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FINA Committee Meeting

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[Recorded by Electronic Apparatus]

Tuesday, May 1, 2001

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The Chair (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I would like to call the meeting to order and welcome everyone here this afternoon.

In accordance with Standing Order 108(2), the Standing Committee on Finance considers the Bank of Canada “Monetary Policy Report, May 2001”.

I'd like to welcome the governor, Mr. David Dodge, from the Bank of Canada—congratulations on your appointment, sir—and Malcolm Knight, senior deputy governor. Governor, as this is your first appearance, you'll take whatever time you need to make your presentation, and thereafter we'll engage in a question and answer session.

Mr. David A. Dodge (Governor, Bank of Canada): Thank you very much, Mr. Chairman. It's a real pleasure for me to be back at the finance committee. This was home turf for me for many years, so it's a real pleasure to be back and appear today for the first time since my appointment as governor, on the occasion of the release of our spring monetary policy report. Mr. Knight and I really hope to be able to return on the day of or shortly after the publication of our reports every May and November, and I hope, once the excellent staff at the bank has got me under sufficient control, to have you over to the bank, so we can chat over there as well.

The report provides our latest assessment of the outlook for economic growth and inflation in Canada. Before I give you the flavour of that assessment, I'd like to say a word about the objective of Canadian monetary policy and how we go about achieving it. As you know, the bank has a commitment to contribute to the economic well-being of Canadians. Thus, we must conduct monetary policy so that it fosters sustained economic growth by creating conditions that favour rising output, employment, and incomes and a more stable macroeconomic environment.

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The unique contribution the bank can make, Mr. Chairman, to sound economic performance is to preserve confidence in the future value of money. Canadians should be able to go about their business fully expecting that their central bank will keep future inflation low, stable, and predictable. In this way they will be able to make sounder economic decisions, and this will lead to better overall economic performance.

Mr. Chairman, the bank pursues low inflation with a monetary policy framework that's based on inflation control targets and supported by a flexible exchange rate. As you know, the current target is to hold the trend of inflation inside a range of 1% to 3%, with an emphasis on the midpoint of 2%. Inflation control targets help to anchor policy and to anchor people's inflation expectations, and they provide the bank with an effective mechanism for assessing demand pressures. In this way we can and do take action to prevent overheating when the economy is strong and pushing against capacity limits and to support growth when the economy is weak.

At the same time, a flexible exchange rate allows our economy to adjust to disturbances, such as changes in foreign demand for our products or changes in the relative prices of our exports compared to our imports, and it helps us to adjust with less overall fluctuation in output and employment, even if the exchange rate didn't move.


With this brief overview of Canada's inflation-control strategy, let me now turn to the economic situation. When Mr. Thiessen appeared before you in May 2000, our economy was growing vigorously, bolstered by strong domestic and US demand. Indeed, with signs of the emerging capacity pressures, and with the need to sustain non-inflationary economic growth in Canada, the Bank raised interest rates the day after his appearance before this Committee.

These higher interest rates led to some cooling off in domestic demand in Canada. What we, and most other analysts, did not anticipate was the abrupt slowing in US economic growth. This is the factor that has contributed to a greater-than-expected moderation in economic activity in Canada.

Since February, the Bank has been saying that we expect growth in the first half of this year to be very modest. And we have indicated that, by the middle of 2001, the Canadian economy will probably be operating somewhat below potential. Overall, the information received today is broadly in line with the Bank's expectations. The monthly numbers have been volatile; some have been weaker and some have been stronger than anticipated. But they are generally consistent with our view that the weakness in the first half will be mainly associated with inventory adjustments in markets facing soft demand—in particular, motor vehicles—and with adjustments in other industries—notably electronics and telecommunications equipment.

The Bank continues to believe that, after very modest growth in the first half of 2001, economic activity in Canada will pick up in the second half and strengthen further in 2002. Let me explain what we are basing this on. Despite lower production in the three high-profile sectors I just mentioned, aggregate economic activity continues to grow, buttressed by underlying strength in other areas, including the energy sector, retail sales, housing, non-residential construction and most service industries.

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Supported by recent tax cuts that boost disposable income, final domestic demand should continue to expand. And we expect recovery in foreign demand in the latter part of the year, encouraged by the substantial reductions in US interest rates. Nonetheless, there are uncertainties about the exact timing and strength of the pickup in US growth.


Here in Canada, Mr. Chairman, we have lowered interest rates significantly to support growth in total demand, in line with our objective of keeping inflation close to 2% over the medium term. Since January the bank has cut rates by a total of 100 basis points, bringing the overall rate, the rate that corresponds to the U.S. federal funds rate, down to four and three-quarters per cent. With this monetary easing and with the strengthening of the pace of economic activity in the second half of the year, we now project annual average growth of between 2% and 3% in 2001. For next year we see the output expanding at a rate slightly above the bank's estimate of potential output growth of about 3%.

Consistent with the bank's expected paths of output growth, core inflation will likely average somewhat below 2% over the remainder of this year, then move back up to about 2% by the end of 2002. Total CPI inflation is expected to be quite volatile over the next few months, before moving down to about 2% at the end of the year, and that's predicated on world energy prices remaining close to current levels.

Mr. Chairman, now I may say a word about recent developments in financial markets. These developments have essentially reflected increased concerns about world economic prospects. In the circumstances, global investors have once again sought the safety and liquidity of U.S. financial assets, and this has led to an appreciation of the U.S. dollar against all major currencies, despite the marked slowdown in that country. Although the Canadian dollar remains firm against other major currencies, the decline in its value against the U.S. dollar, at least until recently, has been the subject of much public commentary here in Canada. Since the exchange rate is a key price in our economy, the bank recognizes that movements in its value can be a source of concern for Canadians. I want to assure you that the bank monitors these market developments extremely closely. We carefully assess the implications of currency movements for aggregate demand and inflation in Canada.

In closing, let me reiterate that the bank remains generally positive about Canada's economic prospects in the period ahead. We continue to expect to pick up in growth in the second half of this year, with further strengthening in 2002. The main risk of this outlook is the timing and strength of the projected pick-up in the U.S. Given this uncertainty, we will have to continue to monitor developments extremely closely and be prepared to respond appropriately.

That, Mr. Chairman, concludes my opening remarks. Over to you.

The Chair: Thank you very much, Governor. We'll now proceed to the question and answer session. It'll be a five-minute round, and we'll begin with Mr. Kenney.

Mr. Jason Kenney (Calgary Southeast, Canadian Alliance): Thank you very much, Governor, and congratulations on your appointment. It's good to have you back before this committee in a new capacity.

Sir, your report mentions how inflation remains near the top of the bandset as a matter of policy, and for that reason it appears to myself and most observers that you're clearly very constricted in your latitude to take action to support our currency, should it continue its slide of the past several months. I wonder if you could comment on this. Given that there is little or no manoeuvring room, given that growth is down and the economy is underperforming, given that inflation is at the top of its band, do you think there is any action that can be taken on the fiscal side to support the currency? I'll just ask you that question off the top.

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Mr. David Dodge: Let me start by reiterating one key point. Our policy of keeping inflation at about 2% is, in fact, a strong dollar policy. That's what's going to maintain, over time, the value of our currency. As I said in my remarks, we all face a situation where, for a number of reasons, the U.S. dollar is extraordinarily strong, not just against Canada, but against almost every other major currency. This has been the case, actually, for a number of years, whether one goes back to the Asian crisis, whether one goes back further to the peso crisis, or, indeed, if one goes all the way back to the beginning of the 1990s. Roughly it's the same story.

