Good afternoon, Mr. Chairman and committee members. Senior Deputy Governor Wilkins and I are pleased to be with you today to discuss the bank's monetary policy report, which we published just last week.
At the time of our last appearance in October, we saw signs that the Canadian economy was moderating after an exceptionally strong first half of the year. Now that moderation turned out to be greater and to last a bit longer than we expected at the time. Still, it's important to recognize that inflation is on target and that the economy is operating close to potential.
Now that statement alone underscores the considerable progress seen in the economy over the past year. The slower than expected growth in the first quarter just passed reflected two main issues.
First, housing markets reacted to announcements of new mortgage guidelines and other policy measures by pulling forward some transactions into the fourth quarter of last year. That led to a slowdown in the first quarter that should naturally reverse.
Second, we saw weaker than expected exports during the first quarter. This weakness was caused in large part by various transportation bottlenecks. Some of this export weakness should also reverse as the year goes on. So, after a lacklustre start to 2018, we project a strong rebound in the second quarter. All told, we expect that the economy will grow by 2% this year, and at a rate slightly above its potential growth rate over the next three years, supported by both monetary and fiscal policies.
The composition of growth should shift over the period, with a decline in the contribution from household spending and a larger contribution from business investments and exports.
Inflation should remain somewhat above the 2% target this year, boosted by temporary factors. These factors include higher gasoline prices and increases to the minimum wage in some provinces. Their impact should naturally unwind over time, returning inflation to 2% in 2019.
Of course, this outlook is subject to several important risks, and a number of key uncertainties continue to cloud the future, as was the case in October.
The four main uncertainties around the outlook for inflation are the same as we mentioned six months ago, but good progress has been made on some of them.
First, in terms of economic potential, our annual review led us to conclude that the economy currently has more capacity than we previously thought. As well, this capacity is growing at a faster pace than we expected. This means that we have a little more room for economic demand to grow before inflationary pressures start to build. That said, some firms, particularly exporters, are operating at their capacity limits, but are hesitating to invest. This hesitation may be due to trade uncertainty, the transportation bottlenecks, shortages of skilled workers, or other reasons. Regardless, it is limiting growth of our exports and economic capacity.
The second source of uncertainty concerns the dynamics of inflation. Here, recent data have been reassuring. Inflation measures, including our various core measures, have been behaving very much as forecast, and they are consistent with an economy that is operating with very little slack. This gives us increased confidence that our inflation models are working well.
The third area of uncertainty concerns wages, and the data here are also all encouraging. Wage growth has picked up significantly over the past 18 months. It is now approaching the 3% growth rate that one would expect from an economy that's running at capacity. However, the most recent figures are being boosted temporarily by the minimum wage increases in some provinces.
The fourth source of uncertainty is the increased sensitivity of the economy to higher interest rates, given elevated levels of household debt. The concern is that as interest rates rise, the share of household income going to service debt will also rise. This will leave less to spend on other goods and services and put downward pressure on inflation. It will take more time for us to assess this issue, particularly because new mortgage guidelines are currently affecting the housing market and mortgage lending. However, the growth of household borrowing is slowing, which is consistent with the idea that consumers are starting to adjust to higher interest rates and new mortgage rules.
As you can see, there has been some progress on these four key areas of uncertainty in the economy, particularly the dynamics of inflation and wage growth. This progress reinforces our view that higher interest rates will be warranted over time, although some degree of monetary policy accommodation will likely still be needed to keep inflation on target. The bank will continue to monitor the economy's sensitivity to interest rate movements and the evolution of economic capacity. In this context, the governing council will remain cautious with respect to future policy adjustments, guided by incoming data.
With that, Mr. Chairman, Senior Deputy Governor Wilkins and I would be happy to answer your questions.
Thank you for the question.
A number of factors are currently impacting the housing market, namely monetary policies and higher interest rates, as you mentioned.
Obviously, interest rate increases go hand in hand with mortgage rate increases. As people start to feel the effects of the increases, their capacity to purchase a first home or enter the housing market will become limited. The increases will also influence the decisions of those looking to purchase a larger home.
This is something we can capture in our modelling. The housing market can clearly support higher interest rates. The new mortgage lending guidelines seem to be having an effect as well. They basically serve as a stress test for borrowers. It's important to make sure borrowers are able to handle higher interest rates.
The data show that, prior to the guidelines coming into effect on January 1 of this year, people decided to purchase a home during the fourth quarter of last year to avoid being subject to the guidelines. That led to a slowdown in the first quarter of this year, as resale housing data show. Right now, we're trying to figure out just how temporary that effect is. The data show that resales peaked in March. According to our projections, the housing market should start to pick up in the second quarter. As far as household debt is concerned, our hope is that a more favourable composition will emerge as the economy begins to reflect the impact of these guidelines.
That comes back to the most important issue, which I mentioned earlier. We are certain that the economy is more sensitive than before to interest rate fluctuations, and that is due to the level of household debt. In the fall, we re-evaluated our model and found the economy to be about 50% more sensitive than before to interest rate fluctuations. It's important that the impact be symmetrical, meaning, that the economy needs to be just as sensitive to interest rate reductions, since changes in monetary flows will work both ways.
That said, it's an issue we examine. Every month, in Newfoundland and Labrador, we check the data to determine whether the state of affairs is more or less in line with our modelling projections. As Ms. Wilkins mentioned, the situation is a bit complicated because we've made other changes at the same time. We'll probably have to wait a few months before we are able to define the key changes. Basically, the economy is just as sensitive, if not more, than it was before, and that could yield the same effect as in the past. The impact, however, could also be more significant. That is the current situation.
That sounds like a fairly straightforward question, but it's not. Our focus there, as you mention, is that the lower net price received by Canadian producers of new oil from the oil sands in particular, heavy oil, is a factor that is constraining investment in new projects in that particular sector. For us, for forward-looking purposes, that's the most important channel of effect.
The question about the gap between WCS and WTI and the effect it's having on the economy has a lot of complicated calculations in it. Not all of Canadian oil production, of course, is paid that price. Some of it is already committed on a pipeline. Other companies have a full upstream and downstream system so aren't hit by the same issue. As well, part of the premium is paid to the transportation companies, so some of that money stays in Canada.
