I'll call the meeting to order.
I have a quick question before we start. On Wednesday, we have votes at six o'clock. We're in the Wellington Building, and we have 16 witnesses, which normally takes three hours. We really don't want to leave them sitting idle while we come up and do five or six votes.
Are we willing to tighten the panels up to about an hour and seven minutes per panel, which would mean we could get out of there at 5:45 p.m.? We could go to five questions, two from the Liberals, two from the Conservatives, one from the NDP, which would be about five minutes for questions.
Are people okay with that, so that we can give them notice now? Part of the problem is the second panel comprises two separate video conferences, so we need to line this up.
Are we okay with that? Agreed. The clerk will inform the witnesses. Thank you all.
Turning to the business at hand, pursuant to Standing Order 108(2), we are studying the report of the Bank of Canada on monetary policy. We are most fortunate to have Bank of Canada Governor Stephen S. Poloz, and Carolyn Wilkins, senior deputy governor.
I believe you have a presentation to start. Welcome.
Thank you and good afternoon, Mr. Chairman and committee members. Senior deputy governor Wilkins and I are happy to be here before you today.
It is our normal practice to appear before this committee twice a year to discuss the bank's monetary policy report. We published our latest MPR last week, and we're happy to answer questions about it and other economic topics.
However, I suspect you may also want to ask about the agreement with the federal government that was announced this morning, which renews our inflation control framework for another five years. Before we respond to questions, allow me to say just a few words on both topics, beginning with the MPR.
Since our last appearance, there have been two significant developments that led us to downgrade our outlook for the Canadian economy. The first is a lower trajectory for exports. After a sharp decline in goods exports over a period of five months earlier this year, we had a significant rebound in July and August. That was not enough to make up for the ground that had been lost.
We worked hard to determine the reasons for this shortfall. About half of it can be explained by weak global trade and composition changes in the U.S. economy; however, the rest is unclear.
In our outlook, we now assume that longer-term structural issues, such as lost export capacity and competitiveness challenges, are responsible for the remainder. This assumption led us to reduce the projected level of GDP by the end of 2018 by about 0.6%, compared with our July projection.
The second major factor behind our downgraded growth outlook is the federal government's macro-prudential measures to promote housing market stability. These measures are welcome because they will, over time, ease vulnerabilities related to housing and household imbalances. That is important because such vulnerabilities can magnify the impact of negative economic shocks.
We expect the government's measures will restrain residential investment by curbing resale activity in the near term, and lead to a modest change in the composition of construction toward smaller units. We estimate this will leave the level of GDP 0.3% lower at the end of 2018 than projected in July.
Given these two sets of developments, we cut our growth estimate for 2016 to 1.1%. The expansion in both 2017 and 2018 should be around 2.0%, which is above the growth rate of potential, which I will remind you is around 1.5%.
However, because the output gap is now larger, and will close later than we projected in July, the profile for inflation is now slightly lower. We project that total CPI inflation will remain below 2% through the end of the year, and be close to the 2% target in 2017 and 2018.
The outlook is clouded by a number of uncertainties at this time. These include: first, the macroeconomic effects of the new mortgage rules; second, the likely path of our exports; third, the impacts of the federal government's fiscal measures; and fourth, the effects of the U.S. election on business confidence.
Given the two-sided nature of these uncertainties, and with the flexibility inherent in our inflation-targeting framework, we judged that the current setting for monetary policy remains appropriate.
Let me now speak about the renewal of the inflation-targeting framework.
Today, the bank and the government announced that we will continue to target inflation at the 2% midpoint of a 1% to 3% range for another five years. This is good news, as our framework has served Canadians well, in both calm and turbulent times, for 25 years. The framework's track record is impressive.
Annual inflation has averaged almost exactly 2% since 1991. Inflation has also been more stable, which has meant that unemployment and interest rates have become lower and more stable. In turn, this has helped households and firms make spending and investment decisions with more confidence, encouraged investment, contributed to sustained growth in output and productivity, and improved Canada's standard of living.
