We need a motion to accept the committee report.
The subcommittee met on Monday, October 29. Members have a copy of the motion that was agreed to, which outlines the procedure and how we'll handle Bill . I don't think there are any additions to it. Point 2 indicated that, in relation to the pre-budget consultations, the proposed travel to San Francisco and Houston, Texas, scheduled for the fall, be postponed until a later date. Third, the order of reference to commence the study of Bill would be dealt with in early 2019.
That's the motion, and members of all parties were there.
Is there agreement on the committee report?
Some hon. members: Agreed.
The Chair: Go ahead, Mr. Sorbara.
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.
Last April, we talked about the considerable economic progress that we had seen. We explained that, after a lacklustre start to 2018, growth would rebound in the second quarter, coming in at around 2% for the rest of the year. We also said that inflation would stay somewhat above our 2% target this year, boosted by temporary factors whose impact would unwind over time, returning inflation to target in 2019.
Six months later, we have seen some very positive developments. The Canadian economy is doing very well and continues to operate near its capacity. Growth is relatively broad-based across sectors and regions. It is also more balanced, as the composition of demand shifts towards business investments and exports and away from consumption and housing.
The economy will grow at a rate slightly above its potential over our projection horizon, supported by both foreign and domestic demand and favourable financial conditions. Meanwhile, inflation is close to target after running a little higher than we expected in July and August, which was due in large part to changes in the way that Statistics Canada measures airfares. While there could be further volatility in inflation in the coming months, our core measures remain firmly around 2%.
Of course, the outlook remains subject to important risks and uncertainties. Please let me highlight two issues: trade and household indebtedness.
In April, we said that the most significant risk to our inflation outlook was the prospect of a large shift toward protectionist trade policies around the globe. We also reminded members that our forecast included the negative effect of increased uncertainty on the export and investment plans of companies. Naturally, we spent a considerable amount of time ahead of last week's interest rate decision discussing the implications of the recent U.S.-Mexico-Canada trade agreement. The USMCA is good news, because it will reduce a considerable source of uncertainty that has been holding back business investment.
We know from our latest business outlook survey, which was completed before the agreement was reached, that investment plans were already quite positive, as firms look to take advantage of a strong U.S. economy. Given the agreement, we reversed some of the markdown of our investment outlook. To be prudent, we did not remove all of it, for two reasons. First, we want to see how firms actually adjust their investment plans. Second, we know that competitiveness challenges are also weighing on investment.
Protectionist trade actions, particularly those involving the U.S. and China, were also top of mind for us, as they are already affecting the global outlook. We've incorporated in our forecast the expected effects of the tariffs imposed to date, as well as the dampening effects on confidence from threats of additional measures. All told, we estimate that this will amount to a drag on the global economy of 0.3% by the end of 2020. That is a big cost. It adds up to more than $200 billion U.S.
The U.S.-China trade issue represents a two-sided risk for Canadian monetary policy. The U.S. and China could find a path to ease or resolve this trade conflict, which would be positive for global trade and investment and for Canada. Or, the conflict could worsen, jeopardizing key global value chains. This would surely reduce long-term growth and prosperity globally, albeit with uncertain implications for inflation. For more information on the potential impact of U.S.-China trade tensions, I refer you to box 1 in our MPR.
As for household indebtedness, we've also been assessing how people are adapting to both higher interest rates and the changes to the B-20 mortgage underwriting guidelines implemented earlier this year. Box 4 in the MPR goes into some detail on the impact of these policy changes on mortgage lending.
Overall, the data tells us that households are adjusting their budgets largely as expected. We understand this can be quite difficult, particularly for those who are highly indebted. At the same time, employment and incomes continue to grow, which can help cushion that adjustment process. Further, the quality of new debt is improving and housing activity is moderating to a more sustainable level. All of this is making the economy more resilient and reducing the chances of painful outcomes for many people further down the road.
The rule changes also appear to have taken the wind out of the sails of speculators in some markets, reducing the pressure on housing affordability. While financial system vulnerabilities remain elevated, the fact that they have stabilized and edged down in a number of respects is positive.
Let me conclude by pointing out that even with last week's increase in the policy rate to 1.75%, monetary policy remains stimulative. In fact, the policy rate today is still negative in real terms—that is, once you adjust for inflation. Our estimate of the neutral rate is in a range: currently 2.5% to 3.5%. The policy rate will need to rise to neutral to achieve our inflation target.
That said, the appropriate pace of increases will depend on our assessment at each fixed announcement date of how the outlook for inflation and the related risks are evolving. In particular, we will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt, and whether strong consumer confidence builds on solid job and income growth and leads to greater-than-expected consumption. We'll also pay close attention to global trade policy developments and their implications for the inflation outlook. Again, this risk is two-sided.
With that, Mr. Chairman, Senior Deputy Governor Wilkins and I would be happy to answer your questions.
Certainly, the Canadian economy cannot sustain itself without a great deal of foreign trade. It's a question of scale. You need to have a certain amount of scale in the production in order to get the efficiency that makes you competitive in the international markets.
NAFTA, as we used to call it—now the USMCA—was a very important building block for our economy. The uncertainty about its future was causing firms to delay or in fact move investment decisions, often to the United States. Even though NAFTA never ceased to exist, and the USMCA now has been initialled or is ready for ratification, the fact of the matter is that over the last almost two years, we have already lost out because of the uncertainty it's raised.
