FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Wednesday, November 7, 2001

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[English]

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

As everyone knows, the order of the day is, pursuant to Standing Order 108(2), for an examination of the November 2001 Monetary Policy Report.

I have the pleasure to welcome the Governor of the Bank of Canada, Mr. David Dodge, and the Senior Deputy Governor, Malcolm Knight.

Governor, welcome, and we look forward to your comments.

Mr. David A. Dodge (Governor, Bank of Canada): Thanks very much, Mr. Chairman. It's a great pleasure for both of us to be here today on the occasion of the release of our November Monetary Policy Report. As always, we look forward to coming before this committee the two times a year we issue that report to have a good discussion.

Mr. Chairman, right now all national economies face difficulties—difficulties stemming from the further weakening of the world economy and from the terrorist acts in the United States. As businesses, governments, and individuals in Canada—and indeed around the world—strive to come to terms with the implication of those acts, the main preoccupation is obviously with the near term.

But as I said in a speech in Moncton a couple of weeks ago, at times like these it really is very important that we step back and look past current developments to the longer-term trends and to the potential of our economy. Viewed from this angle the outlook is brighter. The progress we've made over the past decade in strengthening our economic foundations is remarkable, and it ought to stand us in good stead as we try to deal with the short-term turbulence we face.

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True, at the moment we are beset by tremendous uncertainties, and I think it's important that I start today, Mr. Chairman, by saying a few words on that subject.

[Translation]

When I appeared before you in May 2001, the Bank of Canada had expectations of a modest pickup in growth in the second half of 2001 and further strengthening in 2002. But, by midsummer, evidence began to accumulate that the expected rebound in U.S. investment would be delayed and that the economic slowdown there would be deeper and more protracted than previously expected. Economic activity outside North America had also begun to slow down.

In Canada too, there were signs that domestic demand, which had held up through the first part of 2001, was softening and that the correction of the stock market was less advanced than expected, particularly in the electrical and electronic sectors.

[English]

Then the terrorist acts in the United States and the worldwide fallout from them greatly heightened the degree of uncertainty, further dampening the near-term growth prospects. To underpin confidence in the face of this uncertainty we took the exceptional step of lowering interest rates by half a percentage point on September 17, outside our schedule of regular fixed announcement dates.

Mr. Chairman, the ongoing assessments of the terrorist acts really are difficult to evaluate, because these developments are unlike anything we've ever experienced in North America, and it will take some more time to understand their full implications. As I was saying to Mr. Nystrom earlier, in some ways at this point one needs to be a national psychologist, rather than an economist, to try to fully understand what's going on.

But if we consider the direct effects of these attacks, their immediate impact on consumer and business confidence, and the adjustments needed to address the increased security risks, the Bank of Canada expects output growth in Canada will be close to zero or slightly negative in the second half of 2001, and for the year as a whole that implies a growth rate of about 1.5%.

Members, as we look to 2002, the timing and strength of the recovery will depend crucially on geopolitics and on how soon confidence returns to normal in North America. But I would say this: once the uncertainty stemming from the terrorist acts dissipates, I expect that healthy growth in output, investment, and employment will resume, given Canada's strong fundamentals.

[Translation]

At present, one can envisage two scenarios. In the first, confidence could be restored quickly, and robust growth could resume, supported by the substantial monetary and fiscal stimulus already in place. In the second, confidence could stay week for some time and, consequently, growth would remain sluggish through most of 2002.

Under either scenario, our economy would still be operating at levels that are below capacity by the end of 2002. Core inflation is thus expected to fall to about 1.5% by the second half of 2002. Total CPI inflation is also expected to decline to about 2% by the end of 2001 and to move below that during 2002, if energy prices remain at or below their early September levels.

[English]

Now, members, based on these considerations, on October 23 we again lowered our key policy interest rate, this time by three-quarters of a percentage point. The cumulative reduction of a full three percentage points since January aims to support growth and to keep inflation close to the 2% target over the medium term.