It's very hard to isolate that number. It's not that important to us in the sense of how to make a forecast. It's important that GDP is what it is. The question is, how will it grow from here? In that case, we believe that investment in that sector will remain flat in our forecast because, of course, one of our assumptions is that oil prices stay constant in our forecast.
Yes. Just to put that assessment in context, the assessment is really done so that we can figure out how much it's going to affect GDP. Okay? We need to know that to forecast inflation, so the assessment is really an estimate, a rough estimate.
The way we calculate that is to look at the prior year. In that case, it would have been the year before. For this particular change, it's the prior year as well. We calculate, if the profile of the people who applied for mortgages was exactly the same, how many wouldn't have met it. What we find in the work we published in our November 2017 FSR is that about 10% of uninsured borrowers would have failed the test. Many of those would have been in Toronto and Vancouver. It's not surprising, because that's where house prices are the highest on average.
That doesn't mean that all those borrowers would no longer buy a house. What they could do is decide to wait a bit and then buy a house once they've saved more, or they could decide instead to buy a less expensive house; that's what we need to wait and see for these current changes. What we noticed from the changes from a year ago that were acting on the insured space was that about half of the people who didn't qualify decided to just wait a really long time and not buy a house for a while. The other half decided to adjust and purchase a less expensive house.
Thank you, Governor and Deputy Governor. I appreciate your being here today.
I want to continue the questions around the impacts on housing of a rise in interest rates, particularly variable interest rates, because they're going up. People in some areas of the country.... You mentioned Toronto and the Lower Mainland. I can tell you, as a Lower Mainland B.C. MP, that the housing crisis is profoundly acute and the difficulties people are experiencing are monumental. We have pensioners who have paid into pensions for their entire lives who can no longer afford housing. As the deputy governor mentioned, there are a number of factors, including a problem of supply. We simply haven't been building affordable housing for decades, and with that it has all come to a crisis.
My first question is around the impacts of monetary policy and the rise in interest rates. With your model, do you also look at the number of bankruptcies and foreclosures that come from every quarter-point rise in interest rates? Is that part of the overall model?
We have access to very granular data on household borrowing, on mortgages. We're able to model this quite closely. Where we begin to get more uncertainty in the picture is with how people actually respond. We can do the arithmetic on it, but the economics are more complex, because it concerns behaviour. For instance, as Ms. Wilkins said, we have people deciding to buy a smaller house. It still comes up as a sale, yet they managed to meet the criteria, and there are others who delay, and so on.
It's in the behavioural differences where the more statistical, historical modelling comes into play and where you have a zone of uncertainty around those kinds of predictions. It's why we can't be so definitive about how the thing unfolds. As it unfolds this year, we have three things happening at once. It's going to take more than a few data points to be able to figure out how much is due to the revised B-20 guideline, how much is just due to higher interest rates, and how much is just that pull forward and then the return to quasi-normal.
I accept your point that it is a difficult situation for people. As for the price level of housing, none of these things we've talked about are aimed at somehow controlling the price of housing. They're aimed at improving the sustainability of debt so that our financial system is less at risk. The price of housing is fundamentally driven by demand and supply, and the biggest thing there is that we have strong demand and relatively weak supply.
I think you can be confident that we look at the micro-data, the segregated data, when we try to understand what the interest rate effect is, because the distribution of who is indebted and what kind of assets they have really matters. It matters to the macroeconomic outlook. We've tried to do that in our model changes.
What we also look at in the context of the financial system review are scenarios where it's not just interest rate increases that are happening; it's also perhaps a context in which instead of interest rate increases you end up with a spike in unemployment and things like that. It's there that you see other reactions such as defaults and arrears that would have stronger macroeconomic impacts. According to our modelling, the kinds of interest rate increases we look at in a cycle like this one don't have enough of a reaction in arrears and bankruptcies to create a macroeconomic issue.
That's not to say we don't take it into account, but it's just not big enough. It's really in the tail event, a recessionary situation, or something like that where you would see a remarkable aggregate increase in arrears. That doesn't mean it's not difficult for individuals who are facing that situation. It's just that when you're targeting inflation, it's something that we take into account, but it's not driving the results.
Thank you, Mr. Chair, and welcome, Governor and Senior Deputy Governor.
Obviously, this afternoon our thoughts are with the folks back in Toronto, after the incident that happened earlier today. Our thoughts and prayers are with them, and our thanks go out to our first responders.
Going to the subject at hand, Governor, I thank you for your introductory comments. You commented on the considerable progress the economy has seen over the past two years; the wage growth that's circa around 3%, which is great; and the pace of household growth, which is slowing year-to-year, which is a healthy indicator. I don't think you can binge, if I can use that word, on credit for too long. You need to do that.
There was a correction in the housing market as a result of the corrective measures we have undertaken and OSFI undertook with B-20 and B-21. In the April monetary policy report you increased our potential growth rate in Canada.
As an economist myself, what would cause a central bank to increase a country or nation's potential growth rate?
We don't do that ourselves, but we are acknowledging that the economy's potential has evolved in a positive way since one year ago. We do a full job on that only once a year, in the springtime, for our April MPR.
What we need to take into account, then, are the latest long-term data from StatsCan, which are published late in the year and give the historical revisions. The last historical revision raised estimates of investment quite a lot back in 2014, 2015, and 2016. That means that Canada has been operating with a higher capital stock than we believed before and, therefore, potential output has been higher. Furthermore, its growth rate is slightly higher. That, of course, is good news.
We speculated the last time we were here that as the economy reaches its level of capacity, investment would begin to pick up more and build more capacity. That is happening too, but, as I indicated, less than we would otherwise expect, because of the uncertainty companies face, particularly around NAFTA.
My second question refers to the labour market.
As I often go around the riding that I'm blessed to represent, a number of employers have remarked on labour vacancies and the difficulty of finding labour. On page 13 of the April monetary policy report, it says that job vacancies have risen by nearly 25% in the past year, with 470,000 job vacancies from coast to coast to coast. There's a little catch-22 there, in the sense that the Bank of Canada has identified that we still have a long-term unemployment rate issue.
I want to make this plug. One of the measures we brought in the budget was the Canada workers benefit, which hopefully will pull more folks into the labour force.
With the idea of wage growth following-in, could you talk about how we can continue to attempt to attract people to enter the labour force, whether they are retired or have taken themselves out, and how important that is to increasing our potential output even more?