What we were heartened by was that in our survey of companies, they were still prepared to invest, because they were operating at capacity and they needed to expand in some way. The fact that now we have that uncertainty at least partially lifted augurs well for the outlook in terms of investment and therefore presumably our capacity in job growth, productivity, and wage growth. All those things are connected down the chain. Obviously, other agreements are not really a substitute but a complement for USMCA, because they open up access in other places.
All those things I think are positive in a world where trade has become the way to do business. Tariffs are not that high in many of these cases, so they're not impediments to trade, but anything you do to make it more efficient just goes directly into that engine, which gives us growth.
I appreciate your being here and giving us your update today.
I want to touch on one of the items you mentioned in your opening comments in regard to consumer debt. You mentioned specifically the B-20 mortgage guidelines. I want to touch on those a little bit. You mentioned a couple of things. You felt it had some impact on consumer debt, but you also indicated that it had some impact on housing prices in some markets. I want to touch on both of those items a little bit further.
First, in terms of the consumer debt itself, have you looked at or studied or factored in the idea of consumer debt as a whole? In other words, you're saying that you're seeing some impact on people in terms of the mortgages. Obviously, we've heard anecdotally that maybe as much as 20% of buyers are finding it more difficult, maybe even impossible, to get into the market. Obviously, when we're talking about people getting CMHC-insured mortgages, that is something people can understand, but when we're talking about people who are putting that 20% down payment or more, and are therefore not having the mortgage insurance, are we then instead, by having the stress test....?
Have you done any studies on whether what's happening is that instead of a mortgage, they're just taking on other types of debt, maybe buying a car or whatever? Instead of actually reducing the amount of debt, are we just changing it to a different type of debt? When you're talking about a car or something like that, it's certainly not, in most cases, as good an investment as a home, for example.
I'm just curious to know whether you have looked at that and whether there's just been a shift in the type of debt rather than a complete lowering of it.
Sure. I'll get started. There's a lot in that question.
If we just start with the debt part, it's a very important question how that's evolving, because, as we said, it represents a vulnerability to the Canadian economy that we need to keep in mind. What we've seen in the actual numbers is that the debt-to-disposable income ratio, which is one of our flagship indicators, is not the only one. In fact, that stabilized and started to edge down, so credit growth and total credit growth have dropped by a lot. The growth rates have dropped by a lot, mostly because of mortgage credit, but not entirely. That's a big ship to try to turn around. It will take a while for that to come down, and it requires income growth.
I think more important is really what's going on under the hood there. It's related to the quality of new mortgage lending. There's some very interesting work that's in our monetary policy report, in one of the boxes, and in a couple of weeks we'll have a more complete study that just looks at the quality of the new mortgages that are being underwritten, after not only the most recent B-20 guidelines but the ones before, as you said, that apply to high-ratio mortgages. What we're seeing in the numbers is that the mortgages that are going to highly indebted individuals have dropped by a lot. They've dropped across the board, but mostly for those who have loan-to-income ratio of 450% and above.
Yes, that means it is more difficult for some to get into the market. You used the 20% number. There are others out there. We're seeing estimates that are very close to what we had expected. At the same time, it means that the mortgages that are being written are more likely to stand the test of time and serve those people well, because if you buy a house and later it's too difficult to handle because interest rates increase, that's an issue. Also, if you buy a house and the price of it, your equity, is at risk because house prices, at the time, were rising in the double digits in some jurisdictions and they have slowed a lot, again what that means is that the housing market is operating at a lower but more sustainable pace.
We understand it's a very difficult transition for many people—we know that—but at the same time it does set the economy on a more solid footing going forward. That means that people's jobs and people's incomes are more likely to be less volatile.
In terms of this B-20 test, though, I think it also applies when someone is renewing a mortgage, and I guess we probably haven't had much opportunity to see the impacts there yet. Certainly, we can tie people into situations where they're actually going to have to pay a greater rate for their mortgage, because what happens of course is that if they're not able to qualify under that new test, they can't move to a different lender. They can stay at the lender they're at, but have we looked at whether that's actually driven up the rates of the renewals? Obviously, if a lender knows they have that person captive now, because they're not able to move, they're probably not going to offer them the same kind of rate as they might if they were competing. Has that driven up those rates?
We're not talking about discouraging people from getting into debt they can't afford at that point. What we're talking about is someone who has put down a significant amount in a down payment and is now stuck with one lender and it's driving up the rate, therefore costing them more money, but not really having an impact on debt, of course.
Have we seen whether there's been any impact in that regard?
Thanks for being here.
I want to have you address the issue of regional variations. You mentioned in the monetary policy report a pronounced decline in house prices in certain regions.
I, of course, represent a riding in the Lower Mainland of British Columbia. Rising interest rates have provoked a lot of hardship. These are people who have a high debt ratio; there is no doubt. That's because wages have basically stagnated. We've seen a marked increase in the housing market and the price of housing.
The net impact has been.... Certainly in my area, from New Westminster and Burnaby into Vancouver, about 20,000 housing units are empty. They're being bought by speculators or offshore money. Because of higher interest rates, they are no longer available for folks who have an average salary.
Could you speak to that regional variation? I understand the overall national perspective, but in some regions of this country that increase in interest rates has a more pronounced impact than in others, because of the fact that housing prices are so high to begin with.