What the Americans have been able to do, certainly in the last four or five years, is to generate rates of productivity increase that most of the rest of us haven't. They did that by starting early on to increase investment in the 1990s, and that's started to finally pay off. We, as you will remember, were concentrating in the mid-1990s on trying to bring our fiscal situation under control. Investment in Canada lagged a bit behind investment in the States, but it has now picked up. We expect that we will start to see the results of this increased investment as we move into the first half of the new decade. That's no guarantee that we'll see changes in the relative value of currencies, but it is certainly an extraordinarily important condition if we are to see our living standards in this country improve, which is first and foremost what we're after. That will bring in its train, we think, some appreciation against both the U.S. dollar and other currencies.

Mr. Jason Kenney: To follow up, sir, I'd like to know if you agree with what seems to be a fairly widespread consensus, a view that's been articulated by people such as former chief economist of the Royal Bank Mr. McCallum, your former ADM Don Drummond, and others. Mr. Drummond, for instance, in an article recently said that as such, the low dollar is a reflection of a series of conditions in the Canadian economy; they're less attractive to investors than the United States. He points, as you have, to productivity, but then he points to our enormous public debt and tax burden in the structure of our public spending.

I'd like to know, from the perspective of the Bank of Canada, whether you think it's helpful or hurtful to the value of our dollar that we continue to have the highest income tax-to-GDP ratio in the G-7, amongst the highest corporate tax rates in the OECD, and the second or third highest level of public indebtedness in the OECD. Do you think these factors of fiscal policy help or hurt the value of our dollar?

Mr. David Dodge: It is undoubtedly true that the high level of indebtedness of federal and provincial governments is not helpful. As I have said on other occasions, it would be very helpful to the future of this country if, over the course of this decade, at both the federal and provincial levels, we did concentrate on bringing down our level of net indebtedness. That also underpins good inflation performance and helps us very much in our job.

We have made it quite clear that from that broad perspective—not necessarily the same amount, you're in and you're out, that would be silly—we should all concentrate, in federal and provincial public sectors, on trying to reduce that level of net indebtedness, which gives us more room to manoeuvre as we move into the second decade of the century, when people like me will have lost even the bit of hair that remains.

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The Chair: Thank you, Governor.


Mister Loubier.

Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ): I too would like to congratulate you on your appointment and also on the greater transparency shown by the Bank of Canada in the management of monetary policy. I believe that Mr. Knight has contributed to this as well. We had an opportunity to talk about this earlier. Personally, I really see a difference. I have followed the management of the money supply and interest rates for 20 years, and I see a difference between your administration and that of your predecessors. However, I still have some fundamental problems, and also sometimes some problems of conscience.

I have been looking at the trends in the Canadian dollar. This has been of interest to me for years. We have seen not only a great drop in the value of the Canadian dollar two and a half years ago because of the Asian crisis, but also the ongoing free fall of the dollar.

When I look at the latitude Canada has to manage its interest rates, money supply and value of its dollar properly and independently, it always seems to me that perhaps there is somewhere a risk premium to be paid for holding Canadian dollars, and that is reflected in its value. The Canadian dollar is a secondary currency and is the victim of speculation, but it also reflects the difference in productivity between Canadian and American firms. I am wondering if there is not some type of incredible constraint on the financial market and on the economy generally which means that we do not have the full latitude to introduce an optimum monetary policy. For example, we can easily raise interest rates, that goes without saying, because we are fighting inflation and maintaining the Canadian dollar. However, when the time comes to drop interest rates to give the economy a boost, we no longer enjoy all the freedom we would like to have.

I would ask for your comments on this analysis. These are some of the existential questions I have been asking myself since I have been here and longer ago as well, when I was a student. How can we have this independence and how can we achieve its full potential when we are so constrained regarding the management of interest rates?

I will come back with a second question later.

Mr. David Dodge: That is an excellent question. There have been debates on this subject in many countries.

Monetary policy is one instrument. So we can choose one or even two objectives. We can opt to maintain the external value of the Canadian dollar or of any other currency as compared to a reserve currency such as the American dollar or the mark in Europe. This is an objective we can choose. If we decide on this objective, we have to follow a monetary policy that is often designed to maintain the external value of the dollar as compared to the American dollar in our case.

There are advantages to managing monetary policy in this way, but it does mean that a country has to increase or reduce interest rates in order to maintain the value of the dollar. So we could find ourselves in a situation in which we have to raise interest rates even when the economy is very weak, or when the opposite is true. As you remember, that is exactly the problem we had in 1970. There were some very inflationary pressures coming from the United States, and we add to free up the Canadian dollar to avoid importing American inflation.

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During the 1990s, many countries chose the other approach, as we did. It consists in having a floating dollar and basing monetary policy on an inflation target. I believe we were the second country to adopt this approach. I believe it has been serving us well. However, the requirement for such an approach is a floating currency.

For a long period of time, as you noticed, the Canadian dollar has been dropping in value compared to the American dollar. The fact is that almost all world currencies have depreciated over the last 10 years. The Canadian dollar has actually increased in value as compared to almost other world currencies.

We cannot have it both ways. We cannot base our dollar on another currency and have an independent monetary policy based on an inflation target. It is impossible to do both. We made a choice, and I think this choice is making the best possible contribution to Canadian growth.

Mr. Yvan Loubier: I am not challenging the floating dollar, Mr. Dodge. Far from it, because I think that is the right approach. However, whether we like it or not, the Canadian dollar is a secondary currency, and like all secondary currencies, it is not a safe haven, as is the American dollar. Whether we like it or not, the American dollar, even with an even stronger slowdown in the US than in Canada, is growing stronger. The American dollar as become a safe investment, and whether we like it or not, we find ourselves in a situation where Canada is playing a sort of "loser game" with the Bank of Canada's monetary policy.

More and more companies have a parallel accounting system in American dollars, and I believe you would confirm that. A growing number of Canadian companies have permanent accounts in American dollars, and there are more and more senior managers who demand to be paid in American dollars.

In light of all that, do you not think it is time that we take a serious look at what is going on with the debate on dollarization, even in the context of the Free Trade of the Americas Area? Might we not consider adopting a single currency some day, which would probably be the American dollar, but which would shelter us from the continuing drop in the Canadian dollar and the incredible speculation that we have seen in the last two and a half years?

In any case, even if we close our eyes, we cannot help but notice certain realities, such as the fact that Canadian companies have bank accounts in American dollars. There are more and more of them.

Mr. David Dodge: There are many questions there.

Mr. Yvan Loubier: They're all on the same subject.

Mr. David Dodge: First of all, it should be noted that during the 1990s, most countries that had a fixed exchange rate abandoned this policy. Countries, such as Argentina, that have maintained this policy are experiencing real difficulty. So it is not true to say that most countries turned to the American dollar. That is simply not the case. However, during the 1990s, it is true that the American dollar increasingly became the standard throughout the world. The yen had its difficulties, and Europe is currently establishing a new union, and there is some uncertainty surrounding that.

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So the dollar really became a haven during this period. However, it is important to remember that we have seen such periods before. There was a similar period that ran from the 1960s until about 1973. In 1973, there were problems and the American dollar dropped. There were real problems at that time. There are no grounds for thinking that the circumstances that have favoured the US for the last decade will continue indefinitely.

The fact is that the American dollar is extremely strong. There are some problems at the moment within American industries, and this may be causing some domestic pressure in the US for protectionism, and so on. So the situation is quite difficult, and we hope that there will be a gradual adjustment over the next five years. That would be very helpful worldwide. It will be very helpful in reducing protectionist pressures within the United States.


The Chair: Thank you, Mr. Loubier. Thank you, Governor.

Ms. Barnes.

Mrs. Sue Barnes (London West, Lib.): Thank you, Mr. Chair. Welcome, Mr. Dodge. We're very happy to have you in your new position and back before this committee.