As is the case at every renewal, a great deal of research and analysis went into the process, and we took on board the experiences and lessons of the past five years. Bank staff published dozens of research papers and worked with researchers from other central banks and academic institutions, as well as private-sector economists.
And, as usual, we asked some fundamental questions to make sure inflation targeting is still delivering its economic benefits effectively. We examined potential alternatives to inflation targeting to see if they provide even more benefits. That is one of the great advantages of our five-year renewal cycle—the framework is not set in stone; we are always looking for ways to improve it.
Now it's fair to say that even after years of very low interest rates, the recovery from the great recession in many economies remains weak, so it's not really surprising that some are wondering if monetary policy has lost its power.
Low interest rates are actually doing a great deal to support the economy. To illustrate this point, if we were to raise interest rates to pre-crisis levels, say 3% or 4%, there would be a significant contraction in the economy, and it's these contractionary forces that we are offsetting with low interest rates today. While monetary policy is still powerful, it is true that at the current setting the impact of any interest-rate reduction is less than it would be if rates were at historically normal levels. That's the case in a number of economies.
In this environment, it's particularly important that all policies—monetary, fiscal, and macro-prudential—work in a complementary way. This is why our agreement with the government is crucial. The government is making it clear that it also supports low, stable, and predictable inflation, while leaving us the independence to pursue that goal as we see fit. It's a framework that has worked extraordinarily well for 25 years, and after looking at all the evidence, we could find no compelling reason to change it.
With that, Mr. Chairman, Ms. Wilkins and I would be happy to answer your questions.
Welcome Ms. Wilkins and Mr. Poloz. We would like to thank and congratulate you. I don't want to speak for my colleagues, but I think there's a broad consensus on inflation targeting. Congratulations on the new agreement with the Government Canada.
This afternoon, I'd like to discuss what you said at the end of your presentation. If I understood correctly, you indicated that, at this point in time, new monetary policy measures would have little or marginal impact in Canada or around the world. You talked about the need for fiscal policy to take over, in terms of moving the economy forward. I don't want to put words in your mouth. I'll let you explain.
In light of your observations, how can Canada, but other countries as well, more effectively structure their monetary and fiscal policies to speed up growth in western countries?
Thank you for your question.
You are right that a global consensus is emerging, but the post-crisis focus on monetary policy was probably excessive. Immediately afterward, monetary and fiscal policies were implemented simultaneously around the world. After about two years, we saw a fairly strong recovery, and it was assumed that the bulk of the work had been done. Today, it is clear that it was too early to claim victory and that the world is still experiencing significant distress. Consequently, fiscal policy became more balanced, and monetary policy had to become more accommodative during the second phase.
Today, a consensus exists, but not everywhere, not in every country. It's not universally accepted, but we are in a situation where incremental changes in monetary policy will have less of an impact. We are almost in the same situation as during the Great Depression of the 1930s. That is when Keynesian economics comes into play, meaning that, in such situations, the use of fiscal policy is more appropriate.
As for us, I would simply say that, with the mix of the two policies, which are both important, we anticipate an interest rate of 0.5%, rather than a lower rate, because the fiscal policy is more accommodative.
Our analysis is that given the shocks we've incorporated into our projection, the economy has slower growth and a larger output gap for longer. That longer period takes us out to the middle of 2018.
On the one side we'd say that's unfortunate. We thought just a few months ago that by the end of 2017 we would be back at full capacity. So adding, say, two quarters onto that process means a longer period of time where someone may be out of a job. It increases the side effects, the scarring, or the loss of skill sets, and so on. We know that's not without cost.
We also must ask ourselves what is the complexity of the trade-off and when is it appropriate to try to speed it up? As we said last week, we actively discussed the possibility of cutting interest rates a little further at this time to try to speed up that process, and given the uncertainties that we're facing, we decided we were best to hold where we are.
When I say uncertainty, I don't necessarily mean something bad. It's just that some things are not as concrete today as they might be in a short time. For instance, a lot of companies mention that the U.S. election is giving them uncertainty about the future. Whether it's about their investment plans, NAFTA, or whatever, it doesn't really matter which candidate ends up winning, there's uncertainty. There's a natural tendency both in the United States and in Canada to delay those kinds of decisions.