There's no question that affordability varies a great deal across the regions. Therefore, we get really high mortgage debt in places where houses are more expensive, especially Vancouver, but Toronto was following in Vancouver's footsteps two years ago.
At that time, we had a very strong speculative element running through both markets: bidding wars, prices rising, multiple people bidding on a thing and the price going up enormously.
The presumption was, “I can still do this because I know I'll get the mortgage.” This was one of the symptoms of a period when interest rates had been very low for a very long time. People come to count on that. Throughout that period, there were of course other changes in policies: not just the interest rates, the B-20 guideline, but also some special taxes implemented in your own area, as well as in Toronto.
Disentangling what was responsible for what is basically not really possible. We think we have a handle on how much of an effect interest rates are having. Yes, they have a bigger impact on highly indebted households. You're absolutely right, and that's what Carolyn was speaking to.
In fairness, the stress test was designed to help people understand and test themselves as to whether they could cope with what seemed like a reasonable fluctuation in interest rates, of around 200 basis points. We've now done 125 basis points since the bottom. I would think that most people who went through that stress test would be saying, “I'm glad I can pass that test now that interest rates are rising.”
We were talking about it as a good personal practice long before the rules went into place. It was obvious to everyone that interest rates had been very low and would not sustainably stay there.
Wage increases, overall, have been very modest over the last few years, and even over the last year, as we were hearing more and more from the companies that we speak to about labour shortages. We still see wage growth in the 2.3% range, which is actually quite modest for this point in a cycle, and that might be representative of many people. It's an average, so some have seen none, but others have seen a lot more.
You have to ask yourself what's happening. Why is that? Almost every country that has an advanced economy is asking itself the same question. There's no silver bullet. Clearly, the puzzle isn't as big as it might seem, because in fact wage growth before was quite a lot stronger. If you actually look at a graph of wage growth in Canada, it has picked up quite a lot over the last couple of years, but it still remains slow.
There are a couple of things going on here. More recently, wage growth may not have been that strong, because productivity growth wasn't that strong. If you're a company wondering if you can afford to pay your workers any more than you do now, even though you're short of workers, it's difficult to do that if you don't have the productivity to go with it.
Another reason is that maybe on the workers' side there are a lot of workers in the gig economy, the informal economy, and in that economy it's harder to bargain for your wage. There may be a little bit less power for people to actually get stronger wages.
When we talk to businesses.... In our forecast—you asked about that—we expect wage growth to strengthen and overall income growth—which includes not only your wage but how many hours you're working—to strengthen as well, to the 3% to 4% range. That corresponds with what companies are telling us. They say they're expecting to have to pay more to get the workers they need, and that's not just in the highest-paying jobs. That's across the board.
Yes, it's true. We've talked about this for a long time, because it was one of the characteristics of a return home that we felt was central.
During the post-crisis period, with really low interest rates, quite naturally it was housing and consumption that did most of the growing, and businesses demonstrated a reluctance to invest, given the uncertainty about the economic outlook.
We always believed that getting the economy back to a balance point would mean that consumers would take a less active role in the growth picture. They would become contributors but smaller contributors, and businesses would be doing more of the heavy lifting. That transition appears to be under way.
We think it was interrupted by the uncertainty surrounding NAFTA, so we had a double hit there, because we were approaching capacity just when firms should have been beginning to invest. We had the U.S. election and all the uncertainty about NAFTA, so the investment sort of stopped there. Some firms were desperate to invest, and they did, but many postponed those decisions, and that did two things. It meant that we had less investment than we had hoped, and we had less exports than we had hoped, because they were operating at full tilt and couldn't expand to take advantage of growing demand.
Now that the uncertainty is out of the way, we're watching carefully to see how firms respond, and we expect that to happen. Already we have that shift in the numbers. As we already mentioned, the housing sector has slowed, as expected, and consumption almost always goes along with that. It's not a slowdown, but it's slower than what it was.
On the trade front, obviously with the application of CETA and with the CPTPP now receiving royal assent, even a free trade agreement with Israel and with other countries.... That is something near and dear to my heart as an economist, that free trade integration continues. The lack of disruption to the supply chains.... Now that the USMCA deal is done—not ratified, but completed—I think it has removed a great deal of uncertainty.
My last comment, if I have more time, is with regard to labour in Canada. I represent York region. The biggest complaint I hear from businesses is a shortage of workers. A Bloomberg story said that Canada is enjoying a boom of people coming to our country, but it still seems not to be enough. Do you have any advice on how to help fill those vacancies?
This is a matter of getting the right match. Canada is a big place. Other countries, such as Germany, seem to do a better job, but it's usually because most jobs are within a two-hour commute, and we don't have that situation here.
Skills mismatching is often portrayed as gigantic, that the job growth is in the digital economy space and the job losses are in manufacturing, let's say. In fact, there are many vacant jobs in the manufacturing space and many vacant jobs in home building, construction, renovation, maintenance, all those jobs, which are not a large skills gap away from manufacturing skill sets.
I have to believe that geography is playing some role, but it may just be that the business of moving is not as easy, especially when one spouse still has a good job and the other spouse is looking for a job. It could be hard for a family to move.
Those aren't monetary policies, but perhaps some things could be invented.
The fact is that, as we said, when B-20 was put in place, we put in our monetary policy report estimates on how much of an effect that would have. It's not zero. It would have a slowdown effect in the housing market, because of course it acts very similarly to an interest rate hike in the system.
