impact. When we think to ourselves, demand looks like it's rising too rapidly and it's likely to put pressure on inflation, and we raise the interest rates, what we're looking at is the consequences for everybody across the country, because it's the total national consequences that matter. That's the only thing we can operate on.
The other thing to point out is that if we get this right, what you will see is some temporary increase in short-term interest rates, but if we're credible, you won't see much of anything happening in those longer-term rates. That's a sign of a pretty good policy. I'm not saying they won't go up at all, but you won't see those really sharp increases. That's what we're trying to do, and I think that's in everyone's interest.
Mr. Malcolm Knight: Could I just add one point to that as well? It is true that household debt has risen. Household assets have also risen over the past few years, and there have been some capital gains as well. Actually, the service on household debt relative to household incomes is significantly lower now than it was in the late 1980s and early 1990s. That is because interest rates now are a lot lower than they were at that time. And that in turn, I think, is because the inflation rate has been kept low and stable. That's an important difference in terms of the way households would see interest rate movements at the short end at this time.
Mr. Lorne Nystrom: I have one last question to Mr. Knight, in light of the fact that there's a chance he might be back here in a different capacity some day in a year or so. I wonder if he can tell us what his general philosophy is in terms of the Bank of Canada's responsibility to the Canadian people?
I'm asking for more of a philosophical answer. What is your vision about the role the Bank of Canada should be playing—its responsibility to the common good of our country and to the Canadian people? Is it just a technical role? Is it more than a technical role? Do you have any vision as to how the bank should evolve in the future to make sure we have a stronger economy where you have more fairness and justice, the common good is served, and everybody is happy?
Mr. Malcolm Knight: Thank you.
The first thing I should say is that as I'm sure you all know, the board of directors of the Bank of Canada will be searching over the next months for potential candidates for the position of governor. My job is to be the senior deputy governor and the chief operating officer of the bank, and that's what's occupying my time.
In terms of the general philosophy of the bank, having come to the bank just less than a year ago, I think one of the things I have appreciated most, which is very important not just to us at the bank but to the Canadian people, is the degree of transparency with which monetary policy has been operated in Canada for quite a long time.
The bank has a very clear monetary policy objective, and that is to maintain low inflation. It's an objective that is agreed on with the government, and it's an objective that I think, particularly for people who are old enough to remember the experience of the late 1970s and the 1980s, is one that really is shared very widely across the spectrum of Canadians.
That is something we not only try to do, but we also try to communicate as clearly as we can. I think this occasion is a very useful one to us to demonstrate what our objectives are to the Canadian people. But I think it is a very clear objective, and one that I would hope most people agree with.
The Chair: Thank you.
Mr. Scott Brison (Kings—Hants, PC): Thank you, Mr. Chairman.
Thank you, Governor Thiessen, for being with us today. I also commend you on your record as governor of the Bank of Canada. Where I differ with Mr. Nystrom is that I thought your predecessor did a good job as well during different times.
I also want to quell any rumours among the financial community about speculation about my future and linking it with your decision to retire. There's no connection whatsoever. I just wanted to make sure of that.
The first question is relative to the technology sector in Canada and the linkage with the capital markets in Canada.
Whether it's in e-commerce or biotech, Canada has been behind the U.S. in terms of the trends in those industries. Those industries being the industries of the future, it's awfully important that our players in those areas are well capitalized and that our capital markets are vibrant enough to support them during the critical times.
With the turbulence in the markets currently, isn't there a huge risk in Canada, given that we're probably about a year and half or two years behind the U.S. in these areas, of a freezing of capital available to those ventures, whether it's through angel funding, the venture capitalists? Certainly in the IPO market, there is a danger of it closing off for a period. To what extent are you considering that in your deliberations? From a future productivity perspective, our emergence and role in these areas is critical.
Mr. Gordon Thiessen: I think that's a very important issue. I must say that my reaction to the turbulence has been that on balance it has been helpful. I think it has caused a reassessment. In some cases, the kind of stock market values that some of the high-technology companies had achieved implied a rate of growth of earnings that was just astronomical. What you've seen subsequently is a kind of reassessment of that. In many cases it still presumes some very handsome earnings growth over the period, but nothing that seems quite so unbelievable as before. So I think by and large that's useful.