It's possible, therefore, that when the election is over some of that uncertainty will be lifted and that would be a positive. It's not all one way. But in that context, we decided the uncertainties were sufficient, that we should watch the export data a little longer and make ourselves more confident in that.
I don't have an answer to that question, but there's nothing mechanical about it. Each of these decisions is a complex combination of risks, and we have to weigh the risks of waiting longer against the costs associated with doing something more immediate.
Certainly, as the first part of your question alludes, if we were to be easing further, we'd be very close to using unconventional tools. That's of course not a decision we would take lightly.
When we have the Canadian economy operating on two tracks, one track doing reasonably well and in certain regions doing quite well, and others adjusting through something quite difficult, it's not as easy as it sounds to speed up the fast growing parts to offset the slow growing parts. If everything were the same it would be an easier decision in many ways to do that kind of thing.
This is what I mean by the uncertainties. They are multi-dimensional. We do a fresh judgment every time. Again, we can't plan it that way. Our best plan right now, we think, is to wait for the next 18 months or so.
I have a final question about the agreement, targeting and inflation.
In the document drafted jointly with the , you stated that is a method that has proven effective since its was created.
Yet we live in a very different world than when it was created. You admit this yourself: we are in a slow growth period, which was not necessarily the case when this mechanism was created.
We are in a situation where the target has always been 2%, plus or minus one percentage point, of course.
Was there any discussion or any possibility of actually trying something different, adding this as one more tool in the tool box, as you just said?
The other question is, have you considered having an agreement for less than five years, just to see if maybe we can try something else? We'll try it for a few years and it might actually bring us different results in a very different economic situation.
Welcome Governor and Deputy Governor.
I would like to start off with a couple of comments. It's going to be a three-part question, if I can get it and your response in within the full seven minutes.
First of all, congratulations on the agreement, the policy statement on inflation targeting, going for another five years. Sending price stability to the market is very important for decision-makers, whether you're a saver or investor, and putting capital to work. It's important to know that's in place. So congratulations on that.
My first question deals with fiscal policy.
Governor, in your September 20 speech, “Living with Lower for Longer”, if I can quote you, it says here on policy prescriptions:
|| One important impediment to business growth that is widely shared globally is weak infrastructure. We know that infrastructure projects spur growth in the short term by boosting demand. More importantly, infrastructure projects can support long-term growth by raising an economy’s potential output.
With that statement from your September 20 speech, and really where monetary policy has done a lot of heavy lifting here in Canada.... The monetary policy transmission mechanism has worked very well here in Canada over the last number of years, but it's time for fiscal policy to take over, in my view. I would love to hear your wise words on that. That's part one.
The second part is to deal with two themes that have been identified in the deputy governor's speech in London that were re-emphasized in the monetary policy report that you've touched on, Governor. One has to do with labour supply, not labour participation rates, because they've held steady if you look from 1976 to now. The other one is productivity/competitiveness.
The labour supply we can deal with it with immigration. I think there's a solution there on the labour supply front, the labour growth rate. On the competitive front, on page 15 of the monetary policy report, there are a number of things that are concerning about our competitiveness and headwinds that are restraining export growth. I would appreciate some feedback on what fiscal policy or policy measures you think we may need to look at in terms of strengthening our ability there.
The third and final part is to deal with some ratios. We widely are given the 170% number for debt to disposable income, but if I look at the Stats Canada report where that number is provided, there are a number of measures on net worth of Canadians that we don't talk about. I'm somewhat, not concerned, but it raises a question on which side of the balance sheet we're looking, because if we look at financial asset ratios, Canadians are generally wealthier than they have ever been. There's a lot more net worth there. If I can get my iPad to open, I could pull them up.
I would like to get your take on the balance of looking at this one ratio, but in that same Stats Canada report, a number of other ratios point to a different picture of how the consumer is doing.
Those are the three questions.
In my minute then, yes, the speech on “Living with Lower for Longer” talked about our estimate that the Canadian economy can aspire to a long-term trend growth rate of about 1.5% for the foreseeable future. That's our estimate of growth potential.