Many of my constituents are seeing in their newspapers and their news reports concerns about increases in energy prices. They may have seen it in their airfares lately, their transportation costs, or perhaps the fuel bill for their homes. Now your report comes out saying this is not going to have a major impact on our inflation targets. You've said that's predicated on current pricing, but we're also hearing that could change. Where does the change have an impact? Could you elaborate on why you do not believe, with the core inflationary values, this is having a more important or pronounced impact?

Mr. David Dodge: I've got to be honest here. Central bank governors from a number of countries have raised exactly the same question. Unlike the 1970s, this time we do observe that we don't have the same feed-through in consumer energy prices that we saw in the 1970s and early 1980s, which caused such difficulties. Why is that the case? The proximate reason is that manufacturers who use a lot of energy in what they produce find they cannot get price increases for their products, and so they have to absorb those increases by cutting costs elsewhere, by being more productive, by having lower profits than they would otherwise have had, and relatively little has flowed through indirectly into consumer prices. In fact, this has been quite surprising. It certainly doesn't conform with our earlier experience, but it is not unique to Canada—a number of countries have seen this.

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The real question is, will that continue? I think the answer is that if we can keep the productivity growth going, we can absorb some of that. But as we see, for example, in the aluminum industry, there comes a limit to just how far that can go. Indeed, we see aluminum companies selling their power rather than making aluminum, because the price of power has gone up so much. We will undoubtedly see some price increases. We're starting to see this in the LME price of aluminum. I picked that one because it's so direct and we're very familiar with that industry here in Canada.

We don't really know all the reasons we haven't had more of an indirect impact, but those are certainly two of them.

There is a third problem, which we will face this summer in gasoline and which we faced last winter in natural gas. In the period when prices were relatively low earlier in the decade, the construction of pipelines, the putting in place of new power generation facilities, and the putting in place of new refining capacity didn't proceed as rapidly as it might have in other circumstances. So we have a period now when we are going to face some problems in that regard. We're seeing it right now in regard to gasoline. The shortage of refining capacity in the United States has contributed to a much higher rate of increase in gasoline prices than the crude oil price would in and of itself indicate. Similarly, what we've seen is a big bubble in natural gas prices.

So consumers are going to feel the direct impact. It is feeding through, although much of it, other than gasoline, in the year-over-year measure will have fed through by the time the summer comes. That's why we expect that for the next couple of months the total CPI number is probably going to bounce up again. It's just the mechanics of month-by-month, the way those energy prices come. Then we ought in the fall to see it actually fall quite quickly, because we'll be comparing this year's prices against last year's very high prices.

Mrs. Sue Barnes: I want to switch you over to the topic of a cashless society. Most of us are used now to walking around with the debit cards, and we've become accustomed to using them in our grocery stores or wherever we go. But the smart cards most of us have not had in our wallets up until this time. I think that day is coming, and when it does, is that going to be part of what you consider money supply? How will that affect your looking at the way the financial institutions in this country deal with their electronic funds. How will it affect your governance?

Mr. David Dodge: Let me start, and then I'm going to turn it over to my colleague here.

Certainly, to the extent that it replaces currency, it changes the nature of the Bank of Canada's balance sheet. That is undoubtedly true. It is interesting that old-fashioned cash has retained a fair bit of its allure as a means of relatively small retail payment.

We might have expected the use of cash to diminish a little more rapidly. This is not just in Canada, this is elsewhere in the world. In fact, there are only one or two countries that have had a really significant penetration of the electronic purse.

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Malcolm has worked on this issue for a while, so I will turn it over to him.

Mr. Malcolm Knight (Senior Deputy Governor, Bank of Canada): Thank you very much, Governor.

The question you ask is indeed a really interesting one. As the governor said, we have been doing quite a lot of work in the Bank of Canada to think about the issues that would arise in a cashless society and what it would imply for the policies of the bank. As the governor said, one of the things that has actually surprised us over the past couple of years is that the use of currency has remained as high as it has. But I think it is quite possible that at some stage in the not-too-distant future electronic means of payment will develop that are going to significantly reduce the amounts of currency people are likely to be walking around with. When that happens, we will still have exactly the same fundamental objective of monetary policy that we've always had, which is to keep inflation low and stable, so that Canadians can trust the value of the nominal transactions they're making.

As the governor said, since in the balance sheet of the Bank of Canada, most of our liabilities are in fact currency, we will have to change the way we operate monetary policy to advance with the times, if you like, in order to deal with a cashless society. I don't think this is a really significant issue; it's a fairly technical issue. But as you may know, the way we set monetary policy is by setting the bank rate and through that the overnight interest rate, the interest rate at which the large financial institutions lend money to each other in the interbank market. As long as we can continue to do that and to use our balance sheet to do that, we will not have any trouble maintaining control over monetary policy and maintaining our objectives.

At the same time, when and if the cashless society really comes, it is going to involve a very rapid transformation in the way household transactions are made. We, in cooperation with a lot of other advanced country central banks around the world, have been thinking about this and working on it very hard. So we think we're ready, and we are just waiting for it to happen.

The Chair: Thank you, Ms. Barnes.

Very quickly, in your report, page 17, chart 11 relates to the value of the dollar vis-à-vis the C-5 currencies, and then you also have reference to the American dollar. We, of course, have remained stable with the C-5 currencies, but have lost approximately 10¢ in value vis-à-vis the American dollar. Should we take comfort in this chart? I believe 85% of our trade is with the United States of America. As a Canadian, when I look at this chart, should I be very happy about the fact that we're keeping pace with, or maybe doing better than, some of the European countries, for example, but not doing as well vis-à-vis the United States?

Mr. David Dodge: Happiness really is defined in the welfare of Canadians, rather than in a particular price, which is the price of the Canadian dollar. The real issue is whether we would have been better off had we been anchored to the American dollar and accepted whatever that meant in respect of our domestic policy. The answer, as most people do the analysis, is that the current system, the system we have had, in fact has contributed, some people would say very significantly, others would say significantly, and still others would say somewhat to the growth of income and employment in Canada as compared to our having a fixed exchange rate. That really is the issue: how well off Canadians are in terms of what their wages and salaries will buy compared to what they would have been had we had a different regime. That's what one really needs to focus on.

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Most analysis—and indeed M. Loubier quoted Don Drummond—would say that at this time, given the structure of our economy and given that of the U.S. economy, it is advantageous to have a floating dollar, one that has floated down recently, because that allows us to have the strongest growth in employment and incomes domestically. In the opinion of most analysts it has overshot the mark somewhat, but it may well float up in the future.

Mr. Malcolm Knight: I wonder if I could just add one point to that.

During the whole period that is illustrated in chart 1—and indeed before it—we have had in Canada a lower rate of inflation than they've had in the United States. We've often said that the best contribution the Bank of Canada can make to our exchange rate is to maintain inflation low and stable. So when you look at the gradual depreciation of the Canadian dollar against the U.S. dollar—which has continued some years, really right through the 1990s—one of the conclusions one must draw is that this is a real phenomenon. It has something to do with what productivity has been doing in Canada relative to the United States.

Roughly speaking, one of the conclusions you draw from this is that our productivity growth has been slower than that of the United States but probably a little bit faster than in other countries that are listed in the C-5 currency exchange rate index. In terms of what happens to the real exchange rate, adjusted for price movements, there's not all that much monetary policy can do over the longer term. In terms of maintaining low and stable inflation, however, I think we've had a strong dollar policy.

The Chair: The productivity issue is precisely the point. Doesn't a low dollar in fact create a false sense of productivity gain when it comes to a firm that is in reality winning contracts because of a low dollar rather than a productivity gain?