The fact is that interests rates have been extraordinarily low. The biggest risk we face in the financial system is that household debt is not able to cope with a more normal level of interest rates. That test was designed to help both lenders and borrowers figure out if they were capable of sustaining the mortgage they were thinking of taking on through an interest rate cycle of approximately 200 basis points.
I think that applies whether you are in Saskatchewan or in a market like Vancouver, where there were speculative juices flowing, or in Toronto, or in Atlantic Canada. It doesn't matter where you live; you're going to need to be able to withstand an interest rate cycle, because the economy is normalizing.
The quality of debt is what was at issue. If people can afford it today but can't afford it 100 basis points from now, then we're not doing them any favours.
I don't think that's enough to get them to change their ways.
I want to ask you one other question. It's about the challenges over NAFTA. Some of the initial rhetoric was around cheap steel coming through Canada. That was one of the reasons that were given for the imposition of the tariffs. I think our ambassador was very optimistic last week in saying that he expects that those will be taken away very quickly.
It was interesting. Ambassador Craft's response was that this is not something against Canada; it's just protecting North America from other countries that would be passing raw materials through here. What has changed in that situation to make us think that the tariffs will be coming down? Those countries are still passing that material through.
When we're talking to businesses, we're hearing that those tariffs are killing manufacturers, especially small and medium-sized manufacturers. With the tax reductions in the States, and with the increased payroll tax and all kinds of things, our businesses are not quite as optimistic as you've been today in your presentation about the economy.
Is there a way of dealing with that steel passing through here that won't interfere with international trade and our economy?
Governor and Senior Deputy Governor, thank you very much for your presentation and for your “Monetary Policy Report”.
I have read it. The document is always easy to read and understand, but I know that a lot of research and effort was needed in order to produce the report.
My questions are going to be about household debt in terms of interest rates and mortgage rates.
On page 18 of your Monetary Policy Report, you say: “The ratio of household debt to income has levelled off and is anticipated to edge down.” That is very desirable.
What will be the impact of interest rates on Canada's economic growth if, as anticipated, we continue to see a slight increase in the Bank of Canada's key interest rate?
According to the projections we established in the Monetary Policy Report, the rise in interest rates matches what we mentioned in our media releases. When we make projections, we take that into consideration.
Given the increase in interest rates, we expect the growth of credit to be slower than it has been for several years. That is a good thing. In addition, because the economy is continuing to grow, people's disposable income should increase, at least on average, if not for each individual. The economy has sources of growth that are well distributed through sectors and, we hope, through regions. That situation will benefit all Canadians everywhere in the country.
The level of indebtedness will remain quite high. It will be a long time before we will be able to see it go down. We will also have to contend with a vulnerable financial system. Given our forecasts and our view of the situation, we are very aware of the need to properly assess the speed at which we should be increasing interest rates, specifically because of people's indebtedness.
We have no desire to increase interest rates too quickly. That is clear. At the same time, we must not forget that, if we do not increase interest rates at an appropriate speed, we are only pushing the problem back until later, because there will be imbalances, such as increased prices, in the real estate market. The governor has just said that we are seeing much less real estate speculation than previously. We will choose an appropriate pace and there will be a contribution from the residential construction industry, where there is much less activity than previously.
Once again, it is not a bad thing to have other sources of growth, like investments, which will increase the economy's capacity for growth in a sustainable way.
That's the debt service ratio for households.
We did some nice charts on this, not in this MPR but in the previous one, back in July. We did an experiment on the various segments of the household sector, depending on how much debt they were carrying relative to their income, in each category. We sliced up the data very finely. We simulated a 100-basis point and a 200-basis point renewal cycle through that structure.
There's a lot of complexity to it. If you got your mortgage back in 2014, chances are you're renewing in 2019, or it's 2015 and 2020—about half of the people would pick a five-year in that case. We simulated it in that way. Debt service ratios, or actually mortgage payments as a share of gross income, went up by one or two or three percentage points. In the worst case, they went up by as much as approximately five percentage points. In a very highly indebted household sector, the biggest effect we could find was five.
I want to thank both of the presenters here today. I also want to say thank you for coming to the north and giving the message of a brighter economy. I think it was well received by the people in the audience. I was certainly happy to see that it countered the Conference Board of Canada's opinion.
I think in the north, calculations or issues that are factored into the economy are a little different. I always claim that we have to deal with the transportation infrastructure issue before we can lower costs to make it more attractive. We also have to deal with outstanding land claims and self-government negotiations, which would bring greater certainty and bring indigenous governments as full partners to the table.
I know it's not part of your policy report, but I think if it was exclusively on the north, they would certainly be factors. Maybe you want to say something on it. I did see a couple of concerns that were raised in your report that stood out. The two that you raised were labour shortages and transportation bottlenecks. These are both issues that we recognize very clearly in the Northwest Territories.
In Yellowknife, which is our capital, the employment rate is nearly 80%, which is 19% higher than any other community outside of the city. We have made quite a bit of progress in addressing the northern infrastructure gap, but it's still pretty significant. I want to know, if you could tell me, of the two, what do you believe is more of a hindrance to Canada's economic growth potential?
I share your concern. I will speak for myself, but in our communications last week we sought to put more emphasis on the notion that someday we're going to be back at neutral and that neutral is 2.5% to 3.5%, so that people will begin to digest that as an approaching fact. Of course, the pace is something that we have described before. It's unknown at this stage.