I must tell you, however, that it seems to me that when you have a rapid change in technology the way we have right now, you're going to have turbulent markets. It's so difficult to know which ones are going to succeed and which ones are not. So you get a new piece of information, and it suddenly says, oops, that's not the technology that's going to make it; that one is. You're going to see markets go up and down. I think it is a function of a period of rapid technological change, and we're all going to have to get used to it to some extent.
Mr. Scott Brison: It's indeed hard to do a PE without an E.
The other question again is linked with technology. With global e-commerce approaching in the next couple of years a projected $1.3 trillion, with most of that directly or indirectly based in the U.S., or at least the market these companies are seeking is largely the U.S., isn't there a risk, given that those transactions will be mainly in U.S. dollars, that there could be, through technology and globalization, almost a hollowing out of the Canadian dollar and a further weakening of the Canadian dollar as a marginal currency, at a time when currencies like the Canadian dollar could be marginalized significantly?
Mr. Gordon Thiessen: I don't think so. I think what you're going to find is that international electronic business is also going to be very adept at giving you prices in all sorts of currencies. That's the miracle of computers and information technology. So I don't see that this is suddenly going to say that everybody has to do business in U.S. dollars.
I think there is no doubt that international trade generally is picking up. Everything is becoming more international, and a lot of that trade is, by definition, going to be denominated in U.S. dollars. That is a degree of reality.
That doesn't mean it's not a good idea for us to have a Canadian dollar, because for all the reasons I said earlier, the Canadian economy does need a bit of a buffer against what goes on in the rest of the world. I think that has served us well, and I think it will serve us well in the future. So even though you see internationalization, even though you see international currencies becoming important, the logic doesn't immediately say, well, you don't need a Canadian dollar. I just don't think that's right.
Mr. Scott Brison: I've asked you on previous occasions here about the question of unemployment rates in the U.S. remaining inexplicably below NAIRU for a period of time. Some of the new paradigmers have felt that this indicated some structural change, that in fact unemployment rates would not be as relevant.
Did the Federal Reserve wait too long? There's a three-year lag time with monetary policy to really be able to have that kind of impact. Did the Federal Reserve wait too long, and is it possible that, as such, Canada got sucked into the same vortex in terms of potentially waiting a little too long? We have very different unemployment numbers here, and I guess that's part of the difficulty with an independent but related monetary policy.
Mr. Gordon Thiessen: It is.
Mr. Scott Brison: But did the Federal Reserve wait too long?
Mr. Gordon Thiessen: I don't think so. As I was saying earlier, we raised the risk in there that U.S. inflation rates will go up. But again, as I said before, I think the best projection right now is that the Americans are doing the right thing and that they will end up with a soft landing in the United States with their economy, and that really means that the economy starts to slow down to something that is more sustainable.
I really do believe that is the most likely outcome we're facing right now. As I said earlier, if it isn't, I do believe we have the capacity to differentiate ourselves, that people will come to see that we're on a different inflation track than the Americans. But for the moment, I think the best forecast is that the Americans will keep their inflation rate under control.
Mr. Scott Brison: Thank you, Mr. Chairman.
The Chair: Thank you.
We'll have a five-minute round for Mr. Epp and then Mr. Loubier.
Mr. Ken Epp (Elk Island, Canadian Alliance): Thank you, Mr. Chairman.
Mr. Thiessen, I too would like to add my thanks as a Canadian citizen for the work you've done.
I'm sure you are aware, more than anybody else, of the need to steer the fiscal ship of the country in the right direction, and as you indicated, there's a necessity to make sure you do your predictions in advance, maybe comparable to a huge ocean liner, where the captain has to make adjustments to the rudder two or three miles before the anticipated turn.
I have a couple of questions for you. One of the things you talked about was the scene where the expectation of capacity is perhaps a little less than what Canadians can deliver, yet, on the other hand, you seem to be optimistic about that. I'd like to know what in your view are the main factors that affect the potential capacity to produce in Canada.
Tied with that, what can the Bank of Canada do and what should the Parliament of Canada do in order to enhance that capacity?