Mr. David Dodge: You have to be very careful because there are other firms that sell largely domestically and face the prospect of having to purchase equipment and other inputs internationally. If those international prices are rising, then there's tremendous pressure on that sort of firm. A Ted Rogers, for example, is under tremendous pressure. It's not an advantage for him. The exchange rate is a price.

The Chair: So you're arguing for a stronger dollar.

Hon. Lorne Nystrom (Regina—Qu'Appelle, NDP): It's like the Montreal Expos' situation.

Mr. David Dodge: It's like the Montreal Expos, exactly.

The Chair: That's why we should have a stronger dollar; is that what you're saying?

Mr. David Dodge: No, but let's be careful. The exchange rate is a price. We've seen the price of oil, for example, move from $30 a barrel down to $10 and back up to about $30. Is that good, bad, or indifferent?

Well, if you're a seller of oil, it's very good when the price is going up and it was very bad when it was coming down. If you're a user, it's exactly the opposite.

What the exchange rate is doing, roughly speaking, is equilibrating the demand and supply both on the trade side, where in fact the relative price of a number of things we produce in this country has been falling.... Mr. Nystrom knows well, coming from B.C., that it has not been great fun to see the price of softwood lumber come down. It has not been great fun in Saskatchewan to see the price of wheat come down. There are some areas where it's been really difficult. We produce a lot of these things, and that has necessitated some adjustment on that side.

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On the other side, for the past four years we have been paying down our government debt. That means the Americans, Australians, and so on who have owned these Canadian dollar obligations cash them out when we don't roll them over, in which case they want to convert them into American dollars, into euros, or into whatever. As a result, there is some pressure in that regard.

Finally, I'd really like to go back to the point Malcolm raised—indeed the one Mr. Kenney started us off on. This is that fundamentally it comes down to productivity. If we weren't staying as productive as somebody else, then in fact there would have been downward pressure on our real incomes regardless of how it came about. On the fixed exchange rate we would have got our pressure down on the nominal side under a floating rate. We've had the same downward adjustment, but it's come through adjustment in this price, namely the price of the Canadian dollar.

Mr. Malcolm Knight: Sorry; may I just go on? There is one other element that's very important. You mentioned that exports to the United States are the key thing we're watching, but we have to be very careful to consider our cost structure relative to that of our competitors, who are also exporting into the U.S. market. If the Canadian dollar is appreciating relative to Sweden's currency or that of the countries of the euro area, that creates a lot of pressure on our exporters to improve their productivity. We have to really be careful about our competitiveness vis-à-vis other countries with which we might not have a lot of bilateral trade but that compete with us in our main export markets.

The Chair: Okay. We'll have Ms. Leung, followed by Mr. Nystrom.

Ms. Sophia Leung (Vancouver Kingsway, Lib.): Thank you, Mr. Chair. Congratulations, Mr. Dodge, and please remain associated with my alma mater, UBC.

I just have a two-part question. First, recently I visited Asia, and I had a very good discussion with Hong Kong government officials. They run deficits, and they frequently do that regardless of the fact that they have large reserves. In the meantime, in China I observed that even though they still maintain economic growth, there's a rumour their RMB may consider devaluation, but that would be a disaster.

In Japan we know that the economy is having its problems, and now so is the U.S. economy. I'm just wondering how you perceive all this. Could there be another financial crisis? How would that affect our Canadian dollar?

Mr. David Dodge: I will start off, and then I will pass it to Malcolm because there are really two sets of issues here, and I think this is important for the committee.

First of all, we have been talking so far this afternoon largely vis-à-vis the United States, but I think it is extraordinarily important to know that a major source of wealth generation in this country came in the 1980s from demand from Asia. This was felt not only in places like Vancouver and Whistler but right across the country. The weakness in Japan, as well as the subsequent problems a number of the East Asian economies have had, has made life difficult. Indeed if you look at our trade balances, you'll see that while we've been improving vis-à-vis the United States, we've actually been deteriorating, and deteriorating quite significantly vis-à-vis Asia.

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It has been very unhelpful for Canada to have the weakness in the Japanese economy, initially starting in 1990 and then starting later in the other Asian economies. That certainly has created a problem, and we must keep focused on that. Even though these markets are at the present time temporarily depressed, they remain extraordinarily important for us, and we do have to keep a focus on them and not keep all our eyes trained south of the border.

The second issue you raise is that of financial stability and what we're doing in that regard. That is the second major thrust of what we do at the bank. I'd like to turn to Malcolm to start the discussion on that, because it really is extraordinarily important.

Mr. Malcolm Knight: On the financial stability side, if we talk specifically about the Asian countries that you have raised, there are certainly financial stability issues that arise in the People's Republic of China. The first thing I would say, though, is that the People's Republic of China is not only a huge economy, but it's growing at a spectacular rate. It looks like the projection for this year is going to be raised to above 7.5% in real terms, and the expectation is that China will grow by over 7% again in real terms in 2002. So this is an economy that could hardly be said to be in crisis from that perspective.

Having said that, there are major weaknesses in the Chinese financial system. The authorities have been aware of them for some years now. They were trying to move to better accounting techniques that show up the problem loans, but this is a great difficulty in a country where most of the large loans are lent by nationalized banks to state-owned enterprises. So a large proportion of loans have been written off in China. A state asset management corporation has been set up, but much more work needs to be done in this area.

Japan is a very different economy. The governor has already spoken about it. Financial stability there is also a key issue. The authorities are addressing it, but there have to be questions about the pace at which that's being done.

But the most general point I would make is that as a country that has very good supervision and regulation, Canada can play a role here, and we do by participating in the international meetings with the Bank for International Settlements, with the Financial Stability Forum, with the International Monetary Fund, and with the Basel Committee of Banking Supervisors. The effort there is to get all countries of the world to abide by codes of conduct in the financial area. I think this will be a very important element in addressing financial stability on the international level.

The Chair: Thank you.

Mr. Nystrom, and then we'll go to Mr. Epp and Mr. Brison.

Mr. Lorne Nystrom: Thank you, Mr. Chair.

I want to congratulate Mr. Dodge for his appointment as the Governor of the Bank of Canada and welcome him back to the committee, and welcome Mr. Knight here as well.

I have three very simple questions for you, Mr. Dodge. Your predecessor, Gordon Thiessen, made it very clear that he did not agree with the idea of a common currency for the NAFTA countries, and I suspect you share that point of view. I certainly do, but maybe you could put on the record what you think about the idea of a common currency. I have great concerns about that movement. I think it would be very harmful to us.

• 1630

Mr. David Dodge: From an analytic point of view, it's quite clear that at this stage in our evolution, a floating currency for Canada vis-à-vis the United States, and indeed for most Latin American countries, is a great advantage because the structures of our economies differ.

It may well be that in one, two, or three decades, the structures of our economies will look much more similar. In that case, the advantages of a floating currency, from a strictly economic point of view, go down, and the costs of having a separate currency remain. So one can conceive of a point where they will cross down the line, but we're certainly not there yet. Virtually no analyst comes to the conclusion that we are there.

There's a second issue that goes beyond that, and that is that the Americas are not coming together in the same way the European Union did, where you had three or four major countries and where you had truly a union. There would be zero input from us or anyone else into the fed policy as the Americans would want to do it. That's a political issue; I'll leave that to you. But it is an observation.

Mr. Lorne Nystrom: And I think it's a very important and relevant observation as well.

I want to ask you one more question on the dollar. You've been asked by Mr. Kenney and others about this today.

I have a chart from Statistics Canada that shows the evolution of the dollar from about 1950 until the year 2000. It's interesting when you look at the chart, when you go back to 1953 to roughly 1962 or 1963, our dollar was worth more than the American dollar.