I have children who are adults, and I think they don't understand this, because they've never experienced the kinds of interest rates that you and I have in our lifetime. I hope they never do, because that was all about our inflation history and we worked very hard to fix it.
It was painful to fix. During the 1980s, when I was at the Bank of Canada as a young researcher, you could feel that. It was a very painful experience. That was when I bought my first house, and rates were 12% or 13%.
That goes into the rear-view mirror, and now you want people to understand that 3% would be just a normal thing, given the low inflation environment that we've established.
It shouldn't feel difficult. It shouldn't be a hard thing for people to service their debt at those kinds of interest rates. If, however, people have overextended themselves, given the low interest rates, we then have a transition issue. That is why we're putting so much emphasis on this and analyzing it so carefully and choosing our pace while we gather the data as we go through. We appreciate how difficult this is and how the economy will react.
I assure you it's top of mind—we're not losing sight of it—and I fully sympathize. We're going to be very careful about it.
I want to come back to the issue of the neutral rate, 2.5% to 3.5%. We are experiencing, as we're all aware, the highest rate of family debt in the OECD. Even though it has levelled off, it is still astoundingly high. I'm wondering what the impacts are.
I understand that you can't give us a schedule, but if the objective ultimately is that neutral rate of 2.5% to 3.5%, what, given the rate of family or household indebtedness, is the impact of rising to that neutral rate ultimately?
It is very difficult for the people who are highly indebted—there's no doubt about that—and the adjustment is difficult. When we look at the impact, we look at those individuals but also at the rest of individuals. In Canada, there is a large proportion of people who have no debt or very little debt—debt that is more manageable.
In some of our material, you can see the proportions. That highly indebted group is about 18% of those who hold mortgages. Then many people—30% of people—don't have any mortgage. We are really careful to think about how people are adjusting by looking at different vintages of individual mortgages, and we also build that into our forecasting models so that we can get a better idea—not just talk about it but in fact take it into account in our decisions.
When we do that, in what we've seen so far it has been difficult, but we can see that overall, households are adjusting, the economy is doing well and businesses are getting their investment plans in place. We think that incomes will grow over the period in which interest rates are rising, and that if there is ever a time to get back to normal, as the governor was putting it, it would be during this period.
I'll take a shot at that.
I totally understand. We have some world-class, vibrant, global cities in Canada. Compared to other world-class, vibrant cities, they're still not very expensive. I think this is something we have to reconcile. How do people of the second generation in Paris or London afford to live there? Because they certainly aren't buying houses of the sort you're describing. People adapt and they live differently. In the case we have here, we have a big country and people move somewhere else. In a digital economy, they can be in all kinds of different places and be very productive.
We don't know how all this is going to turn out. People of our age have a culture where we buy our house and we have our mortgage and we pay it off. Someday you're debt-free. Other people in other societies choose to rent their entire lives. We say, “Well, it's too bad they're not owning a home,” but they may rent exactly the same place that whole time. If you have a large debt and you're just servicing that debt your whole life and you never actually own the place, you're just paying rent to someone else. You're paying rent to a bank instead of to someone who owns the apartment.
Many of these models may look the same, but the finances are just different. We have a very innovative financial sector that I think can manage it for people. I don't like to pre-judge it as a problem, per se. The best contribution we can make to affordability is to keep inflation under control. Part of that is getting interest rates back to normal so that we don't have 20% or 30% price hikes in a market like Vancouver, which was for sure destroying affordability.
Thank you for being here.
Governor, you know London, Ontario, very well because you studied at Western University. That's where I'm from. That's the city I have the honour of representing in the House of Commons. As I think you know, London sustained itself for many years. Its economy was based on manufacturing, and that has changed now. When 2008 hit, many of our factories left. We are trying to transition and are doing well in that regard. There's a thriving technology sector that's come to our city. Our downtown is quite vibrant in that regard. There are many tech-based companies there. Even where manufacturing exists—and it certainly does—it's taking on a more advanced form.
I ask this question because I know you spoke in late September in Moncton on the issue of technological advances and disruptive technologies and what that poses for economies. I'm obviously interested in this from London's perspective, but for the country as a whole.
I'll quote from your speech, from the conclusion. You said, “technological advances represent opportunities to be seized, not a force to be resisted.” You continue by saying, “we know that in the long term, these advances will create more jobs than are lost, and create enough income to ensure that those who are affected can adapt and access new opportunities.”
I wonder if you can delve into that and expand upon that a little more.
Yes, we have roughly 200 years' worth of economic history and technological change throughout that period that we can study in detail. Throughout that history, there has never been a technological change that has not created more jobs than it has destroyed. The term “creative destruction” that Schumpeter developed is very apt. When there is technological change, somebody's job is eliminated.
We take cases like the driverless vehicle that is going to eliminate truck drivers' jobs. It's going to reduce the number of truck drivers' jobs; that's true—gradually, of course, because it's expensive to buy those trucks—but it's going to create jobs for all those people writing the software and building the trucks, and of course, monitoring the traffic and all those kinds of things. That's an example I use.
Most of us think of growth as a bit like yeast, it's everywhere and it grows incrementally, but in the real world, growth is like mushrooms, they pop up here and there. The person who thinks of that mushroom makes out like a bandit because they have the new idea, and the destruction is around that mushroom.