One question I had is on the business loan survey that came out, I think, last week. The “Business Outlook Survey”, I think it's called, is an indicator I looked at. It seemed pretty robust. The overnight rate is at 1¼% versus where it was even in 2010 at above 4%. When inflation came in at 2.3%, you identified some transitory factors in play. It was the highest rate in four years, I believe, on a year-over-year measurement.
Should we be worried about inflation, especially on the wage side, but also on the cost side at all? Rates have been low for a very long time, since the financial crisis in 2008. We see U.S. yields now backing up to around 3%.
Should we be concerned, Governor and Senior Deputy Governor?
No. Our forecast is for inflation to be 2% in the window that we have some influence over, which is 18 months to two years from now. Over this year, it will be above 2% because of the short-term factors that we've identified, primarily energy costs. Those things will come out in a year-over-year basis by the end of next year.
As it connects to your previous question, what we're really watching is the pickup in wages as those job vacancies continue to grow. As wages pick up, this will encourage more people to re-enter the workforce.
We are just now, in the last six months, reaching wage movements that are positive in real terms—above 2%. That's an important bridge to cross. As we said, when we get up into the 2.5% to 3% zone, then we have more scope for getting faster reintegration of people back into the workforce.
That's correct. There are, and Canada is taking advantage. I'm quite certain that our export growth is higher today than it would be without those extra opportunities. However, it's still a little on the lacklustre side because of our uncertainty around our principal trade partner. These are as you call them, “green shoots”. These are promising changes.
In some sectors, we're doing quite well, especially in IT services, transportation services, and tourism, which are the fastest-growing areas of our economy, and goods sectors, things like aerospace, heavy trucks, machinery and equipment. So we have encouraging effects. I'm hopeful that when we get past the bottlenecks we saw during the wintertime, we will get some clearing of inventory out. Exports will rebound, and we will feel more comfortable of our baseline.
I also want to thank the governor and the deputy governor for being here today, and the work you do for Canadians every day.
Governor, during the pre-budget consultations that we did across the country, there were concerns around NAFTA and competitiveness. I certainly appreciate members raising the need to continue to open up free trade market access for Canadian producers. The challenge, as you know, is that we may be able to open up new markets, but if we do not have competitive products at a competitive price, then we may not be able to succeed in the world.
In the report, on page 19, you mentioned concerns around being able to access global growth in areas like trade specifically because of competitiveness. Is investment going to the United States instead of here, and what steps can we take, as parliamentarians, to encourage the government to do what it can to encourage more investment in this country?
Our primary source on questions like these is our BOS, our business outlook survey, which is quarterly and quite thorough. Companies for quite some time have been talking about the uncertainty around NAFTA giving them pause in their investment decisions. A pause is one thing; another is a step further, where in a handful of cases, companies that straddle the border and have capacity on both sides of the border may be focusing more of their attention on their U.S. presence because of that uncertainty. It's very early days for this because these are long-term decisions.
Nevertheless, as we say, there are competitiveness challenges, which are, by the way, not actually that new. They've been with us for quite some time. They are often spoken about by the companies we talk to. Their investment, in fact, is doing all right but we think would be stronger without that uncertainty around NAFTA. The sooner it becomes clearer to people, I think, the better it will be for business decision-making
In terms of what happens to other sources of competitiveness, those are obviously very structural things in the Canadian economy, such as energy costs or regulatory burdens. Those are other things that companies mention to us.
Do you want to add something?
To the presenters here today, I'm very impressed, as always, that you're able to take a snapshot of where we're going as a country and how well we're doing.
In the north, we've been very happy to see the number of investments being made in infrastructure, housing, and other things, which have really helped us move forward. That includes transportation. However, until we get certainty in our land claims and self-government for our indigenous peoples, and further investment to lower the cost of transportation infrastructure, we will continue to be challenged. We're probably not growing quite as fast as the rest of the country, but it's good to see that the country is doing well.
In your opening comments, you admitted that things were not going as you had forecast. In your first paragraph, you said that some things are taking longer, and in another place, you said that the capacity is growing faster than you expected. I guess it's a hard read at the best of times.
I want to ask if you could elaborate more on the measures in this year's budget that are really leading to the improved economic outlook. Could you tell me that first?
The reason I'm asking is that we always assume that deficit spending is stimulative in nature, but we forget sometimes that this money came from somewhere and that if it weren't lent to and then spent by government, it would have been invested somewhere else. Perhaps it would have been invested elsewhere in the world, but with home bias. Probably a large share of it would have been invested here.
I know that, for example, in the Israeli context, one of the great stimuli of the start-up nation, as it's called, was that the government just stopped borrowing so much money. Pre-institutional investors couldn't get 6%, 7%, or 8% by simply buying government bonds. They actually had to invest in productive assets. That's one of the reasons there is an enormous tech boom in that country.
Have you thought at all about the substitution effect of lending to governments?
I won't pass a judgment on that.
One thing that we have talked about, and I've talked about myself, is the question of what different mixes of fiscal and monetary policy do. If the economy is facing shocks—which we have, of course, and not just shocks, but the legacy of those shocks—it means that the economy is like riding a bike up a hill. It's hard work to get up the hill. In that context, some form of stimulative policy is advisable in order to get the economy back to its potential.
While monetary policy does it through interest rates, it's the household sector that does most of the borrowing for houses and cars, etc. If it's the government that provides the extra stimulus, then it's the government that does the extra borrowing. You can picture two stocks of debt: fiscal debt and household debt. You face a choice by choosing a mix between the policies about who is actually doing the borrowing. Over the past ten years for us, it's been mostly a matter of households, and we have a household debt problem, which is well known.
Thank you to both of you for your wonderful presentations.
I have two questions. The first is tying productivity labour market and immigration. My riding of Davenport in downtown west Toronto has a lot of people in the building trades. Consequently, I get a lot of employers in construction saying to me, “Julie, it's wonderful that we have so much investment in infrastructure and affordable housing, but we have a great number of vacancies that we are just not able to fill.” I'm going to follow up my colleague's comments about the 470,000 vacancies. I wonder whether or not you're able to break down that 470,000 between skilled workers and maybe highly skilled workers, etc. That's part one of my question.
