I call this meeting to order.
Welcome to meeting number 38 of the House of Commons Standing Committee on Finance. Pursuant to Standing Order 108(2), the committee is meeting on the report of the Bank of Canada on monetary policy.
Today's meeting is taking place in a hybrid format pursuant to the House order of November 25, 2021. Members are attending in person in the room and remotely, using the Zoom application. Per the directive of the Board of Internal Economy on March 10, 2022, all those attending the meeting in person must wear a mask, except for members who are in their place during proceedings.
I'd like to make a few comments for the benefit of witnesses and members.
Please wait until I recognize you by name before speaking. For those participating by video conference, click on the microphone icon to activate your mike and please mute yourself when you are not speaking.
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I remind you that all comments should be addressed through the chair.
For members in the room, if you wish to speak, please raise your hand. For members on Zoom, please use the “raise hand” function. With regard to a speaking list, the committee clerk and I will do the best we can to maintain a consolidated order of speaking for all members, whether they are participating virtually or in person, and we appreciate your patience and understanding in this regard. That being said, I request that members and witnesses treat each other with respect and decorum.
Before we begin, I'd like to remind our members, as discussed during the last meeting on the Emergencies Act draft report, to please submit any final comments or suggestions in both languages to the clerk as soon as possible.
It's my pleasure to be able to welcome our witnesses today. I say “welcome back” to the Governor of the Bank of Canada, Tiff Macklem. Joining Tiff is his senior deputy governor, Carolyn Rogers.
Welcome. The floor is yours.
Let me say how pleased senior deputy governor Carolyn Rogers and I are to be here in person to discuss our monetary policy report and our decision of a couple of weeks ago.
We published our monetary policy report as Russia's unprovoked invasion of Ukraine entered its eighth week. The war is causing tremendous human suffering and our hearts go out to the Ukrainian people. The war has also injected new uncertainty into the global economic outlook. It is boosting already high inflation in many countries, including Canada, and it's disrupting the global economic recovery.
Against this backdrop, we have three main messages. First, the Canadian economy is strong. Overall, the economy has fully recovered from the pandemic and is now moving into excess demand. Second, inflation is too high. It is higher than we expected, and it's going to be elevated for longer than we previously thought. Third, we need higher interest rates.
Our policy interest rate is our primary tool to keep the economy in balance and bring inflation back to the 2% target. Two weeks ago we raised our policy rate by 50 basis points to 1%, and we indicated that Canadians should expect further increases.
Let me expand on each of these three themes.
Canadians have been through a lot in the past two years. Everyone has been touched by the pandemic, through illness or the loss of loved ones, fear and uncertainty, job loss or business closure. We experienced the sharpest and deepest recession on record, and repeated waves of the virus have made the recovery bumpy.
Thanks to exceptional monetary and fiscal stimulus, effective vaccines and a willingness to adapt and innovate, the economy has bounced back remarkably quickly. It has been the fastest and sharpest recovery ever, and now demand is beginning to run ahead of the economy's productive capacity.
The labour market shows this clearly. Before the pandemic, the unemployment rate was 5.7%. When the pandemic hit, it quickly soared to 13.4%, and now, two years later, it is at a record low of 5.3%. Job vacancies are elevated and wage growth has reached prepandemic levels. Businesses can’t find enough workers to meet demand, and they're telling us they’ll need to raise wages to attract and retain workers.
We expect strong growth to continue in the months ahead. As remaining public health restrictions ease, Canadians are spending more on services—travel and recreation, lodging and restaurants—and they're still buying a lot of goods. Housing activity is still strong, and while we expect it to moderate, it will remain elevated.
Business investment and exports are both picking up, and higher prices for many of the commodities Canada exports are bringing more income into the country. Robust business investment, improved labour productivity and higher immigration should help boost the economy’s productive capacity, and higher interest rates will slow spending.
Putting all this together, the bank forecasts that the Canadian economy will grow 4¼% this year, before moderating to 3¼% in 2023 and 2¼% in 2024.
That brings me to my second point.
The bank’s primary focus is inflation. The CPI inflation in Canada hit a three-decade high of 6.7% in March, well above what we projected in the January monetary policy report. The war has driven up the prices of energy and other commodities and is further disrupting global supply chains. While most of the factors pushing up inflation come from beyond our borders, with the economy in excess demand, we are facing domestic price pressures too. About two-thirds of CPI components are growing above 3%, which means that Canadians are feeling inflation across their household budgets, from gas to groceries to rent.