It seems to me every time we have that spike in the dollar and then it drops off, and then it goes up again and drops off, every time it stabilizes, it stabilizes at a little bit lower level. I wonder if you can shed any more light as to why that is happening. Are there some structural weaknesses in the economy over a long period of time?

Particularly since 1977, we've had a radical drop in the Canadian dollar. Every time it stabilizes, it seems to stabilize at a lower plateau, and then we have another drop and it stabilizes again at a lower plateau.

Mr. David Dodge: That period from roughly the mid-1970s when we were at $1.02 U.S. through until the late or mid-1980s when we'd gone down to $1.39....

Mr. Lorne Nystrom: Or slightly over 70¢.

Mr. David Dodge: Sorry, I'll do it the other way—we'd gone down to 72¢. That is largely accounted for by rather poor price performance in Canada relative to the United States. So that period is accounted for by that. The reason we in fact appreciated against the United States from 1970 until 1974, from the time we floated, was because they were having relatively poor price performance compared to us. So I think one can largely look at those earlier periods in terms of relative performance on the price side.

We then come to the 1990s, where we've gone from roughly 85¢, mid-eighties let's say, to the high sixties or low seventies, and that is not the case. Our inflation performance over that period has been at first equal to and then subsequently superior.

What is different over this last decade is that our productivity performance has been really quite inferior to that in the United States. So we've had what we as economists call real depreciation there because we're just not as relatively productive.

• 1635

Our analysis would say that we expect some catching up on that over the next five years as we begin to get the productivity flowing through from investments that really started in the mid-1990s. But we had pretty poor investment performance in the early 1990s, while the Americans were having a very good one.

There really are two different explanations over that rather long period of time. Neither is totally correct, of course, but, oversimplifying a bit, that's really what has been driving it.

Mr. Lorne Nystrom: My third question is on interest rates and why you haven't dropped them a bit more aggressively.

I look at interest rates in the United States compared to Canada and our interest rates are higher in this country—our real rates, our nominal rates. If you look at inflation, I think our inflation rate is around 2.5%, Mr. Chair, and the Americans' is around 3%. So our inflation rate is lower than the Americans', and theoretically we should have a bit more flexibility.

When you look at the unemployment rate in this country, we're at roughly 7% and they're at roughly 4%. So our unemployment rate is really 75% higher than theirs. We have an unemployment rate that is a lot higher than the Americans'. We have an inflation rate that is a bit lower than the Americans', and we have an interest rate that is higher than the Americans'.

Isn't that the scenario where you'd be a bit more aggressive in terms of lowering our interest rates? Don't you have more flexibility and elbow room than perhaps you've taken up to the present time?

Mr. David Dodge: This is an extraordinarily pertinent question, because what you're going at is the heart of how we go about actually setting interest rates.

I would note, to start, that in nominal terms Canada, the U.S., Europe, and the U.K. are right at the moment all at about the same nominal level. You're absolutely right, our real rates are a bit higher because our inflation rate's lower.

What we had been doing until just a little over a year ago is we actually had been running nominal rates that were below U.S. rates because we thought we had more room to expand before we hit capacity constraints. It's clear—it's always clear in retrospect, as you know—that we were beginning to run into those constraints last summer. Our view, as we laid it out in the report today, is that over the first half of this year we are opening up some room, and that is what is giving us some room to move those rates down.

As you know, the trick and the great difficulty is that we have to be looking six to twelve months forward because it does take time to have the impact on the real economy. That's why it's so critical where we think things are going to be next winter, because what we are doing today is really affecting things next winter.

We have said that we thought there was room to ease. We have eased. We are struggling to figure out whether we have it pretty much right as to where we think we're going to be next winter and a year from now.

Our view, as we set out in the report, is that while we'll continue to open that gap over the course of the second quarter and won't do much by way of closing it in the third quarter or fourth quarter, we think that by 2002 we are going to be closing the gap again.

But that is very much a judgment call. That is why we say we're going to be watching very closely what the numbers are.

The other point I would make is that we do have sectors that are performing really quite differently across the country. So at the moment we have had the greatest deceleration in southern Ontario where in fact the market was pretty hot, but we still have a very strong energy sector in Alberta, we have parts of Ontario, much of Quebec, the Atlantic provinces, that are actually relatively stronger at the moment.

• 1640

So it's a bit of a mixed bag and it certainly is a mixed bag as you go across sectors. The housing sector and the construction sector are quite strong, and we are pressing against constraints, as Dr. Bennett knows well, in the health sector. So we have a number of sectors where we are actually still pretty tight.

The Chair: Thank you, Governor.

Thank you, Mr. Nystrom.

Mr. Epp, you have 12 minutes.

Mr. Ken Epp (Elk Island, Canadian Alliance): Thank you very much. I would like to add my congratulations to what the others have said on your new position. I wish you well and great success in your years in office.

While you were talking and the other people were questioning you, I thought of the analogy of the airplane. The airplane moves on three axes: there's pitch, there's yaw, and there's roll. And there's a separate control for each of those. Yet it seems to me that when I look at the different economic factors—and I wrote down some of them as this conversation went by—there's the cost price index, inflation, the value of the dollar compared to other currencies, our currency supply, productivity, consumer confidence, unemployment, and employment on the other side of it, gross domestic product, and growth of the economy. All of these different factors respond I think to different things that governments and central banks do. Yet it seems to me you're trying to control all of the factors with only the throttle. You're not touching the other control surfaces at all. And trying to fly an airplane just by using the throttle makes it really difficult. The only thing you do is adjust interest rates. Am I right, or are there other things you do that I'm not aware of?

Mr. David Dodge: No, you're absolutely correct. We really have one tool. It is slightly more complicated than just interest rates, but basically it's one tool to control those monetary conditions out there.

Mr. Ken Epp: So do you think you should be exploring other things? For example, I think that by raising the interest rates, you basically decrease the money supply, and vice versa. Of course, when you change the money supply, you're changing inflation. But that rate of inflation is also affected by unemployment. Right now in Canada, and particularly in this region, there's a lot of concern about the huge number of very high-paying jobs that are being lost in the high-tech industry, which has a tremendous impact, first, on the local economy and then on the wider one.

I'm also very much aware that many of our people who are losing jobs here in the high-tech industry are then going to probably emigrate, go to a different country, most of them to the United States, and we may lose them forever, with a major change in the long term in our economy as a result of that. What measures can you take that would stop that and would stem the flow?

Mr. David Dodge: First of all, you're right, we have one instrument and it's relatively blunt. Over time, it's quite powerful, but it is relatively blunt and it does take time to operate. There's absolutely no question.

We are seeing at the moment two or three things going on, and you've mentioned a couple of them. We are seeing a rather classic inventory adjustment that has gone on in the automobile industry and a number of other durable goods industries. And we expect to see ourselves work our way through it. There are some structural problems in those industries, as well.

Second, we've had a real boom in the telecommunications industry and the hardware for information technology, probably to the point where, at least temporarily, we have more capital in place than we actually have demand for, and all of a sudden that became realized. Things moved extraordinarily suddenly from everybody adding band width as if there were no tomorrow to all of a sudden realizing that we probably had enough band width out there to last us for a couple of years, and from people adding switching capacity as if there were no tomorrow to them suddenly waking up and saying the demand to fill up all of those switches isn't really going to be there for a couple of years. That is a much more classic investment cycle, and that characterizes the industries you were just talking about.