Second, I read from a very credible source that a lot of Canada's productivity has come from immigration. I want to know whether that's true and whether our current immigration levels are right in order for us to continue to support growth here in Canada. If we're not able to fill the 470,000 vacancies, what will the impact be on our economy?
Those are a lot of interesting questions.
Companies are telling us is that the vast majority of vacancies are for skilled workers, and it's the lack of supply of workers with the appropriate skills that is causing that to be the case. As I said before, it's possible that it can be a geographic imbalance. We could have pockets of very skilled workers still in oil-producing provinces—Alberta, in particular—who have not moved to where the jobs are. This, of course, can be one of the reasons.
It sounds to me that it's become more general. If we look to where the growth has been, the highest growth rate and job creation has been in IT services—financial firms with 600 or 700 IT workers in them, whereas it was 200 before. There's been really big growth, and these are, of course, very high-skilled, very well-paying jobs. It may just take longer for the supply of workers to meet that demand.
One of the solutions, as you suggest, is immigration. Immigration levels, of course, are higher than they were before, and everybody knows where there are skills shortages in the market, and so there's a guidance thing that's happening there. I'm not sure what you mean by productivity from immigration, but in terms of how much our potential output is growing, it's true that a lot of our workforce growth is coming from immigration. It is very important to our growth and potential. There also tends to be a higher percentage of entrepreneurs among immigrants. They start their own businesses, etc.
That's all I have in terms of big statistics, if you like. I really couldn't comment specifically on your hypothesis.
Since the first vice-chair had to leave, I'm going to take over, as the second vice-chair.
It being the NDP's turn to ask questions, I'll ask my questions from this seat.
Thank you very much, Governor.
I wanted to come to the issue of wage growth and the overall family debt load, which you noted a number of times in your presentation. I thought that two of most interesting graphs in monetary policy report dealt with the following. Number one, in the English version on page 13, it speaks of wage growth, which appears to be just shy of 3%. Second, it then looks at slowing household credit growth, which continues to be remarkably higher than wage growth. I think that continues to be the dynamic we've seen in this country over the last decade or so, with family debt at profoundly record levels, but wage growth not in any way seeming to compensate for that high level of family debt. Despite the fact that household credit growth is slowing and wage growth is increasing, we're still seeing a worrisome gap, I would assume, between the level of family debt and overall wage growth. I'm wondering if you could comment on that overall.
What we are seeing is a firming of wages, and as the governor explained earlier, it's a product of a labour market that is growing, and it's more in line, although still a little bit less than one would expect, given where we are in the business cycle.
You're right that what we've seen over the past few quarters is a continued slight uptick of household indebtedness as a relationship to disposable income, which is a function of both wages and the number of hours that people are working.
We don't just look at wages; we also need to look at hours worked, to get that number that we care about, and what we're seeing is a slowing in household credit. A lot of it is coming from the mortgages side, but there are also other forms of household debt, and that's slowing at a somewhat slower pace than labour income is increasing. But what you would expect with the economy continuing to grow is that those would become more in line, so we expect credit should continue to keep slowing, while labour income is continuing to rise.
Over time, over our projection, and over the next few years, we should observe that ratio of household debt to disposable income stabilizing.
My perception is that demand for housing remains very strong, throughout Canada, actually, not just in those markets, and therefore, the pace of construction and the jobs in construction are basically determined by the demand. The supply is the constraint that prevents it from being faster.
I think the main result of the interventions that have happened to the market itself has been to take some of the extrapolative expectations out of the market. For us, it's very unhealthy to hear people say they've got to buy a house because they're afraid of missing out. They wanted to buy one in two years but they need to do it now. And they can.
Even worse are folks who have paid down enough of their mortgage that they can then borrow enough to buy another house while it's being built and then plan to sell it when it is built. That's just to earn a return. That's speculative.
When people think there's nothing that can go wrong in that, then you know expectations have become extrapolative, and that's a very unhealthy place for people to make lifetime decisions.
In that sense, at the time I thought that could be just a temporary effect on the market, but at the same time it has an important disruptive effect on those expectations, and therefore it has a longer term positive impact.
I certainly appreciate the conversation we've been having thus far. Obviously, the bank was established to ensure price stability and stable economic growth, so, again, there have been some changes in the way the bank looks at inflation. I believe that recently there's been different way of approaching it to see what indicators better track inflation over a longer period of time. Obviously inflation is up in certain areas, and yet interest rates have not gone up.
For the people at home, could you please reiterate why the Bank of Canada made its decision the other day, and why this new method is going to benefit Canadians?
As you know, the inflation rate tends to be very variable. It's influenced by many short-term things. We're always looking for a better way to filter out those variations, especially since, as a policy-maker, I know that we can only affect inflation 18 months to two years from now. It's our forecast of where it will be two years from now that determines whether or not we need to do something now. We have to see through all the noise and the data, so we created some core measures, which were intended to strip out the noise, and we published them and said we're going to follow them, and they promptly fell well below two per cent and, of course, gave rise to concern that maybe our modelling was off.
So we did a lot of extra modelling over the past 18 months or so, and sure enough, as expected, those measures have converged very close to two per cent over the last six to eight months. That has confirmed for us that we have the right models and the right framework. That means our forecast for inflation, which two years from now is two per cent—exactly on target, or within 0.1 per cent of target—is well within the range of one per cent to three per cent. This means, given what our outlook is, that we have monetary conditions roughly where they should be. In that context, the fact that inflation is rising above two per cent for now is due to temporary factors, and we can see through them. We explain that to people so they can keep their expectations firmly at two per cent, and the economy should continue to run nicely on that.
When I return to my riding, one of the benefits of being able to go home and chat with people is that I hear where they're at.
For the first time, Governor—and I'm actually going to direct this question to the deputy governor—I've had different conversations with constituents, different people with different backgrounds, about cryptocurrencies.
I do know you've made some statements recently and that there is a need to have a broader contextual look at it, not just from a Canadian viewpoint but also from an international one. You also made a distinction between a cryptocurrency itself, or what's broadly referred to as a “cryptocurrency”, and have called them “crypto assets” instead.
Could you please give an explanation to the Canadian public why you're using those terms and what, from the Bank of Canada's position, should be the proper way to start discussing these things? Many people are talking about them in terms of speculation or gambling. Some people are looking at them in terms of investments. It would be helpful to have some context for them.