Our latest outlook is for inflation to average almost 6% in the first half of 2022 and remain well above our 1% to 3% control range throughout the year. We then expect it to ease to about 2½% in the second half of 2023 before returning to the 2% target in 2024.
High inflation affects everyone. Inflation at 5% for a year—or three percentage points above our target—costs the average Canadian an additional $2,000 a year, and it's affecting the more vulnerable members of society the most, because they spend all their income and because prices of essential items like food and energy have risen sharply.
This broadening in price pressures is a big concern. It makes it more difficult for Canadians to avoid inflation, no matter how patient or prudent they are as shoppers.
This brings me to my third point—interest rates are increasing. The economy needs higher rates and can handle them. With demand starting to run ahead of the economy's capacity, we need higher rates to bring the economy into balance and cool domestic inflation.
We also need higher interest rates to keep Canadians' expectations of inflation anchored on the target. We can't control or even influence the prices of most internationally traded goods. But if Canadians' expectations of inflation stay anchored on the 2% target, inflation in Canada will come back down when global inflationary pressures from higher oil prices and clogged supply chains abate.
We are committed to using our policy interest rate to return inflation to target, and we will do so forcefully if needed.
Increases in the bank’s policy rate raise the interest rates on business loans, consumer loans and mortgage loans, and they increase the return on savings. We have been clear that Canadians should expect a rising path for interest rates, but seeing their mortgage payments and other borrowing costs increase can be worrying. We will be assessing the impacts of higher rates on the economy carefully.
We recognize that everyone wants to know where rates might end up. How high are they going to go? It's important to remember that we have an inflation target, not an interest rate target. This means that we don't have a preset destination for the policy interest rate, but what I can say is that Canadians should expect interest rates to continue to rise towards more normal settings. By “more normal”, we mean within the range we consider for a neutral rate of interest that neither stimulates nor weighs on the economy. We estimate this to be between 2% and 3%. Two weeks ago, we raised the policy rate to 1%, still well below neutral. This is also below the prepandemic policy rate of 1.75%.
How high rates go will depend on how the economy responds and how the outlook for inflation evolves. The economy has entered excess demand with considerable momentum and high inflation, and we are committed to getting inflation back to target.
If demand responds quickly to higher rates and inflationary pressures moderate, it may be appropriate to pause our tightening once we get closer to the neutral rate and then take stock. On the other hand, we may need to take rates modestly above neutral for a period to bring demand and supply back into balance and inflation back to target.
Finally, let me a say a word on our balance sheet. As of this week, we are no longer replacing maturing Government of Canada bonds with new ones, so our balance sheet will shrink. This brings our exceptional monetary policy response full circle.
When the economy needed exceptional support in the depth of the recession, we lowered our policy rate to its lower bound and complemented this with quantitative easing, QE. Last November we ended QE and began reinvestment.
We have now moved to quantitative tightening, QT. With the economy fully recovered, it's time to normalize our balance sheet. QT will complement increases in our policy rate by putting upward pressure on longer-term interest rates.
Mr. Chair, I will stop here.
Senior deputy governor Rogers and I will be very pleased to take your questions.
It's a very important question.
If you look at our own projection, which we laid out a couple of weeks ago in our monetary policy report, what you see is that growth is moderating. Growth needs to moderate to bring demand in line with the economy supply capacity. That moderating growth is pretty solid growth: 3¼% next year and 2¼% the year after. And if you look at most private sector forecasts, they're broadly similar. They have inflation declining, with growth continuing at a more moderate pace.
I do want to underline, though, that getting this soft landing is not going to be easy. There is a delicate balance here. There are some good reasons to believe we can continue to grow while bringing inflation down. The two most important ones are, first, much of the inflation we have now comes from beyond our borders. We've seen increases in commodity prices and global supply chain disruptions. If oil prices stop going up and begin coming down—even just stop going up—and these global supply chain pressures begin to abate, we should see some natural reduction in inflation, provided we keep inflation expectations well anchored.
Let me underline that last point, which is critical. If we don't keep inflation expectations well anchored, inflation will get stuck at a higher level. So we need to do that, and that is reflected in our actions.
The second reason why you can have growth with declining inflation is that demand is running the house. We can see this in the labour market, where we have a very high level of vacancies. We have very strong employment, but we have a lot of vacancies. If we can moderate demand, we can reduce those vacancies, maintain high levels of employment, bring the economy back into balance and bring inflation back on target.