The whole world has slowed down because of slower demographics. We're not excepted from that, and the U.S. is only slightly higher at 1.7%, with a slightly younger population.
It's 1.5%, and in that context, what is it that we can do to make the trend line higher? We can remove some of the impediments to growth, which are structural things. These are not things that monetary policy is equipped to do much or anything about. Indeed, in the narrow sense, neither is fiscal policy.
By structural things we mean deficient infrastructure, which, of course, would mean providing better infrastructure, but it can be other things such as interprovincial free trade and free trade internationally. These are things that, when changed, can boost that growth rate by 0.1%, 0.2%, 0.3%, and pretty soon you're rounding up to 2.0% instead of 1.5%. That's what I was talking about there, and we have control over many of those policies.
Of course, the one that's happening right now is the infrastructure plan, which will be welcomed by firms. That helps them grow their business. Turning to labour supply, productivity, competitiveness, and the debt-to-income ratio, over to you, Ms. Wilkins.
It's interesting that about half of the decline in Canada's growth and potential output is due to slower growth in labour supply. There's a real focus on figuring out how to increase that. Of course, the arithmetics of it are that immigration can do that.
I think there are other things, as well, that we've noticed, and that's just trying to look at the prime-age worker participation rates. Getting those segments of the population, discouraged men and women—women who perhaps haven't yet decided to join the labour force—could increase the labour input to potential output.
There's also the youth. When you look at the participation rates for young people since the crisis, they've declined. The governor's standing line is that they're probably not retiring. I think that's true. Some of them are in school, but some of them aren't. They're looking for work and could be productive.
When I talk to firms, they talk about the need to have the right labour in the right place at the right time. With regard to labour mobility, especially when you have the kind of shock we've had, where some areas are doing less well but there are jobs in another part of the country, that labour mobility is so important. Having the right education to fill the needs that are emerging is important as well.
That's not independent of productivity. The governor already mentioned a few things that firms tell us with respect to productivity. Clearly, regulation in electricity prices and other things affect their decisions about where they're going to locate.
You're right to say that on the measures of the health of the household balance sheet and their financial position, it's always wise to look at a number of indicators. Looking at that aggregate debt-to-income ratio is one way to look at it. We delve in, looking at net worth. That is another thing.
I think the best way to look at the health of the household sector is to look at the distribution of those things. You can have a lot of those average numbers hiding a lot that's underneath.
If you look back at our financial system review in June, you'll see that we did a strong analysis of debt-to-income ratios and loan-to-income ratios, and that a very high and growing percentage of the population is taking on loans that are over 450% of their income. That means that their debt service ratios are very high.
It may be that they have an asset. Most Canadians' assets are their houses. The issue, though, is that if they get into trouble from an employment point of view or an income stream point of view, they don't necessarily have those liquid assets that allow them to keep meeting their debt obligations.
It's great to see that net worth is high, but that depends on the value of the asset and the stability of the value of that asset, but also the liquidity of that asset. It's good to look at a number of indicators and look at the distribution across those indicators.
The downgrade is almost entirely from external forces, as has been our series of downgrades. There has been a global disappointment, which has pushed down everybody's forecast, over and over again, over the last five or six years, in our case, primarily the U.S. On the edge of that, it's even a little less for us, because our share of exports to the United States has been gradually declining. That's just to put it into context.
In terms of how much growth we expect from the fiscal plan, that remains something to be monitored. What we have built in is approximately 0.5 percentage points this year, and one percentage point on the level of GDP by the end of the next fiscal year. Of course, that remains to be seen, because there are no signs yet in the data we have available. It's a little early. We had the child benefit in July, so as we go through the rest of this year, we should see something in the retail sales data.
Importantly, there is no category in the StatsCan publication that is going to tell us, “This came from fiscal expansion.” It will tell us how much of a contribution the government made to GDP, but that won't be mapped directly to the fiscal plan. It's important that we understand that.