• 1645

I would say, however, in that regard that there are a lot of companies that need to use those skills to really take advantage of this new technology, our own bank being one, where we've essentially been priced out of the market for some of the skills we need to do the work internally. There are lots of companies in our position. If you talk to people in the industry, you'll find they're not necessarily all that upset that we've had this slowdown. It's a little rougher and bumpier than we would like. But some reallocation of these skills to do other things is probably very much in our long-term interest.

Third, and this comes back to the point Mr. Nystrom was raising, we have had a rather lengthy period, about a quarter of a century, where by and large non-energy commodity prices have been moving down, sometimes with a bump up here and there, but, basically, they have been moving down. We are still big net producers of these products. Our companies out there are having to work extraordinarily hard to keep up and to produce these products. That means there are just not what we call the economic rents to spread around in order to be able to do other things that were being generated out of some of these industries early on.

Mr. Ken Epp: One of the factors that affects us in Canada big time is our very low Canadian dollar compared with the American dollar right next to us. We find this when we're talking hockey players, and we find it when we're talking high-tech people. In order for Canadian companies to compete, they have to pay a great deal more than what they would normally pay in terms of the number of dollars.

Again, I would like to ask your opinion about the value of the Canadian dollar. There are two questions. If you look at the history of the dollar, you'll see that it has been going down quite steadily over the last 20 years. I wonder if that really is in Canada's best interest, because it is imposing a wage cut on pretty well every Canadian worker regardless of what they're doing in real terms in the world economy. You disagree with that.

Mr. David Dodge: Yes.

Mr. Ken Epp: Let me ask my second question. Just by the way you're shaking your head, it looks to me that you're going to reject that, so maybe the next question will be redundant. But my question was going to be, what can be done to bolster our dollar?

Mr. David Dodge: I would go back to what I said earlier. The objective we have in formulating monetary policy is in fact to try to provide the conditions that will provide room for the maximum growth of the Canadian economy and the maximum growth of incomes of Canadians. That's what the real objective is.

• 1650

Our view, which is supported by domestic work and by work elsewhere, is that maintaining the purchasing power of the Canadian dollar and people's confidence in that purchasing power is an extraordinarily important contribution.

The purchasing power of that dollar you have in your wallet has been going down at about 2% per annum. That's what our target has been for the last 10 years. Over that same period the purchasing power of the dollar that the American has in his or her wallet has been going down by about 2.5% or 3%.

You ask, how can that be? Most of what we purchase gets translated into Canadian dollars. In fact, had our salary been going up at 2% a year, we would be equally as well off against the basket of goods we normally purchase as we would have been earlier on regardless of the change in the exchange rate, because built into the prices of what you and I purchase is the impact of those changes, which Sue Barnes talked about earlier on. It has forced Rod Bryden and the Senators to find ways to keep costs down and the telephone companies or whatever to find ways to deal with it.

It is true that a holiday in Florida is more expensive today than it was 10 years ago. It turns out, though, that a holiday in France is somewhat cheaper. There is a price signal there that instead of travelling to Florida or Arizona when you want to go somewhere warm for your holiday, maybe you should go to some other place. Indeed, there's a price signal vis-à-vis travel in Japan, where in fact it is considerably cheaper today for us to go there than it was four or five years ago, as the yen has depreciated against the U.S. dollar. These are all relevant price movements.

But for the basket of goods and services we consume, the loss of purchasing power of that Canadian dollar is roughly 2% per annum, which is our targeted inflation rate.

Mr. Ken Epp: If I'd been given an executive summary of what you just said—and I want you to correct me if this is wrong—it would be that the Governor of the Bank of Canada says that the current rate of our dollar of between 60¢ and 65¢ is acceptable and is fine for the Canadian economy, and he either can't or won't do anything about it. Is that accurate?

Mr. David Dodge: I'm sorry, Mr. Epp, I didn't hear the last phrase.

Mr. Ken Epp: Okay, I'll say it again. The Governor of the Bank of Canada has said that the current rate of our Canadian dollar of between 60¢ and 65¢ American is acceptable, and, in any case, he either cannot or will not do anything about it.

Mr. David Dodge: No. First of all, the word “acceptable” is a strange word. It is a price out there for our currency, just like the French franc is roughly 20.5¢. It is a price that's there. It's not acceptable or unacceptable or anything like that.

But it is true that with a weaker currency vis-à-vis the U.S. dollar, it does mean that even though we haven't seen a lot of inflationary pressure, it does have an impact on inflation in Canada and an impact on output, and that impact is not necessarily helpful. A declining dollar is not necessarily helpful in respect of inflation. In some circumstances, though, it could facilitate adjustment, and in other circumstances you definitely would very much like an appreciating currency to avoid importing inflation from abroad.

• 1655

So I don't think you can summarize it quite the way you did.

Mr. Ken Epp: I was blunt. Thank you.

The Chair: Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC): Thank you, Mr. Chairman. Thank you, Governor, for appearing before us today, and Dr. Knight. It's great to have you here.

First, over the last several years arguably the Bank of Canada has actually maintained a high-dollar policy, not a low-dollar policy, from an inflation-target perspective, at 2%, as opposed to 2.5%, with the Federal Reserve in the U.S. Despite that high-dollar policy of the Bank of Canada, exercising the monetary levers available to you, to what fiscal, structural issues do you attribute the precipitous decline in the dollar in the last several years? You mentioned debt earlier, in response to Mr. Kenney's question. You also spoke of some of the convergence issues in respect of economies with Mr. Nystrom. But if there's a convergence occurring, why is our dollar declining so precipitously, with this monetary policy you're promoting?

Mr. David Dodge: There are a number of factors. We talked earlier about productivity. As people in Canada and around the world look at where they can get the highest returns on investment, there has been a period when people around the world have felt they could get a higher return on investments in the United States than they could in Europe or in Canada or in Japan. So we have seen some positive capital-flow into the United States because of this perception that you could get a somewhat higher return. All the exchange rate is doing is equilibrating those flows. That's one reason we haven't talked about so far.

We are reducing our net international indebtedness. I forget the precise numbers, but I think we were up in the order of 36% or 37% net international indebtedness. I think the latest numbers I saw show we brought that down to about 23% or 22% of GDP. When you're paying back debt, that means you are really saying to foreigners, here are your U.S. dollars back, you give me your Canadians, here's your U.S., you give me your Canadians, your pounds, your euros, or your yen. So that also has an impact. It's doing something that will stand us in very good stead down the line, but as you're doing it, it has that impact.

Finally, it is fairly clear that because our net trade position with respect to non-energy commodities is still very large and the relative price of non-energy commodities has been falling, not precipitously, but steadily over a rather long period, there is downward pressure.

Mr. Scott Brison: You say one of the reasons the U.S. dollar has performed well has been the buoyancy of the U.S. capital markets, but in recent months there has been no market hit more severely in downturn than the NASDAQ, and yet the U.S. dollar has still maintained its strength. How do you square that with your argument that the buoyancy of the U.S. capital markets has helped keep the U.S. dollar strong?

• 1700

Mr. David Dodge: We've certainly had a movement out of equities and into fixed income, and U.S. fixed income instruments have been relatively attractive. It's only very recently that the interest rates in Canada on those fixed income instruments have moved up very much above the mark, and we were well below for a long period of time. That's number one.

Number two, we have had some disturbances around the world. Turkey, Argentina, the Brazilians, unfortunately, have been having some problems, and of course, I don't have to mention the Indonesias and so on. And even countries that have made very good productivity gains, like Korea, have been having some problems. So the U.S. is, at the moment, still the parking place when those problems arise, and it's only when the costs of parking get high, in the sense that U.S. rates are significantly below other good parking places, like Canada or the U.K. or Europe, that you can divert some of those parked funds.