What I was alluding to at the end is that the yield from that technological change is sufficient that we can always fund safety nets to help those who are left behind, and second, that as the income and the entire economy goes up, all those regular jobs such as building houses and maintaining them, etc., are also increased. Those are not giant leaps in skill sets away from the jobs that have been eliminated by this process.
We shouldn't be pessimistic about it. That was my main message.
We expect growth at the global level to moderate from what it is doing at the moment, and that's primarily because the United States has had this big bulge in growth, and quite naturally, it's at its capacity so it has to moderate.
Second, because of the trade actions that have been put in place, we're having these spillover effects, hopefully temporarily, but in any case, even if those trade actions go away, we will still be left with a moderation in global growth. We have that built into our forecast.
Canada continues to do well under that. We're just settling in at our potential growth rate and unemployment at a 40-year low and inflation on target. Right now, things are okay. We still have some rebalancing to do, but all the motion is there.
Before I go to the last question from Francesco, on page 7 of your monetary policy report, where you deal with trade concerns weighing on non-energy commodity prices, you talk a fair bit about the energy sector. You make this statement:
||The effect on the price differential is being amplified by a faster expansion of oil sands production than of transportation capacity.
How serious is it that we have no access to market, other than basically rail, for some of that oil sands production?
From where I sit, there's a law of diminishing returns in terms of the railway capacity to haul other commodities when oil is taking up that capacity. We have to move potash, coal, all kinds of grains and oilseeds. There is an increasing problem as more oil, bitumen or whatever ends up on rail.
Do you have any thoughts on that?
Clearly the transportation issues are what is driving the difference between the price of WTI and WCS. How serious is it? If you happen to be one of those companies that has the marginal barrel of oil that needs to be shipped by rail, you're getting paid a lot less for it. Also, you may be displacing some agricultural product. As we know when we talk to companies—and you know it too—they also have to wait and maybe have stockpiles of their product to ship as well.
About 93% of the oil is actually shipped by pipeline, so it covers a smaller proportion of the oil than one might imagine. As well, within that, some of the returns—the costs that are being paid for the rail—are actually accruing to Canadian railway companies, so not all of that is lost.
A cost that's outside how much I get paid today and how much I could get paid if the price were higher is really what it does to investment in the sector, where a price at that level may make it so that there's no business case to create further capacity. Certainly in our outlook, as you can see from one of the charts, investment in the energy sector is rather flat and slightly declining over the projection horizon because of that.
The Bank of Canada has raised rates five times in the last year and a half or so, and you're about 75 basis points from hitting the lower bound of your neutral policy rate. Obviously the rise in rates connected with the bond market and so forth impacts interest-sensitive sectors within the economy. My estimate is that inflationary expectations are quite well contained now.
As my colleague mentioned, you have removed the word “gradual”. Some economists have said it means nothing. Others have said it means something. I think it means, Governor, that you don't like to give forward guidance in terms of data points, data plots or anything like that, like the Fed does.
Can you comment on the interconnectedness, and how we can avoid going too fast in raising rates and doing damage to interest-sensitive sectors, while still keeping inflationary expectations well contained?
Our situation, as I mentioned a moment ago, is that the economy is approximately at its capacity. It is also growing at its capacity rate. Inflation is on target, and unemployment is at a 40-year low. We have all the readings we're looking for, except that interest rates are still extraordinarily low by historical standards and certainly relative to our notion of neutral.
But you're right that getting from here to neutral—as we've said many times today—is a process in which we need to evaluate continuously how the effects are playing out. It's certainly not going to be a rapid process. It's a process, though, and we wanted to make sure we weren't locked into a perception that we would move every second meeting. That's what the market said that “gradual” meant.
We thought that it might mean that, but it could easily not mean that, so we needed to clarify. We defined the pace more carefully, so that people would understand what we would be looking at. The most important thing is how households are responding. That's the most interest sensitive part of the economy, given the level of debt. We will be analyzing that in every which way, and in much detail. At each time, we will be offering more and more insight into how people are responding.
Of course, if we move too quickly, the economy will slow below its potential growth rate and that will put downward pressure on the future outlook for inflation. That's not what we want. That would mean “slow down”. That's what that would tell us. But if the economy continues to perk along at this stage and is adding to excess demand, then we would become concerned about inflation pressures down the road. We're at that point where we need to balance the risk of going too quickly against the risk of going too slowly, and there are a number of unknowns in that grey zone in the middle. We will be monitoring each of those carefully and forming our judgments at each meeting.
We have, from the Office of the Parliamentary Budget Officer, the Parliamentary Budget Officer, Yves Giroux. This is his first time before this particular committee. Welcome, Yves.
With you, we have the senior director, economic and fiscal analysis, Mr. Matier, and Mr. Shaw, director, fiscal analysis.
Just to explain, bells will ring at a not too distant time and members will have to leave to vote. There will be a 30-minute bell. Hopefully, if we get permission from all parties, we will stay here until about eight minutes before the vote. Then we will come back following the vote and finish our questioning for a period of time.
I know that at seven o'clock tonight, there are also briefings on the budget implementation act, and there's a vote on the NATO Parliamentary Association that people will want to vote on, at 6:30, so we can rotate in and out of that. It's a little complicated tonight.
Welcome, Mr. Giroux. The floor is yours.
Good afternoon, Mr. Chair, vice-chairs and members of the committee.
I would like to thank you for the invitation to appear before you today to discuss our October 2018 economic and fiscal outlook, which we published last week, exactly a week ago.