Years from now, we will be analyzing this episode, and the economists will figure out how much actually came, but that's very common. We referred to the U.S. infrastructure spending, where the components on roads and bridges delivered over an eight-year period three times the initial investment. That came both on the level, because of the spending, and because of the fact that those roads increased the potential growth rate for businesses to move their stuff around.
Thank you, and welcome, Governor.
I'm from Alberta. There has been a view in the yesteryear, I think, that if oil prices came down, the dollar would come down with it, exports would increase, and we'd be back to the good old days. That has not happened.
There are strong indications that, regardless of the outcome in the U.S. election, the fed is probably going to increase interest rates in the United States. Maybe you have some information on this that is different from what we are led to believe, and if your monetary policy doesn't track that, the obvious result is going to be a lowering of the dollar.
I'd like you to make some general comments about where the dollar can go, based on some of the monetary policies we have little control over, before it becomes an issue in itself, relative to inflation.
I would like to go back to the inflation-targeting agreement.
Ms. Wilkins, you said that you had considered setting a range from 2% to 4% with a target of 3%. You said the disadvantages by far outweighed the possible benefits. It is still an increase of one percentage point though, which represents a 50% increase over the current rate.
Were other possibilities considered, such as a target of 2.25% or 2.5% rather than 3%?
Are there studies comparing the potential costs and benefits?
I'm just trying to see what the process was in studying that possibility. I would like to put that in the light also of the announcement that core inflation will not be used as a benchmark anymore. We're going to have to have different types of inflation with CPI. On the other side, in the last few years we have been a lot more worried about the possibility of getting into deflation than out-of-control inflation.
That said, I'd like to see what the thought process was at the bank on that issue.
Yes, we did consider a 3% target in a range from 2% to 4%. As you will see in the documents we provided, we assessed the benefits in the context of a lower interest rate. We examined this for various targets up to 4%.
What we observe in this process is that the benefits of changing the target are limited and that the costs, which are in a way fixed, are the same. One of the reasons that monetary policy works so well is that inflation expectations are very stable. The potential benefits would be derived if people revise the credit system and their expectations in an orderly way.
As to core inflation measures, we have for a long time used the index measuring basic inflation or the inflation trend, CPIX, which strips out eight of the most volatile CPI components. As you can imagine, we try to target inflation, but—if you look at a graph—, it goes up and goes down; it fluctuates a lot. That is usually due to consumer energy prices. If we truly want a monetary policy that achieves stable inflation, the volatile components must be removed.
We did a study including the various core inflation measures used around the world. We found that, among certain criteria, there were three that worked. We also noted that the CPIX no longer works and was not helping us much. No measure was perfect, though. So we decided that it wasn't the target that was important, but rather that these measures would serve as an operational guide for us. We found that it was better to keep the criteria that worked very well and to use them as a base case.
I have very little time left.
I have one last question for you, going back to the inflation target.
I completely understand the success of the targeting agreement that has been in place since the 1990s: the key is that expectations are known. This also stabilizes expectations.
Ultimately, the argument you are making for the future, say in five years. when the agreement will be renegotiated, is that once again the rate will not be changed.
The agreements are for five years, but your argument is that the target rate will always be 2% because market expectations, those of investors and other influential actors, are always based on a rate of 2%. Would there be a way of changing that in the future or will it always be 2%, even though the agreements are for five years?
All I can say is that every economist and every economics team does their own analysis. This is less a matter of opinion, but more a matter of modelling, and the assumptions that go in them. There can be many, many reasons why two different estimates could differ.
Traditionally, the kinds of models that we use would show that if there was a government fiscal expansion, there would be a tendency for interest rates to rise in response to this, and would actually cut off some of the effect.
If you look at any model that economists use, it will give you this result, but what's important is that you take the model into today's context. Today's context is one in which the economy has a great deal of excess capacity; whereas the original analysis would be where the economy is more or less where it belongs, so you get this kind of adjustment that happens.
When you're in a situation like we find ourselves in today, where interest rates are very low, where there is indeed a risk, as we talked about last week, that interest rates would need to be adjusted lower in order to get our inflation on target, in that context, you don't have those kinds of offsets that you often have in a standard model.