It's really important that people who purchase these kinds of assets know what they're purchasing and know what an asset is. When you think of a currency, a currency is something that you can store value in; you can use it at a store to buy goods and services; and you can be reasonably sure of what the value is going to be from one day to the next, as you can with the Canadian dollar. That's why we target inflation, so that households don't need to worry about that kind of fluctuation in the value of the holdings they have.
If it's an asset, you may hold it for a variety of other reasons, as you hold other investments. You may hold it because you think you have a stake in a company. I'm thinking about an initial coin offering, on which I may earn a high return over time. I might hold something like Bitcoin, and I may hold a return on that over time as well. When you're a purchaser of that and you're a household, you need to know what kind of risk is associated with that and you need to know also that you have the same guardrails that are in place for investor protection and consumer protection with respect to other assets.
What I have been saying, as have the governor and the G20 countries, in fact, is that it's really the right time to start to put in place a regulatory structure that provides those guardrails, whether it's guardrails against anti-money laundering or terrorist financing, or just guardrails to make sure that investors know what they're getting into.
In order to do that, the best approach is for regulators and concerned parties in Canada to get together and think about how we're going to define these things, how we're going to treat them in our current regulatory environment, and also to do that internationally, because these are cross-border assets. They're being traded all over the world, so if we're not consistent across the world, then we're likely to be faced with regulatory arbitrage.
We will proceed with our next panel of witnesses.
Mr. Fréchette, the Parliamentary Budget Officer, cannot be with us today, I understand for reasons of illness, but we do have with us the deputy Parliamentary Budget Officer, Mostafa Askari. With him on the panel is Chris Matier, senior director of economic and fiscal analysis; Trevor Shaw, economic adviser and analyst; Tim Scholz, economic adviser and analyst; and Carleigh Malanik, financial analyst.
Without further ado, please begin.
Good afternoon, Mr. Chair, Mr. Vice-Chairs, and members of the committee.
Thank you for inviting us to appear before the committee to discuss our April 2018 economic and fiscal outlook. The parliamentary budget officer, or PBO, supports Parliament by providing economic and fiscal analysis to parliamentarians. Pursuant to section 79.01 of the Parliament of Canada Act, the parliamentary budget officer provides analysis “for the purposes of raising the quality of parliamentary debate and promoting greater budget transparency and accountability.” In addition, consistent with the legislated mandate of the parliamentary budget officer, our office provides economic and fiscal outlooks.
Since October there have been external and domestic policy developments that will impact the Canadian economy over the medium term. These include changes to fiscal policy in the United States, implementation of Canada's carbon pricing levy, as well as an expected fallout from ongoing NAFTA negotiations. We have incorporated into our April outlook assumptions with regard to the impact of these developments.
We project real GDP growth in Canada to average 1.7% annually over 2018 to 2022. Over the medium term, we expect the Canadian economy to rely less on consumer spending and the housing sector as business investment and exports make a greater contribution to economic growth.
Our economic outlook reflects the view that possible upside and downside outcomes are, broadly speaking, equally likely. In terms of downside risks, we now believe that the most important risk is weaker export performance. In terms of upside risks, we maintain that the most important risk is stronger household spending.
Compared with our October outlook, the projected level of nominal GDP, the broadest single measure of the tax base, is on balance unchanged, with upward revisions to GDP price levels offsetting downward revisions to real GDP.
On the fiscal side, revisions to our outlook for the Canadian economy have modest impacts on our medium-term projection of the budgetary balance. Incorporating our new projection of direct program expenses along with new year-to-date financial results contributes to reducing projected budgetary deficits on a status quo basis—that is, prior to policy actions since October 2017.
We estimate that policy actions taken since the government's 2017 fall economic statement amount to $22 billion over 2017-18 to 2022-23. These new measures more than exhaust the projected increase in fiscal room, resulting in a somewhat larger budgetary deficit compared with our October outlook.
That said, we project that budgetary deficits will decline gradually, falling to $10.6 billion in 2022-23. This projected reduction is essentially due to restrained growth in the government's operating expenses, resulting from declines in future benefits for federal employees and slight decreases in the number of federal personnel through 2019-20.
In light of the various assumptions included in our economic outlook and in the absence of other strategic measures, it is unlikely that the budget will be balanced or in surplus in the medium term. However, we estimate that, in 2020-21, there is approximately a 75% chance that the federal debt-to-GDP ratio will be below the government's anchor of 30.9%.
I would also like to draw your attention to another report we published today that provides the PBO's independent costing of 10 large revenue and spending measures announced since October 2017.
These measures are fully reflected in our April fiscal outlook. All together, PBO’s costing of these new measures is $1.4 billion higher than the government’s estimates provided in budget 2018.
My colleagues and I would be pleased to answer any questions you have on our economic and fiscal outlook or any of the parliamentary budget officer's other analyses.
Thank you to the presenters today.
I'm very happy to see the presentation here today. In your economic and fiscal outlook you analyzed the impact of the carbon pricing levy. This is a very important issue for me and the people I represent in the Northwest Territories. Climate change has been impacting us more than any other jurisdiction in Canada. We really never had the opportunity to invest in alternative energy or infrastructure that would allow us to reduce our greenhouse gas emissions. We're hoping that this program is going to do this for us. A lot of the communities I represent still have noisy generators, sometimes right in the middle of the community, running 24 hours a day every month of the year. Most of our communities are built on permafrost, which is now melting. I just came from a meeting in our coastline communities. Some of the communities are forced to now start moving houses. We have graveyards that are falling into the ocean, and many serious issues.
This is an important issue for me, but it's also an important issue for the committee because we're starting to study the measures in the budget implementation act this week. It was really interesting that you said in your analysis that it would be more beneficial for the Canadian economy and for the provinces and territories to use revenues from the levy to cut corporate or personal income taxes than to return the revenues as lump sum payments to households. Could you explain how you arrived at that and why it would be better to do in that fashion?
I want to thank all of the public servants who are here today to help us better understand the reports.
I would like to start where Mr. McLeod left off. Some on this committee may remember that we actually had all three premiers of the territories, either in person or through teleconference, comment on the carbon tax. I specifically remember the testimony of the Premier of Nunavut, who stated that 80% of the costs of diesel are subsidized by the government. I asked him how a carbon tax would work under that kind of system, because most of the money was being recycled from the government's own revenue. He said he imagined that it didn't work.