Consistent with the PBO's legislated mandate, my office produces an independent economic and fiscal outlook and today, as you mentioned, I am joined by Chris Matier and Trevor Shaw. The three of us will be happy to respond to your questions.
I would first like to start with the economic outlooks.
Canadian economic performance remains solid. Fuelled by strong export growth, the Canadian economy continued to operate above our estimates of its potential output in the first quarter of the year.
We expect growth to slow as the economy comes to rely less on consumer spending and housing, and more on business investment and exports. We project real GDP growth to decrease from 2.1% in 2018 to 1.8% in 2019 and then to 1.5% annually through 2023.
We continue to monitor macroeconomic developments and risks to our outlook. In our October report, we highlight recent tariff changes, Canada's investment climate and household financial vulnerability.
We judge that the risks surrounding our economic outlook are broadly balanced. In terms of downside risks, we continue to believe that the most important risk is weaker export performance. On the upside, the most important risk is stronger household spending.
Regarding the fiscal outlook, our fiscal outlook takes into account recent policy changes in Canada and abroad. The report highlights the revenue implications of recent Canadian tariffs and U.S. corporate tax changes. Furthermore, based on some preliminary assumptions, our fiscal outlook reflects the recent change in the government's discount rate methodology used to measure its long-term liabilities.
For the current fiscal year, 2018-19, we project that the federal budgetary deficit will be $19.4 billion, which amounts to 0.9% of the Canadian economy. Over the medium term we project the budgetary balance to reach a deficit of $9.4 billion, or 0.4% of GDP, as revenues outpace growth in the economy and the government's operating expenses remain restrained. In addition, we project that federal debt will decline to 30.3% of GDP in 2021, which is 1.5 percentage points below the government's official debt anchor.
Given the possible scenarios surrounding our economic outlook, and without further policy actions, it is unlikely that the budget will be balanced or in a surplus position over the medium term. However, we estimate that it is likely the government will meet its debt anchor commitment of bringing the debt-to-GDP ratio below 31.8%.
My colleagues and I would be pleased to respond to any questions you may have, and I am sure you have a few regarding our economic and fiscal outlook or other PBO analyses.
Thank you, Mr. Chair.
Thank you, Mr. Giroux, for being here.
I was very interested in the report that you recently released. You say that U.S. tax cuts will not have a material impact on Canada's investment climate. I wonder if you could expand on that point.
Tell us how you arrived at that conclusion, specifically, because it differs from accounts that we have heard at this committee in our pre-budget consultations, both here in Ottawa.... I certainly did the eastern Canada trip and I know my colleagues did western Canada. I can't speak for western Canada, but I know this was a common theme, the concern about the U.S. tax cuts that Mr. Trump introduced a number of months ago, and what that means for investment in Canada.
The first point I'd make is that the U.S. has reduced its tax rates, but they are bringing them into line with Canada's. Over the last several years the U.S. tax rates for corporate income tax were significantly above Canadian tax rates.
Also, the U.S. tax cuts are temporary in nature. They will be phased out over a five-year period, and that, to an economist, doesn't have the same impact as permanent tax cuts. Businesses know that there are incentives to shift income and some investments in the U.S. when the tax rates are being lowered. When it's temporary, however, it doesn't have the same powerful incentive.
I'd also add that marginal effective tax rates are one element in businesses' decisions to make investments, one of many factors. One can think of the availability of labour, the quality of the labour force, their prospects for profits, obviously, also the macroeconomic environment, as well as trade certainty or uncertainty. These are a few of the many factors, including tax rates, in firms' decisions.
Given all this, we looked at the evidence. Was there evidence suggesting that there was a reduction in investment in the Canadian economy? We looked at foreign direct investment in the first half of this year and found that foreign direct investment in Canada has remained roughly at the same level as the average of the last couple of years. Furthermore, business sentiment is still positive in Canada despite the small difference in tax rates.
One also has to put the tax cuts in their broader macroeconomic perspective. Canada has a deficit of less than 1% of GDP, while the U.S. has a deficit of more than 3.5% of GDP. The debt-to-GDP ratio in the U.S. is rising and is slated to hit 100% over the next five years, while the Canadian debt-to-GDP ratio is going down. All that points to further increases in tax rates in the U.S. or a reduction in expenditures, because eventually something has to give.
Finally, if you'll allow me to go back to the testimony that this committee has heard, my bet would be that you heard testimony from business owners or business councils or the Canadian Council of Chief Executives. Business owners are representatives of business owners, and I would say they probably have a vested interest in arguing for lower tax rates.
I appreciate your being here.
I want to ask you a little bit about an issue relating to the so-called dividends that the Canada Mortgage and Housing Corporation is paying out to government revenues—almost $6 billion over the last couple of years. What that essentially is telling us is that we're seeing homeowners paying far bigger premiums than necessary and are seeing $6 billion flowing to government. It's almost like a taxation, I suppose, in a way.
What I wanted to ask you about, though, taking a look at that almost $6 billion—$5.7 billion, anyway—is what that money would look like in the hands of taxpayers. What would it look like circulating in the economy rather than in the hands of the government?
I'm just curious as to your thoughts and your opinion on that.
Mr. Giroux, you and you office and your predecessor are heroes, I think, to many Canadians, particularly because of the fight the PBO has waged to get the information from the Canada Revenue Agency. It allows us to get a good estimate of the tax gap in Canada—the money that's lost to overseas tax havens, the money that's lost to tax loopholes. The PBO waged a five-year fight to finally get that money. The previous government wouldn't permit it. The current government wouldn't permit it. Thankfully, the PBO finally said, “We'll take you to court unless you give that information.”