Mr. Gordon Thiessen: The two big areas that contribute to expanding capacity are capital stock—machinery, equipment, technology—and the labour force, both the number of people in the labour force and how skilled they are. Those are the things that matter, and then you add to that, finally, resources. As you look into the future.... The thing I was stressing is the rapid growth in investment in machinery and equipment and new technology that has been taking place in Canada over the course of the last four years, because as we look at the American experience, where they have seen productivity improvement, that investment boom that has gone on in the U.S. seems to have been one of the crucial factors. So I think that's probably the most important thing.
But I guess I would also put with that the great importance of good education and training. That doesn't mean you have to turn everybody into technological wizards, but I think it really does mean that people have to be aware of the likely changes that technology will cause, and they have to be flexible in adapting to those changes to take advantage of it. That's something that is terribly important.
But as far as I can tell, all of that is going on in Canada these days. The people I talk to are all saying, yes, we're investing, and yes, we're engaged in training our people to ensure that they are capable of dealing with changing technology. So that seems to me to be the most important thing.
I find it very difficult to say precisely what government should do. But I think there's no doubt again, as I was saying earlier, that you have to get that right balance between incentives on the taxation side and a successful safety net for people who drop out of the workforce, people who have difficulty coping. It's getting that balance right that really does matter a great deal.
Mr. Ken Epp: Over the years in which you've been the governor, you've done a commendable job, by most measures, in keeping inflation under control.
I have a couple of questions on that, which I guess I won't have time to ask, but I'm going to get to one that I think is perhaps more important. When it comes to productivity, I think one of the largest factors for Canadian manufacturers is that the machinery and equipment they're buying, which could be used to enhance their productivity, is unfortunately bought at international prices that are 50% higher than they should be, because of the value of our dollar. I don't think you've done enough to protect the dollar and its value in the international market. Our productivity perhaps has failed because of that.
I have some empirical evidence of that. A manufacturer, not in my riding but close to it, who purchases his manufacturing machinery from Europe, basically made a decision not to buy a machine, because by the time he got it to this country and paid all the import taxes and the exchange rate and everything, it would be uneconomical for him to have it.
Could something more be done in that area?
Mr. Gordon Thiessen: I think what you constantly have to remember is that the exchange rate, the Canadian dollar, reflects what's going on in Canada relative to what's going on in the United States. We've been through a very difficult period, one where we've had an Asian financial crisis that reduced the value of commodity prices in Canada by 20%. We had to get through that. I think we got through it very well, but part of the adjustment process was a Canadian dollar that weakened for some time and has only recovered partially.
That's a reflection of what's going on in the economy. You ask why monetary policy doesn't do something to strengthen that dollar. What that would require is substantially higher interest rates. My reaction is that I can't imagine that substantially higher interest rates are going to encourage new investment—quite the contrary, I think.
We have to live with the reality we are confronted with, and I must say that I think keeping our inflation rate low, keeping our interest rates low, is, over the long run, going to serve us well and is going to help those people who invest.
Now, for example, the manufacturer who chooses to buy a piece of machinery in Europe will find that the Canadian dollar in the last four years has appreciated against the Deutschmark by 25% to 35%, so that German machine should be really inexpensive in Canadian dollars these days.
Mr. Ken Epp: I don't think he was buying it from Germany. It was one of the Scandinavian countries.
Perhaps my last question would be this: do you view, with some anticipation, that the Canadian dollar will go up? Will it ever get back to 75¢ or 80¢, which is where it was about seven or eight years ago? Will we ever again see, as we did in my youth, where we get $1.10 American for $1 Canadian?
Mr. Gordon Thiessen: Those long-term projections are very difficult to make. If the Americans have 20 years of higher inflation rates than we do, then we could well get there. We ended up having 20 years of higher inflation rates than the Americans, and that undermined our currency relative to that of the U.S. If the reverse were to happen, we might have a stronger currency, but I don't think anybody wants that. We don't want to wish an inflationary economy on the Americans. That's not going to be good for them. That's not going to be good for us.
But I guess if you do look into the future, you can imagine this. Malcolm was saying earlier that the Americans have a very large current account deficit in their international payments right now. As long as the American economy is booming ahead and no other economy is, you have a lot of people wanting to invest in the United States, and they're prepared to finance that deficit. At some point, that's going to turn around. At some point, the Americans have to stop running a deficit and have to stop borrowing from the rest of the world.