I'll make a few comments here.
First of all, the economy is strong. That means, yes, when the economy is strong, companies tend to do well, profits are healthy and wages go up.
We do look at how income gets divided between labour and business. Clearly you want shared prosperity. The other thing I would say is that—and this gets to price increases—for a long period before the pandemic.... We regularly go and talk to businesses. We survey them. We have a quarterly business survey, and one of the questions we ask them, when they get increases in their input costs, is if they are passing those on to their customers.
Typically what they tell us is that, yes, there's going to be some pass-through, but competition is really tough, our customers are very price sensitive, and it's very hard to pass those through, so there's very little pass-through.
Currently, against a background of an economy that's moving into excess demand, against a background of an economy where prices are increasing overall, what we're hearing is companies telling us that they're passing through price increases more quickly to consumers.
The best way to deal with that is really to get inflation down, to re-establish price stability.
One of the benefits of low, stable inflation is that then price increases stand out and consumers react and businesses are sensitive to that. That's one important reason why we need to get inflation back down, and that's why we're raising interest rates.
Thank you to the governor and the senior deputy governor for being here today in person.
Governor, you sound a little hoarse today and I think it's probably because you've been saying over and over to everyone who will listen to you that inflation is too high and that we need higher interest rates. You got a lot of things right and a lot of things wrong, the economy is moving to excess demand, and we note that you want to keep inflation expectations well anchored, and demand is exceeding supply.
Stephen Tapp from the Canadian Chamber of Commerce has noted that the nominal policy rate of 1% is still below the bank's estimate of the neutral rate, which is between 2% and 3%. He further noted that until your rate rises above 2% to 3%, “the Bank is pouring gas on the inflation fire”.
I know that the government can't help itself, it spends at any time it can, but you're different, Governor. Your institution is independent and your number one job, as of last December, is still price stability.
What is your explanation for continuing to pour gas right now on inflation?
First, I would say that, in Canada, inflation is slightly below the average in other countries, but Canadians feel it is too high, and clearly, we need to control inflation.
As for housing prices, what we have seen is a significant year-over-year increase of about 25%.
That factors into the consumer price index, or CPI, but not on a one-for-one basis. With the CPI, the idea is to measure the cost of the service being received, in other words, the house or dwelling. However, the cost of the service, to replace or improve the home, is based on the measure used for new homes. It is part of the CPI but does not have a direct impact.
If we look at the cost of housing within the CPI, we see clearly that it is rising sharply, and that reflects pressures here, in Canada. They are domestic excess demand pressures, not international pressures.
Yes, it is exactly as you've outlined. Through the pandemic, for services people wanted to buy and consume, they couldn't do it because that required close contact, so what happened was that people substituted that with goods. They couldn't go to the gym, so they bought home fitness equipment. They couldn't go to restaurants, so they bought better kitchen equipment. You could see this in the housing market in general. Many Canadians were working at home, their children were going to school at home and all the recreation was at home. Not surprisingly, they wanted bigger houses. That showed up in the housing market. If you want a bigger house, you want more furniture and new appliances.
Usually during recessions it's these durable goods that get hit more, because you can keep your old couch a little longer, but during the pandemic you were sitting on it all day. You were using it a lot more. It was very unusual, this big shift in demand for goods, and it wasn't just in Canada, it was globally. The effect of the very strong demand for goods, with these disrupted supply chains, is that we've seen very large increases in the prices of these goods.
As the pandemic recedes, we actually think that there will be some natural rebalancing of demand. We're already seeing it. People want to get back to going to the gym, going to their local restaurant and getting out, so what we expect to see is that the demand for goods will diminish as the consumption of services increases.
Now, overall, though, demand is running ahead of supply, so the average of that has to grow more slowly going forward than it's grown in the past, or else we're going to have ongoing inflationary pressures, so there are two things going on. We are looking very closely at this rotation from goods to services.
So far, what we've seen is a strong rebound in services. We're not seeing much reduction in demand for goods, and some of that may be related to these supply constraints. If you're trying to buy a car, well, it may take six months for you to get that car and for that sale to show up. We're not seeing yet much reduction in demand, and that's one of the reasons why the economy is strong. Hopefully, as those supply constraints diminish, people get the goods they wanted and we start to see more rebalancing. That's something we'll be watching closely.