Mr. Scott Brison: So you're saying that when things are good, the U.S. is a capital magnet, and when things are bad, there's a flight to.... So you win your case—

Mr. David Dodge: Well, not quite. I think there were particular issues, but it is undoubtedly true that the New York market is the deepest, broadest, and most efficient capital market in the world.

Mr. Scott Brison: First, even with the tumult in the world of technology, there has been and continues to be a growth in, particularly, business-to-business e-commerce. Business-to-consumer e-commerce is getting traction. Do you see the growth of e-commerce as another contributing factor to further downward pressure on marginal currencies, given that much of this commerce is occurring in U.S. dollars and given the borderless nature of this trade?

And second, with the strength of the U.S. dollar, the emergence of the euro, and the convergence of fiscal structural issues that you described earlier, what do you see as the future of marginal currencies like the Canadian dollar in, say, ten years?

Mr. David Dodge: We're in a very competitive world, and we have to work like hell to make sure Canadian capital markets are efficient, work extraordinarily well, and remain liquid and deep. That is a struggle, when you're competing against the depth of New York. We can see the Europeans struggling. We can see that the Japanese market, which was developing and was really quite powerful, if you go back to about 1988, because of poor performance, has run into very hard times. So in a sense, we're left with the New York market as the big boy out there and the rest of us struggling.

Is there room for a regional market? I think the answer is, yes, but a bit like Avis, you've got to try harder in order to make it work.

But, Malcolm, you're the real experienced guy in this game.

Mr. Malcolm Knight: Let me just say a few words. In all this discussion I think we have to remember that what we have been seeing for some years now is a very strong U.S. dollar against all currencies. And as the governor said, a number of actions in Canada have laid the basis for strong performance of the Canadian economy over the longer term. We have a lower rate of inflation than the U.S., and governments at both the federal and provincial levels have brought their budgets first into equilibrium and then into surplus. We've had up to now a lower rate of productivity growth than the U.S., partly because, as the governor said, investment started to rise in Canada later than it did in the United States. But investment, particularly in machinery and equipment, which brings e-commerce and high technology, has been a major feature of the Canadian economy since about 1996. So after the U.S. economy, Canada, with its telecommunications system, is probably in a very good position to pick up these new technologies and the productivity gains that go with them.

• 1705

But at the end of the day, we also have a current account surplus. The U.S. has a deficit on its current account. It's importing more than it's exporting to the rest of the world, to the tune of 4% of its GDP. This is bound to have some impact on the exchange rate of the U.S. dollar against all its trading partners, including Canada, over the longer term. So history may not repeat itself in the future.

The Chair: Thank you.

Mr. Brison.

Mr. Scott Brison: In response to that answer, I asked the question about the future of marginal currencies in ten years. There is a convergence. We saw preceding the euro a Maastricht Treaty with agreement on some of the fiscal structural issues. We're seeing that almost naturally occurring with the acceptance of certain fiscal truisms in respect of debt issues and tax issues in other parts of the world. With this convergence occurring, and again in reference to Governor Dodge's response to Mr. Nystrom's questions earlier, what do you see as the future of marginal currencies, i.e. in some ways non-U.S. or euro, in ten years?

Mr. Malcolm Knight: I'm not sure I like the use of the term “marginal currencies”. One of the things we're seeing around the world is that as countries improve their techniques of operating monetary policies, they find they want to pursue policies of inflation-targeting, of the type we have had for a decade in Canada, and have flexible exchange rates. They find it's more difficult to maintain a separate currency and a fixed exchange rate than it is to maintain a monetary target that targets low and stable inflation and allows their exchange rate to move around as their countries are subjected to shocks that require adjustments in relative prices.

So it is true that the U.S., as the centre country, gains substantially from being the most important currency. But having separate currencies and having flexible exchange rates is giving countries that can manage their monetary policy well an extra degree of freedom to adjust to real shocks, and that is quite important to a large number.

Mr. Scott Brison: I don't disagree with that, but I'm wondering whether you believe the ability to maintain that independence is going to be there in ten years.

The Chair: Mr. Brison, thank you very much. You tried to sneak in another question. You don't even have to answer this, Mr. Dodge. The bell's going to ring at approximately 5:15. Disregard the bell. We'll leave here at 5:29. It will only take us a minute to get to the House.

We have two final questioners, Mr. Cullen and Mr. Pillitteri.

Mr. Roy Cullen (Etobicoke North, Lib.): Thank you, Mr. Chairman. Mr. Dodge, Mr. Knight welcome. Congratulations, Mr. Dodge.

I have three questions. We may not get to them, but if we have time, I'd like to ask a bit about capital inflows and outflows—you touched on it briefly, Mr. Dodge, in your response to Mr. Brison—and talk about savings rates and consumer debt.

Before I do that, the European Central Bank has been under some pressure to reduce interest rates. I don't want to put you in an awkward position, but what I've read in the paper is the governor—if that's what he or she is called—of the European Central Bank saying, we know Europe best. I presume there's a policy rationale beyond that in their being reluctant to reduce interest rates.

• 1710

I wonder if you could comment on that and what the implications are of how the Europeans go with their interest rates.

Mr. David Dodge: Mr. Cullen, let me start by reminding everybody that the European rate is at 4.75%, we're at 4.75%, and the Americans are at 4.5%. So we're not very far apart in terms of levels right now. That's number one.

Number two, the European Central Bank and the governors who are the heads of the country banks say, first, they have inflationary pressures. Indeed, inflation is moving up in Europe rather than down, in part because they have some really bad structural problems that they haven't gotten after as fast as they themselves say they should have.

So what they would say is, look, with inflation at around 3% and interest rates at 4.75%—certainly they've moved down 25 points, or maybe 50 points, but we're talking about a real rate of 1.5 points—by European standards, that's actually a fairly low real interest rate. So don't look to us, the European Central Bank, to bail out governments for not having taken the appropriate structural measures to get more efficient. We'll do a little bit, but we need to work with all the measures in order to get there.

That's how Mr. Duisenberg would reply to you if he were here.

Mr. Roy Cullen: Without putting you on the spot, do you think that's a cogent argument? Does it make sense?

Mr. David Dodge: Look, I'm not in a real position to try to second-guess the Europeans. I think what is true is that the Europeans have a responsibility that goes beyond just little Europe, so to speak. They have a responsibility to the world, just as we're saying the Americans do. Whether it's necessarily monetary policy that is the key lever they want to use in order to try to promote stronger growth, in particular in Germany....

You know, France has actually been performing very well. It's the big engine in Germany that has been in low gear. That's up to them, but please, Europeans, don't neglect the fact that you're an important player in the world and have a responsibility.

Mr. Roy Cullen: Thank you.

If I could jump to savings rates and consumer debt in Canada, could you compare the trends in Canada versus the rest of the world and what the implications are in terms of policy-making at the Bank of Canada or fiscal policy-making by the Government of Canada?

In that discussion, if you look at the United States economy, you often hear that the strength of the economy is consumer spending. The savings rate is low, which must have some relationship to investment, although there has been strong investment in the United States in terms of capital spending, as I understand it. So how do you square that circle, and what are the trends in Canada in these two areas? Is it something we should be concerned about, and what can we do about it, if it is?

Mr. Malcolm Knight: Maybe I could respond to that.

If you look at the United States, for example, there has been a very sharp decline in the household saving rate over a large number of years. In fact, the household saving rate right now is negative. It's partly an effect of high stock market valuations and the higher wealth that has resulted from it in recent years, which now is dissipating. So the private household sector isn't contributing to U.S. savings.

But in the United States, because of relatively high earnings in recent years, corporate sector savings have risen, and of course, government dissaving has declined very markedly with the bringing down of the fiscal deficit.