Part of that adjustment process is going to be a much weaker U.S. dollar than what we've had recently. That is going to include a U.S. dollar that is weaker against the Canadian dollar. Exactly when that's going to happen, I can't tell you, but it really will depend on when the U.S. economy starts to slow down, when perhaps some of the productivity gains ease off and the rest of the world picks up.
Mr. Ken Epp: Thank you, Mr. Thiessen.
The Chair: Thank you.
Mr. Yvan Loubier: Since I get to ask the last question, I am going to take the opportunity, Mr. Thiessen, to reiterate how much we have appreciated your services, my party and I. You have appeared, you have answered our questions intelligently, and demonstrated great skill in explaining things. It is all to your credit. So much for my remark.
As for the final question, I am dying to ask you, and I am going to ask you. During your term, which has actually been quite long, what achievement are you most proud of, and what are you least proud of?
Mr. Gordon Thiessen: I am very pleased that we have kept the rate of inflation within the target range. I think this is very important for Canada. This has given an element of stability to our economy. I think this is a great help to people who have to make decisions for the future, who have to make decisions regarding investments, equipment, material, etc., and also people who have to make an investment for a few years. I think this has helped the behaviour of our economy a great deal.
There is another important thing, which Malcolm mentioned, and that is the degree of openness and transparency of the central bank. The bank felt it was important to account for the way it was run. I think these things are very important.
On the other hand, I would like the rate of exchange to be higher, for it to reflect a stronger economy with a high growth rate, because the productivity growth rate is increasing. I think that will come, but up to now, our productivity gain has remained at a fairly low level.
Mr. Yvan Loubier: And you are not proud of that?
Mr. Gordon Thiessen: No, but I think it is very hard for monetary policy to change these things.
Mr. Yvan Loubier: What would be the value of a Canadian dollar reflecting a strong economy that had grown consistently over the past seven years?
Mr. Gordon Thiessen: It is impossible for me to answer you since, as I said, there are two sides to the rate of exchange. It depends on what is happening in the U.S. and what is happening in Canada. It would be very hard for me to say what the ideal level of the Canadian dollar would be. It depends on a lot of things.
Mr. Yvan Loubier: Obviously, you think that the Canadian dollar is under-valued, to judge from what you have just said. It does not really reflect the strength of the Canadian economy and growth over the past seven years. That is what you have just admitted.
Mr. Gordon Thiessen: No. I mean that I hope in future we will have growth in our economy and our productivity, which will increase our rate of exchange.
Mr. Yvan Loubier: Thank you, Mr. Thiessen.
Mr. Gordon Thiessen: Thank you.
The Chair: Thank you, Mr. Loubier.
I have a final question. Governor, Mr. Loubier's question really addressed the past and what you are proud of and what you're not proud of. I'd like to get a sense from you of what are the future challenges for the Bank of Canada. What advice are you going to give the new governor?
Mr. Gordon Thiessen: I think it involves some of the things we've been talking about. Traditionally, monetary policy focuses on demand in the economy. By and large the supply capacity of the economy over most the post-war period has grown fairly steadily. So you can predict that. You can extrapolate that. The crucial thing for monetary policy is to make sure demand does not exceed the supply capacity of the economy.
Now we're in a period of change, where it's much more difficult to judge what's happening to capacity. Are we going to get some large productivity gains? Is all this new technology really going to pay off in a period of relatively rapid growth?
I think that provides a challenge for central banks. You can see Alan Greenspan in the U.S. Federal Reserve trying to cope with that. The rest of us are just coming up to it. I think Canada, of all the other countries, is closest to what's happening in the U.S.
These are difficult times to deal with, but I must say they are the sorts of challenges I'd far prefer than having a high rate of inflation that we had to get down. If I had to choose between the two, I'm much happier to see these challenges. But they are nonetheless challenges. What's going to happen? How can you keep track of what's happening? How can you be sure you're allowing productivity to have its full expansion and that you're not taking some risks on the side of inflation? I think that's going to be a real challenge in the period ahead.
The Chair: Thank you, Governor. I think I speak on behalf of the people of Canada when I say that we've been extremely happy with your performance as governor. Perhaps we'll have the governor back one day on a round table entitled “Reflections of a Governor”. Thank you.
Mr. Gordon Thiessen: Thank you very much, Mr. Chairman. Thank you, everyone.
The Chair: The meeting is adjourned.