I want to state categorically for the record that I believe that the Northwest Territories as well as Nunavut...I guess Yukon already has instituted its own carbon tax. But the territories that are not in favour, those premiers, I believe we should be exempting. I think we should be working with members of Parliament to remove diesel through other means.
Anyway, I'll come right to the same question. The report on page 8 says specifically that “we assume that federal revenues returned to provinces and territories will be transferred to households as lump-sum payments.”
Were you unable to get any kind of indication from the government as to whether or not it will be a tax-and-dividend-like system? You mentioned earlier that the preference would be through a decrease in income taxes, whether corporate or personal. Could you go over that, please?
I do hope there's some follow-up on that, and that this is looked at specifically, because many people would be surprised to know that we see this number dropping because of the decrease in labour participation, rather than because of other factors that some government members have spoken about.
On page 7 it states that “We also expect that the Federal Reserve will increase its policy rate at a faster pace over 2018 to 2019 than we projected in October.” I believe it was last year that I tried to talk to the regard rising interest rates of bonds.
Right now a lot of people are looking to invest in the United States versus other places. Obviously, Canada has a very strong process for foreign bondholders, for example, or even for domestic investing in the notes of the Government of Canada.
Will this mean that we will have to pay higher interest rates down the road to attract those bonds?
I'm afraid not, you have exhausted your time.
On the same question, I do note that in the report the interest expense of the Government of Canada by 2022 rises to $39.1 billion from last year's $24 billion. This is a $15 billion increase, which is roughly a two-thirds increase, in the cost of interest to the Government of Canada. It's also significantly higher than the government anticipated in its recent budget.
For 2022, interest expenses were supposed to be $32 billion, so the gap between the two is $7 billion, or over 20%, and you're only about a month apart in making your projections.
Why is there such a difference between the government's projection and your projection?
I'd like to point out that the biggest difference between our point of view for the budget balance in 2018-19—so the current fiscal year—and the figures published in budget 2018 is that line in operating and capital expenses. This report marks the first time that our office has actually published its own independent projection for the operating and capital expense components of direct program spending.
You'll see that, earlier in the report, on page 21 of the English version, we provide a breakdown of exactly how we construct our estimate of the operating and capital components of DPE. You'll see that in 2018-19, there's considerable growth in expenses attributed to future and other benefits. These benefits include future benefits for veterans, payments for pensions, etc. They're highly sensitive to interest rates. Interest rates over the past eight or 10 years have been declining, and the relationship between future benefits and the interest rates is inverse. As interest rates fall, the expenses attributed to future and other benefits start to rise. That peaks in 2018-19, so this is—certainly as part of our direct program expense forecast—a source of cost growth.
I can't comment on whether that's consistent with estimates in budget 2018 because, unfortunately, the government does not provide a decomposition, as we do here in table 9, of its direct program expense forecast. It summarizes transfer payments and then operating and capital expenses just in two summary lines. Hopefully with table 9 we're able to depict exactly how we're putting our direct program expense forecasts together. Unfortunately, I can't compare that to the estimates of the government because that information is not public.
Thank you very much for being here. It's a very interesting and detailed report. You do a lot of work without a lot of resources. Hats off to you for all of the work that you do.
You're also heroes, I think, in the Canadian mind in that you pushed the government. It took five years to finally get from the CRA an acknowledgement that tax gap information should be shared with the Parliamentary Budget Officer. That is fight that you had to have with the former Conservative government and now with the current Liberal government. It's a fight that you never should have to go through on behalf of Canadians, but thank you for pushing the government to do the right thing and to provide that information.
My first question is really around that. The tax gap has remarkable impacts in terms of the deficits, in terms of what programs and investments we can make as a country. It's been estimated at anywhere from $10 billion to $40 billion a year. It's money that goes to overseas tax havens. It's money that wealthy and the well-connected are able to simply not pay when everyone else, tradespeople and small business people, all pay their taxes. A lot of very wealthy people don't have to. That tax gap has enormous implications.
What I'd like to know is how the PBO intends to use that information. Are you getting it now from the CRA? Have you gotten it yet? Do you have a plan laid out in terms of publishing that very important information about Canada's tax gap, about the difference between what government should have in common to invest and to support programs and job creation, and what the federal government is actually getting to make those investments because of these offshore tax havens and massive tax loopholes?
Thank you very much. We look forward to having you back before committee when you do publish that tax gap information. It's something that governments should have been providing for decades and have refused to. I again thank you, because even though you had to push the government and threaten to take them to court, you stuck to your guns. On behalf of all Canadians, thank you for that valuable work. Canadians need to know what the wealthy and the well-connected take offshore rather than investing in all of those programs that we need.
One of those programs, of course, is pharmacare. This is something that's been promised for decades. The PBO did an excellent report last fall around the federal cost of a national pharmacare program. You did very detailed work about what the overall savings are to Canadians, and I'd like you to speak to that: what we as a society spend currently for medication when one in five Canadians can't afford the medication they need, what the overall costs are, and what could be saved if we had a national pharmacare program.
Just to add a last note on this, we know that we're losing anywhere from $2 billion to $5 billion a year for the costs to our emergency rooms and our hospitals by not having a pharmacare program. In other words, somebody who can't afford their medication ends up in the hospital or in the emergency room, and it costs Canadians a lot more not to have pharmacare than it would to have pharmacare in place. I'm interested in why that wasn't calculated in terms of the PBO report on the federal cost of a national pharmacare program.
Thank you, Mr. Chair, and welcome gentlemen from the PBO.
In the projections that are used you noted the sensitivity to interest rate increases in terms of discount rates. For the last 10 years, the other side racked up a lot of debt—I think it was over $150 billion—but actually benefited because rates fell or declined quite a bit. If you look at past budgets, they always overshot what they said their interest expense number would be, because a lot of the debt that was rolling over was rolling over at much cheaper rates due to a very weak economy that the Conservatives presided over for a number of years.
Our situation is a little different. Rates are going up because the economy is doing a lot better. You guys have looked at some of those numbers. When debt, whether new or old debt, matures, and the government goes out to market, it's refinanced at a higher rate, unfortunately, but due to a very good thing because the economy is doing well, and rates are going higher.