• 1715

So aggregate saving in the United States—total national saving, as it's called—is somewhat lower as a proportion of GDP than it is in Canada. It has remained stable. Investment has been higher than that, and that is why the U.S. economy, even though it is the most wealthy economy in the world, has relied very heavily on foreign savings in recent years. This is one of the issues that arises in the whole question of the adjustment process for the U.S. dollar over the longer term.

If we look at Canada, I don't think we see quite the same trends. Basically, I would say the financial condition of the household sector in Canada is financially stronger than in the United States. We have seen a rise since 1992 in the ratio of household indebtedness to disposable income. But over that period we've also seen a rise in household net worth to disposable income, and we've seen a fall in households' debt service requirements as a proportion of their disposable incomes. So the average household is spending less servicing its debt even though its debt is higher than it was in 1992. That's because the policy of maintaining low and stable inflation ultimately results in low interest rates.

As far as total savings are concerned in Canada, household saving rates haven't fallen as much as they have in the United States. Corporate and government saving is also high. So that is financing investment and actually resulting in a current account surplus.

The Chair: Thank you, Mr. Cullen.

Mr. Pillitteri.

Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you, Mr. Chairman.

Mr. Dodge, again, congratulations, as has been offered by all my colleagues here.

Last week I was at a function, and somebody made the remark that all we need in Canada is another Greenspan. My response was, it is precisely people like you—money managers—who, when they haven't the ability to know where to invest, run to the American dollar and therefore bring down the value of the Canadian dollar.

My question to you is a bit different. Being a businessman, sometimes we like to deal, as we have in the past, in short-term rather than long-term loans, being that, for the past five or six years, short-term loans have been about 1.5% lower than those in the United States. Of course, low interest rates have benefited us immensely, and now we're looking at how we're doing in the investment sector. We investors have been quite successful in that.

Now, all of a sudden, the tables have turned on us in the fact that it had no real effect on the value of the Canadian dollar. By having that 1.5% lower interest rate than the United States in short-term loans, the fluctuation of the dollar really didn't mean that much. I think we've maintained it within the 64¢ to 67¢ range.

All of a sudden you say we need more room to manoeuvre, and there is a difference of about 1.25% now. We were 1.5% lower, and now they're 0.25% lower than we are in Canada. How long do you think this trend is going to continue, or when do we go back to that?

As an individual right now, it costs me, or any businessman in Canada, 1% more compared to the United States. That means in competition, in some way, they have a little more advantage than we do. How long do you think this trend is going to continue in trying to have higher interest rates than those of the United States in the short term?

Mr. David Dodge: We are trying to set rates such that the Canadian economy marches along at about potential without creating any inflationary pressures upward or without having such downward pressure on prices. That's what we're trying to do.

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That's not precisely how the Americans go about it, but in the end we're not in fact operating all that differently, and our approximate targets are the same.

If indeed we find, as I said in my remarks, that in the latter part of 2002 we actually have been successful and that we have both the American and the Canadian economies growing at a rate at or above potential, then there will be upward pressure on prices and we will be moving rates up, as will the Americans.

I can't tell you who will move faster, who will move farther, who will move first, or who will move second because what we're really trying to do is to look at the performance of the economies. It may well be that we will move ours up first because we will start to grow faster and get more pressures than they do. That would probably be the case if we really got ourselves into an energy boom, if we had rather stronger, non-energy commodity prices, and if we continued to have good performance in the manufacturing sector.

We are trying to do things to maintain that inflation target, and if we're going really strongly, then you can expect that we will have to react down the line by pushing rates up. If we're growing really strongly, well over the Americans' rate, we'll go up earlier than they will.

The Chair: Thank you.

Mr. Gary Pillitteri: I want to follow up here. Mr. Dodge, in the last couple of months we have seen that they were anticipating a real slowdown in the American market. That has now materialized in the second quarter. The slowdown is not by as much as anticipated. They were looking at something from zero growth to 2% growth, and now they've adjusted those rates, foreseeing stronger growth. Our growth is still stronger than theirs. I have not seen anything.... Don't you think we could move faster on that, the trend of lowering interest rates?

Mr. David Dodge: We're all struggling, and it would be very nice to have an absolutely perfect crystal ball. You will recall that a lot of people criticized us last February when we said we thought growth wasn't going to be quite as weak as a lot of doomsayers were predicting—

Mr. Gary Pillitteri: That's the other side.

Mr. David Dodge: —and that our economy would recover earlier and a bit more strongly. Indeed, I would say that we haven't changed our forecast very much. Clearly we had to adjust it because the results of the fourth quarter turned out to be worse than had been thought. Mechanically, we had to make that adjustment.

In February, we said we thought we were at about three; we're now saying two to three, which has a centre point of two and a half. Four-tenths of that is simply the mechanical adjustment because we had a lower number in December.

We really haven't changed our view very much, but look, numbers are going to move around. There are going to be weeks when everybody is going to be tremendously optimistic and weeks when they're going to be pessimistic, when you get a bad number. We have to try to look through that. Our view is still that we are going to start to have reasonable performance—not great, but reasonable performance—in the second half of this year. In 2002 we should be back to pretty good performance.

The Chair: Thank you.

Mr. David Dodge: That's the best I can say to you.

Mr. Gary Pillitteri: I have one more thing, Mr. Chairman.

Mr. Dodge, you stated that the foreign debt is going lower. You mentioned 38%. I understood that. It was combined federal and provincial debt at one time.

Mr. David Dodge: That's counting all debt. That's net national debt.

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Mr. Gary Pillitteri: It has gone down in total, including federal and provincial debt, by about 24%, as you stated.

Mr. David Dodge: Right. It's gone down in part because there's less government debt held by foreigners and in part because Canadians own more foreign assets than they did. The net indebtedness has fallen, and that's a very good thing.

Mr. Gary Pillitteri: Thank you.

The Chair: Governor, thank you very much.

Before you leave, I just have one final question.

One of the interests of this committee and a personal interest of mine is the issue of productivity. I personally think productivity is the number one issue in this country, by the way. I often wonder why it was that in the 1980s we were so slow to adapt to changes while the Americans were making great investments in capital machinery and taking productivity enhancement measures. Why does a businessperson residing in Canada not do that when an American does? Have you looked into that at all?

Mr. David Dodge: I'm not sure my opinion is worth any more than anybody else's, but there are three things I would say here.

First of all, the major technological changes we were getting in the late 1980s and through the 1990s really lent themselves by their very nature to small startup enterprises coming in and doing very interesting things. It was the nature of what was going on. The Americans have historically been very adept at that, perhaps more adept than we have been.

What you do observe, however, is that they have not been quite so adept at some of the bigger sorts of things—for example, if you look at California with regard to energy, and so on. We have historically tended to be actually quite adept at the big project stuff, so it may have been a case of timing and what the technology was.

Second, going back to the issue we talked about earlier, they do have more efficient capital markets, and that certainly has helped.

Finally, they didn't get themselves into quite as bad a fiscal position and so didn't have to spend quite the energy we spent to dig ourselves out of a really serious problem.

In the end, however, one has to admire their entrepreneurialism and really hope that we're going to come back and regain that entrepreneurial spirit, which we have had a number of times in our history.

The Chair: Yes. Thank you very much, Governor.

Another area I think the committee will probably be interested in—I haven't asked them yet, but I think they will—is the whole area of North American integration. One day, if you're willing to appear before us, we would certainly be interested in getting the bank's point of view on this particular—

Mr. David Dodge: We look forward to doing that, Mr. Chairman. I hope we can come back very shortly after our November report so we can go through that, and we'll deal with those questions then. I really look forward to that, and I hope we'll be able to have you over to the bank.

The Chair: Thank you.

The meeting is adjourned.

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