At the time, your predecessor, Mr. Fréchette said the time that it would take to actually produce a tax gap report depends on the quality of the information we receive. This report would be vital, I think, for the next federal election, when Canadians get a chance to look at the fiscal platforms of each of the parties. He said that if the Canada Revenue Agency gives us a paper version of files in boxes, it's going to take a lot longer than if there's a transfer of legitimate electronic information.
I think Canadians would be interested in knowing what quality of information you have received from the Canada Revenue Agency, and what you think in terms of a timeline to produce this important report. I think a lot of Canadians are waiting for it and want to know how much the federal government loses to wealthy tax dodgers and tax havens overseas.
That's an interesting question, given the fight that my predecessor entered into with CRA.
On the quality of data, my office received a first batch in February, and contrary to what people were fearing, we didn't receive boxes and boxes of paper documents. We received USB keys that were secure and protected despite not containing confidential taxpayer data. It was very secure and there was quite a bit of information.
We looked at what we received and determined that we need some more refined information and data from CRA. We have made the request and we have received, so far, very good co-operation from CRA on getting the information that we think will be useful in determining the tax gap.
There are discussions under way still with CRA, because I don't know that it has all the information that Canadians would expect it to have on international tax evasion, and on those who are more likely to get into these arrangements. That's why we are in ongoing discussions with CRA to determine what it is that it has, and what it is that we can get from CRA. It's not by lack of co-operation from officials. It's more out of determining what it is that CRA does indeed have. That's for quality.
Regarding timelines, we expect to be in a position to have an estimate of the tax gap in the spring of 2019, because on purpose it spans a three-month time horizon. If I were a betting man, I would probably go for the latter part of spring as opposed to the earlier part of spring. That is because trying to put a number on the international tax gap is eminently difficult.
It's trying to nail Jell-O to a wall, as somebody explained to me. It's trying to get information on the one hand on the taxes that Canada collects with respect to international income and international activities, but what is difficult is trying to get information on the taxable income. What part is declared and what part is not declared. The part that is not declared, under the radar, is very difficult to identify and estimate. This is not only in Canada, but other countries have faced the same challenges.
Moreover, when one of the committee members asked the governor what keeps him awake at night, I wondered what my own answer would be. I sleep well at night, but one of the things that concerns me is the level of household debt.
The rate of indebtedness has reached a very, very high level, despite the fact that interest rates are low. That continues to be a concern for me, because interest rates will be going up, even if they are forecast to do so only slightly. The governor mentioned it earlier. The interest rate is supposed to stabilize around 3%, which will mean servicing the debt will cost more. As a result, the part of disposable household income that is used to pay back the debt will go from about 14% to almost 16%.
That may seem like a small increase, but, for a middle class household, it can easily mean an average of $1,200, $1,500 or $2,000 per year, which is not a negligible amount. As you know, families just starting the first phase of family life take out large mortgages and car loans. For them, the increase I have just mentioned will be bigger.
So, yes, it does concern me.
Okay, we'll have to go to Mr. Fergus.
Before we do, we're soon going to have to cut the mustard here and go to vote. Where there was one vote, there are now four, so we have to figure out what we do following this round of questions and whether we come back. There's a NATO meeting that I know people want to vote at, at 6:30, and there's a BIA briefing at seven o'clock for all parties and senators.
People need to think about what they want to do, whether we cut it here or come back and go to four more questions.
We'll go to you, Mr. Fergus.
Thank you very much, Mr. Chair.
Welcome, Mr. Giroux. Thank you for your report.
I would like to continue along the same lines as Mr. Julian and talk about Canadians' household debt. You said that the thing that keeps you awake at night is not so much the debt as our ability to repay it.
When I was young, my parents had to contend with interest rates of 12% or 13%. When I bought my first house, the five-year rate on my first mortgage was about 8%. Now the rates are around 3%. That is unheard of.
How able are Canadian households to pay back their debts? The Bank of Canada indicates that the key rate should range from 2.5% to 3.5%, but, if the part of household income that goes to paying back the debt exceeds 16%, it would be the straw that breaks the camel's back, don't you think?
To answer that question, we have to look at the economic situation of the households in its entirety. Over the years, interest rates have dropped markedly. The government mentioned it, as you did. I lived through it too, not when I bought my house, but a lot earlier. Interest rates were high.
The drop in interest rates has improved access to property. The price of houses then started to go up. When interest rates go down, house prices go up. So is access to property better now than it was 20 years ago? It is difficult to answer that question with absolute certainty.
We are seeing some effects today: interest rates are low, but household debt levels are high. When I entered the labour market, it was very difficult to find a job. Now, my 19-year-old daughter drops off a resumé or two and gets a job immediately. Access to property is a little difficult because of the high prices, the level of household debt is high, but the labour market is very solid.
As every good economist could say, you have to look at both sides. Even though household debt is a particular concern, especially at the start of a period of increasing interest rates, the labour market is very solid. That makes me optimistic as to the capacity of the households to pay back their debts, if interest rates increase as we expect. As economists, we also know that we are often wrong.
The concern would be if interest rates continue to increase and exceed the rates we are expecting in the medium term. The problems for households could then be excess debt and the inability to pay it off.