I'm glad you also made the observation that with higher rates, the present value of future liabilities declines, so your direct program expenditures fall, which is a benefit for us. I'm very glad that the PBO has highlighted that. It's something I'm proud of because our government has worked with the unions representing those hard-working government workers who work day in and day out to serve all of our residents, whereas the prior government did not and just forced collective bargaining agreements on them.
That was my statement. My my question is on the pricing of carbon. It is a fact that each province will be allowed to do what it sees fit with funds that are collected from pricing pollution. Going to your comment in the report, if the funds, for example, are in B.C. where one of my honourable colleagues is from, those funds can be used for taxation purposes, i.e., to reduce personal and corporate tax rates. If that is done, it will largely offset any sort of impact.
Is that a fair assessment from one of the pages in the report?
There are two major fiscal developments. There is the Tax Cuts and Jobs Act that was passed into law on December 22 last year, then there was also the Bipartisan Budget Act that came into force on February 9.
For the former, with respect to the tax cuts, we've taken an estimate by the staff of the Joint Committee on Taxation and basically taken their estimated economic impact on U.S. GDP of about 0.7% over the course of our projection. Then, with respect to the Bipartisan Budget Act, we've looked at what the Congressional Budget Office has predicted in terms of additional government spending over the medium term by the U.S. We've used their fiscal multipliers, essentially meaning how much they estimate that government spending will translate into economic activity.
We've come up with two impacts on the level of U.S. real GDP. Once we had those impacts, we brought those into our Canadian macroeconometric model. We estimate that this would lift Canada's real GDP by 0.1% in 2018, which will rise by 0.25% by the end of our projection period, primarily through higher exports.
I was going to continue on the carbon tax and then talk about table 9 on page 21 again, which Mr. Shaw mentioned.
You're showing a $22-billion deficit, whereas in the previous campaign, the Liberals talked about a $6-billion deficit at this point. You have an estimation of half a GDP point loss because of the carbon tax on the economy, and in the projections you have on table 1, it shows exports are halved, post-2019. It goes from 1.5% to 0.7%, and then it's 0.7% again in 2021-22.
What other government policy measure in the past, since as many years ago as you can remember, has cost the economy, basically, half a point of GDP growth? Is there anything like it?
Yes, that's reflecting a few factors.
First of all, it's really the slowdown in foreign activity, so the U.S. demand for our exports. If you refer back to the slide, figure 4, you'll see that the U.S. economy is slowing down to about 1.8% in the medium term, so the growth in our exports would be roughly in line with the U.S. economy at that time. It's really the strong U.S. growth that's lifting it up, and then the moderation in U.S. growth that is bringing it down.
At the same time, we're seeing that some of that initial pickup in exports is coming from the dollar remaining around 77 or 76 cents, so there's still some benefit from the lower dollar.
Thank you to the PBO office.
I don't get the chance to be in this committee often, so I'll take advantage of it.
I have a riding that is a “Main Street” type of riding. It's a growing economy—Surrey Centre. We have high levels of immigration. In the just over two years that I've been the member, I've yet to have anybody come to me to say they can't find a job. It's usually been the opposite. I get employers who are asking, “How do I get more workers? I'm not getting enough.” We've noticed an increase in immigration levels, and I want to know whether that increase has had a positive impact on the economy, particularly the employment rate, as it does not appear to have any adverse effect. I want to know if there has been any analysis on the impacts of increased immigration on our economy as a whole.
I want to go back to an earlier point that Mr. Kmiec raised in regard to the fiscal framework of the government. At some point, the PBO will be asked to look at electoral platforms, etc., and I want to put it on the record one more time.
You don't have to say anything in regard to this, but we know from the last election that the government had a costed framework wherein it was going to apparently invest in infrastructure, $10 billion a year, and run for the first two years a deficit, and then a return back to balance. This, I am sure, will be the challenge. If someone doesn't honour that, then what is the point of having you investigate this in the first place and approve that those fiscal frameworks are there? That's a bit of a side note.
On page 17, you stated that “Our downward revision mainly reflects a lower estimate for direct program expenses, due in part to infrastructure spending delays, that more than offset $4.0 billion in new policy actions in 2017-18.”
Could you go through the explanation of that? I know you had a report recently that talked about the rationale for some infrastructure not being funded. Could you please give the explanation of what exactly you meant in this paragraph?
Thank you so much, Mr. Askari and your team, for being here today.
I want to start by talking a little bit about labour force participation. On page 6 you say, “The unemployment rate has continued to trend lower”. It's at 5.8%. Then you say, “This decrease, however, largely reflects a decline in labour force participation.”
When you are talking about labour force participation, is this due to the natural birth rate falling fairly rapidly, as well as our retirement rate?
I think what you're referring to is our costing exercise. We looked at the equal parenting employment insurance measure. In general—just to walk you through it—in preparation for the electoral platform costing where we will have to cost various requests from political parties, we took budget 2018 as an opportunity to undertake an exercise. We went through the budget and identified roughly 160 new measures. Then we classified these into two types. One is where the government is just saying they are going to increase spending on something or to commit dollars to a specific organization, and we determined that a cost estimate would not be required by the PBO. The other is these measures where stakeholders would be affected, some benefits going out, and things like. That's where we would need to do a cost estimate. We identified 17, and we had the capacity to undertake cost estimates of 10 of those. That's how we got down to this list of 10 budget measures that we actually included.
With respect to the labour force participation rate of women, there was a budget measure, the equal parenting employment insurance measure, where the other spouse—and the literature and information tells us this is typically the fathers—does not necessarily partake in employment insurance or share parental leave with their spouse. With this measure, because it was one that we identified, we could include it and provide a cost estimate. We did include it in the EFO, but, more generally, we don't include this gender aspect in the underlying labour force impact on the economy.
I hope that answers your question.
Thank you very much, Mr. Chair.
I want to come back to the tax gap examination that you're going to do, and force the CRA to provide information on, because the massive amount of money that goes overseas rather than serving a common purpose for Canadians to make those kinds of investments has real implications. I'm interested in two aspects of the study that you'll undertake on the tax gap. The first is whether or not you're going to come up with a figure on the real effective tax rate for large Canadian corporations. The Canadian Centre for Policy Alternatives has estimated that the effective tax rate for large, very profitable Canadian corporations is less than 10%—in fact, 9.8%. Will it be part of your study to determine to what extent these overseas tax havens and massive tax shelters are allowing some of the most profitable companies in Canada to get away without paying their fair share, which contributes to a profoundly unequal tax system?