Yes. If you go back to January—and I don't have the January report in front of me—before the war, we were starting to see some beginnings of easing of these supply chain disruptions. I would say that they were somewhat tentative, but if you looked at shipping delays, for example, they'd certainly peaked and they were starting to get through. On computer chips, for example, we were seeing some evidence that supply was improving. You saw some rebound in our own car production as they got the chips that they needed.
I would say that things were not improving perhaps as rapidly as we might have hoped, but they were starting to improve.
The war has certainly been a new setback. It is causing, particularly in Europe, some new supply chain disruptions. Certain key components of the supply chain that are produced in Ukraine—or Russia, for that matter, but more Ukraine—for example, neon, are not available now.
I think that what is more significant, certainly for Canada, is that global shipping is being disrupted.
Then, the other element I would highlight is what new outbreaks of COVID and new lockdowns in China are causing. The Port of Shanghai is very backed up at the moment.
So war and COVID continue to disrupt supply chains. We do expect, as we get into the second half of the year, that these things will work their way out. However, yes, there is considerable uncertainty about these supply chains, and unfortunately that's not going away soon.
I would point to a few things.
The first thing I should note is that the study we released lays out various scenarios. There is a lot of uncertainty around the effects of climate change and the associated risks, and we don't have the ability to make those predictions. However, having scenarios to assess those risks is extremely helpful and important.
The scenarios were based on the risks stemming from the transition to a zero-carbon economy, but the scenarios do not include physical risks, such as more frequent storms and droughts. We will nevertheless take those risks into account at a later stage.
Recent events have brought to light another aspect, time frames. Even our scenarios take into account time frames for initiating the climate transition. As Ms. Rogers pointed out, delaying policies is more costly.
That said, the scenarios are probably overly optimistic because the modelling includes assumptions for climate policy and forecasts. Under the scenarios, investments in new energy sources will become accessible as investments in oil drop, and coordination isn't really a problem.
Throughout the world, energy security is becoming increasingly important, but it isn't clear that supply will be able to meet demand.
We have a great deal of modelling work to do in terms of a scenario that involves weak coordination.
One of the things I appreciate about this chair is that he always saves the best for last.
We've talked about a number of different factors today, whether it's COVID, the war or climate change that has had an impact on inflation. We've talked about some domestic causes such as perhaps price-gouging in the corporate sector, which I think has been well documented by folks at Canadians for Tax Fairness and the Canadian Centre for Policy Alternatives. There's clearly a lot of conjecture, and we've heard some of it today, about the role of government on fiscal policy and inflation and perhaps some calls that were made at the Bank of Canada on the monetary policy question and “what if” scenarios that have come up.
If we rewind to any time prior to October 2021, a big part of that narrative from certain folks in Parliament was that pandemic benefits, particularly CERB and the CRB, were driving inflation. I mean, let's be honest: The largest share of government spending through the pandemic was on direct income support to Canadians. That's what we're talking about when we talk about fiscal policy. I think it was implicit, clearly, and sometimes explicit that the line of that argument was to say that if pandemic income supports were removed from the equation, you would see a slowing down of inflation now.
The pandemic benefit programs were all but completely cancelled at the end of October 2021. The programs that were put in place in this Parliament were quite a lot less. They were harder to access. They delivered less benefit to Canadians through the omicron lockdown than their predecessors did in previous waves, yet inflation spiked and has been doing so ever since the elimination of the benefit. I'm certainly not implying any kind of causal or even correlative link between the elimination of those programs and inflation, but it seems pretty clear to me that pandemic benefit income support was not a significant driver of inflation or we would have seen some kind of relief in inflation, had those programs not been there.
There are still people who are in significant distress, not because of lockdowns explicitly, but I think of people in the travel and tourism industry, specifically independent travel advisers. I think of people in arts and culture who, while venues are open, just haven't seen the same number of people coming back. In some cases they have, but in others they haven't.
I wonder if you have some reflections with hindsight on pandemic benefit programs and some thoughts about where there might be a need for ongoing support within certain important aspects of our economy like travel and tourism that we want to see come back. In a tight labour market, we don't want to see all those people convert to another area of the economy, because those are skills and expertise that won't be available to Canadian businesses as those industries rebound, which hasn't yet happened to the extent that we might like to see but is no doubt coming.
I wonder if you might provide some reflections on that for the committee.