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Given the many unknowns in the current environment, Mr. Chairman, we at the bank are going to have to continue to monitor the situation extraordinarily closely and adjust our outlook and our actions in the light of new information.

Mr. Chairman, Malcolm and I would be pleased to respond to your questions.

The Chair: Thank you very much.

We'll now proceed to the question and answer session. We'll begin with Mr. Kenney. It's going to be a ten-minute round.

Mr. Jason Kenney (Calgary Southeast, Canadian Alliance): Thank you, Mr. Chairman. I'd like to thank the governor and Mr. Knight for taking the time to appear before us today.

Governor, it's no secret to you that in the second quarter of this year, the economy in Canada came to a virtual halt. In the third quarter we saw negative growth, and I'm sure you would accept the overwhelming consensus that in the last quarter of this calendar year we are seeing negative growth as well. That means a recession. Do you agree that Canada is in a recession?

Mr. David Dodge: As we've said, our best guess is that growth in the second half of the year is zero or negative. The numbers will come out and will bounce around a bit as we get preliminary and then final numbers. But it's quite clear that essentially since May there's been no growth, and we probably are going to have something slightly negative in the second half; that's right.

Mr. Jason Kenney: So, in a word, you believe Canada is in a recession?

Mr. David Dodge: I've told you precisely what our best view on growth is. The precise measure, quarter by quarter, we're going to have to see. But, you know, last year at this time we were coming off a period of more than 4% growth. We're now at zero or slightly negative. It is not a healthy economic environment.

Mr. Jason Kenney: Generally speaking, as a matter of principle, Governor, at times of recession do you believe it's appropriate or necessary for fiscal policy to play a role in stimulating demand, alongside and in tandem with monetary policy?

Mr. David Dodge: I think one always has to be careful about very broad generalizations. As you will recall, in the early nineties, when we had severe economic difficulties, governments were limited very strongly by their fiscal positions. Indeed, during the last downturn and really sharp contraction, the Government of Canada, because of its fiscal position, actually had to reduce expenditures right in the middle of the recession.

We've done a lot of work—all of us, at the level of both the federal and provincial governments—over the past decade. We're now in a position where we can allow what we economists call the “automatic stabilizers” to work. We're clearly on the record saying we think it is appropriate at this time to allow those automatic stabilizers to work.

Mr. Jason Kenney: Of course, Governor, they will work. That's why they're called “automatic”. Unemployment insurance benefits will kick in. But do you really believe that's adequate on the fiscal side? Observing the American response—both aggressive rate cuts from the Fed; a $100-billion stimulative tax cut package, which is now in Congress, leaning heavily towards corporate tax cuts, in addition to $40 billion to $50 billion in additional spending—do you think that for the American context that's right? Do you think it's appropriate for the federal government here to simply let, as you say, the automatic stabilizers do their work without any additional fiscal policy response to a recession?

Mr. David Dodge: I think what is critical is that governments, whether federal or provincial, make those expenditures that will help us with long-term economic growth prospects and try to deal with structural problems in the economy.

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Now obviously, at this point in time we have a problem in terms of security measures, which affects in particular the federal government but some provincial governments as well. It's really very appropriate to move ahead with that problem because we need those measures for the long-term health and security of the economy.

Mr. Jason Kenney: I take it you would support the principle that the federal government should stay out of deficit and do everything possible to stay in a surplus position. Is that accurate?

Mr. David Dodge: What I've said—and it's quite clear—is that I think those automatic stabilizers should work. What we do know is that tax revenues are going to be considerably less next year than we thought they would be a year ago.

Unfortunately, it's quite probable that unemployment insurance payments are going to be higher than we would have thought a year ago. And it's quite clear we're going to have to spend some more on various measures related to security, and particularly security at the border.