The second aspect is the implications for the deficit. If we have this significant tax gap, is our deficit—and the additional spending or investments that we could make in people—due in fact to what has been a growing tax gap over the last few decades that neither the former government nor the current government has been willing to take on?
Those are my two questions around the tax gap study that you're doing.
Once again, I'm very grateful to the PBO for coming forward. I do appreciate the modelling exercises that you do. Over the years, you've proven to be quite accurate.
From what I understand how the Office of the PBO works, and the information you gather to make these assessments, do you rely on the same set of data that the Department of Finance would have? Let's take a look at schedule B, in terms of the economic outlook. Your modelling is different, which seems to produce different results.
For my benefit and that of Canadians, could you explain why the modelling ends up being slightly different? What variables are you placing greater weight on, or for what reasons do you feel that the great folks we have over at the Department of Finance have different results than your shop does?
Sure, I'll follow up with a little more technical detail that can address your second question.
Our projection is model-based, so we have an estimated macro-model, in conjunction with assumptions and outlooks for the U.S. economy and commodity prices. These are key inputs. This contrasts with the Department of Finance's approach, which uses a survey of 15 or so private sector forecasters to prepare its outlook. One of the key weaknesses of this approach is that it doesn't necessarily ensure consistency in the forecast. You can have divergent views on, let's say, the exchange rate and commodity prices that you wouldn't have to reconcile in a single model, which we have to do. Some forecasters may not provide an outlook for certain variables. The survey itself doesn't ensure internal consistency as a macroeconomic model would.
The last point I would make is that we did look at forecast performance and quality in a report last year, and we found that in terms of accuracy, at least for the headline macroeconomic variables such as nominal GDP, we were in line with the survey-based outlooks from the Department of Finance. But one of the key differences was that our forecasts were less biased, so that when we did make an error, it wasn't typically over- or under-predicting the economy. That's another key difference.
How do you explain that? Why are we less biased than a survey-based result? As Mostafa said, maybe it's because we're not working for a chartered bank with incentives to talk about a bullish outlook, for instance. We don't have that kind of sentiment in the background.
Picking up from where MP Fergus left off, I certainly do appreciate that. It's helpful to have competing models side by side, and then find out from Stats Canada, after the relevant data has been accumulated and we can look at it, who's closer. Certainly, I think it's good to have a variety of models, because we shouldn't just be thinking one particular way.
In regard to that, there's been a lot of discussion in the last few years about balanced budgets. Obviously, the Conservatives favour them; other parties have various views. In the report you estimate that the probability of the budget being in a balance or a surplus position in 2017, 2018, or 2019-20 is effectively nil. I appreciate that you've modelled that.
You've also talked on page 25 about the net debt-to-GDP ratio and where that might go in several years. These are the two most common references when we talk about the fiscal framework, and I understand why, because you have to start with something, and it's easy to count numbers.
What other metrics should parliamentarians be looking at? For example, that net debt-to-GDP ratio may tell one story, but again, as we know, we have a long-term demographic issue that may skew the effects in certain areas, where certain provinces are far more exposed than others. Where should we be looking to, as Wayne Gretzky used to say about the direction of a puck?
I'll start, and maybe Chris can add something.
You're aware that we do a long-term projection that we call a sustainability report. There, we look at the federal situation, and we show that on that basis, the federal government's fiscal position is actually in a very good position over a long period of time, whereas most of the provinces have some issues. That's the difference between the two levels of government.
Chris, do you want to add something?
Mr. Chris Matier: [Inaudible--Editor].
Thank you very much, Mr. Chair.
I have two quick questions to finish off.
First, I was in Alberta last summer, going to town halls and meeting with energy workers. Their question was always about why the federal government isn't providing any supports for clean energy. They see their skills as eminently transferrable, and they're absolutely right. I notice from the economic and fiscal update how miniscule the support is for clean energy by this federal government.
This is my first question—and I'll ask both. To what extent are you studying the economic impacts of substantial investments in clean energy and how that could lead to job creation in this country? If you're not looking at it, what would parliamentarians be required to do to enable you to do that? Would it take a motion through a committee, for example, finance?
My last question is on the government providing information that is relevant to your work. With the CRA you had to battle five years under the former Conservative government and the current Liberal government, and had to threaten to take them to court before the CRA and the government finally said they would provide the information on this massive tax gap and wealthy tax cheats. Is there any other information the PBO is looking for right now that the government is withholding?
Those are my two questions.
Thank you for your very valuable work on behalf of Canadians.
I think that's the time, and I have a closing question.
The reference to net debt to GDP refers only to the federal government's debt. Typically, this government has used as its anchor the federal debt-to-GDP ratio. As you point out, provinces have their own debts, and as we all know, households are extremely indebted. If the economy is a workhorse that is pulling a wagon up a hill, and that wagon has debt to pull, it's not just the federal government's debt that's in that wagon. That one horse has to carry federal and provincial debt, plus corporate debt, plus personal debt, because we only have one Canadian economy, one GDP of roughly $2 trillion.
When we're judging the ability of governments to borrow more, do you think we should consider the total debt load of the nation, rather than that of just one level of government?
Again, I think the question is focused on whether you're looking at it from a fiscal sustainability perspective, or you're looking at it in terms of economic capacity and private sector job growth. I think the question really has to be focused along those lines.
In terms of overall sustainability in the government sector, part of those high debt loads in the public sector could be captured indirectly through the risk premium that a government would have to pay in financial markets. Financial markets are aware of the government's ability to raise revenue from heavily indebted households. They will charge an additional premium, because they know that the probability of a credit risk is higher. That will be picked up through there.
Really, the signal should be coming from financial markets, and right now, at least for Canada, the Government of Canada can issue 10- or 30-year bonds at about 2.5% to 2.75%. Right now, at least from a financial-market perspective, those concerns aren't there. In contrast, the U.S. government over a similar period is facing interest rates that are probably about 50 to 60 basis points higher. There might be some concerns about both fiscal sustainability and U.S. debt levels, and maybe not so much on the household side. But those financial markets should be able to—should, I say—price that credit risk appropriately.