It is why we say that the mix of policy is such that fiscal policy has quite an advantage in this situation compared to monetary policy. Nevertheless, they both can work on the same issue at the same time, and it gives you a better mix than you'd otherwise have.
All those possibilities are open. I'm not going to debate a specific estimate with you, but economists are like that.
Good afternoon, Mr. Chair, vice-chairs, and members of the committee.
Thank you again for the invitation to appear and discuss the October 2016 economic and fiscal outlook. Today I am joined by Mostafa Askari, assistant parliamentary budget officer, as well as Jason Jacques, Chris Matier, Tim Scholz, and Trevor Shaw. They will be pleased to answer any questions you have regarding our outlook or other PBO analysis.
Before reviewing the key points of our report, I would like first to note that our updated outlook reflects the June agreement in principle and the Canada pension plan enhancement. However, our updated outlook does not incorporate the government's recently announced measures related to the housing market, the carbon pollution pricing, or the indexation of the Canada child benefit amount.
Regarding the economic outlook, on balance, the PBO's outlook for the Canadian economy is unchanged from our April report. Weaker real GDP growth in the near term is offset by stronger growth over the medium term due to increased provincial government spending, as well as additional monetary stimulus and lower long-term interest rates. Over the period 2016 to 2021, we project real GDP growth to average 1.8% annually, the same as in our April report.
Average annual growth in nominal GDP, which is the broadest single measure of the government's tax base, is only marginally lower than we projected in April, at 3.7% versus 3.8% in April. This revision reflects weaker GDP inflation in 2016. Adjusted for historical revision, the level of nominal GDP is on average $15 billion lower per year over the period 2016 to 2021 compared to our April report.
Despite this downward revision, PBO's projected level of nominal GDP is, on average, $26 billion higher per year over the period 2016 to 2020 compared to the budget 2016 planning assumption. That includes the government's downward adjustment to the average private sector forecast of nominal GDP.
Our fiscal outlook is largely unchanged from April. We continue to project that the deficit will decline over the medium term, falling from $22.4 billion in 2016-17 to $9.4 billion by 2021-22. Compared to our April report, we are now projecting slightly larger deficits in 2016-17 and 2017-18, but smaller deficits thereafter.
PBO's outlook for the budgetary deficit over 2016-17 to 2020-21 is $4.8 billion lower, on average, than budget 2016. This difference is roughly in line with the government's forecast adjustment, which removed the equivalent of $6 billion in revenues in each year of its planning horizon.
In budget 2016, the government committed to reducing the federal debt-to-GDP ratio to a lower level over a five-year period ending in 2020-21. This translates into a fiscal anchor of 31% or lower for the federal debt-to-GDP ratio in 2020-21.
Under current tax and spending plans, we project that a federal debt-to-GDP ratio will decline to 29.7% in 2020-21. Consequently, based on the PBO's outlook, the government is on track to reach its debt-to-GDP target two years ahead of schedule. As such, the government has flexibility within its current fiscal plan to meet the medium-term debt-to-GDP target.
On that note, Mr. Chair, my colleagues and I would be happy to respond to any questions you may have regarding our economic and fiscal outlook or any other matter related to our mandate.
Thank you very much, Mr. Chair.
It is true that we have revised down our outlook for the level of nominal GDP. However, it hasn't been revised down by as much as that forecast adjustment factor. I think on average we've revised down our outlook by about $15 billion, just to put it in a rough ballpark.
The choice of characterizing it as excessive is relative to historical experience and how we've seen the private sector misses. At least historically speaking, it's very rare that you see both years come in so weak. We can put aside the longer term or the more medium term, but at least one year and two years out, it is very rare, outside of the great recession, to see this happening.
The last point I would comment on is about the use of prudence. The government isn't constrained like households and businesses are. When there are shocks to the economy, the government can absorb them, whereas it's very difficult for businesses and households to do so. That and the current fiscal situation in Canada are other factors you want to take into account in setting these adjustments.
It's also possible to have adjustments made on the opposite side. I'm sure there could be instances when the government might feel that there's some upside risk to the private sector outlook, but that's something we just haven't seen historically. It's always been an adjustment to the downside.