Whether that means we end with a surplus of $1 billion or a deficit of $1 billion I don't think is really that material. What is critical is to continue to focus on those measures that improve the structure of the economy over the longer haul.

Mr. Jason Kenney: Governor, you're in favour of changes that will improve the structure of the economy. I infer, then, that you believe some government program spending is more useful in that respect than other program spending. Would you agree that the government should look at reallocating its priorities?

That's one question. I have a second one, and I yield the balance to my colleague, Mr. Solberg.

Today our dollar is trading at 62.62 cents—the lowest intraday trading in history, again. So you are, on the one hand of a mandate, trying to protect the Canadian currency—which is at its all-time record low with bleak prospects for the foreseeable future—and you are lowering rates to try to support the economy at a time of recession. How can you meet these two competing objectives? How can you support the Canadian dollar by continuing to lower rates? How do you deal with the conundrum?

Mr. David Dodge: We're very clear. Our job is to try to keep inflation at about 2%. What we see is that as we go through next year the core inflation is going to fall below 2% because of the weakness of the economy; therefore, we're taking the appropriate actions to do what we're trying to do, and that is to keep inflation at around 2%.

The Chair: Mr. Solberg.

Mr. Monte Solberg (Medicine Hat, Canadian Alliance): Thank you very much, Mr. Chairman.

I have a question about the U.S. dollar. Some people may think the U.S. dollar is overvalued right now. Considering the U.S. has really a massive current account deficit, do you believe it will bring the U.S. dollar back down to earth any time soon?

Mr. David Dodge: Forecasting prices of currencies is really a mug's game. Obviously, though, you're absolutely correct that over the long haul no economy can run current account deficits of 3% or 4% ad infinitum, and at some point a correction will come. As I've said before, I hope it will be smooth rather than very jerky and disruptive, but there will be a correction over time.

The Chair: Thank you, Mr. Solberg.

Monsieur Paquette, five minutes.

[Translation]

Mr. Pierre Paquette (Joliette, BQ): Thank you, Mr. Chairman.

A poll was published this morning which indicated that 55% of Canadians wanted a common currency with the United States. However, 59% were against the idea of immediately adopting the U.S. dollar. Therefore, Canadians agree on a common currency, but they are against the dollarization of the Canadian economy.

You once floated the idea that if economic integration with the United States accelerated, the Canadian dollar may disappear within a generation. But you later played down those remarks.

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At the moment, there is much speculation surrounding the Canadian dollar and this is normal. Europe has created its own common currency, and as a result there are fewer secondary currencies to catch the attention of speculators. But the Canadian dollar, as we have seen these past few days, will be constantly under speculative attack, as has the Australian dollar and the Norwegian crown have been.

In light of these events, don't you think that the Bank of Canada should seriously study the possibility of a common currency? Shouldn't the Canadian government also launch a debate on a common currency? If we do not do this, the American dollar may one day be forced upon us and we would have to submit to the dollarization of the Canadian economy, rather than taking control of the situation by setting up a schedule and setting out conditions, as was done in Europe.

I would like to know what your position is today regarding the possibility of a common currency with the United States.

Mr. David Dodge: I believe that the last time we appeared before the committee, we made our position clear. It has not changed since then.

For now and for the foreseeable future, it is in Canada's interest to maintain the status quo, that is, to set inflation targets and maintain a floating currency, because this approach allows us to react to any situation.

If, over time, the Canadian and American economies converge, it may be a good idea, but for now, our respective structures are fairly different, and a floating currency makes it easier for us to make adjustments to our economy when the relative price of products on the market change.

Mr. Pierre Paquette: Some people claim that the weakness of the Canadian dollar is an incentive for laziness in terms of investment and productivity, because there is a certain artificial benefit, a competitive advantage to the weak Canadian dollar. But in the long term, isn't there a risk that this will weaken our economy even further?

In certain trade areas, such as softwood lumber, which is currently on the table, the weakness of the Canadian dollar is a competitive advantage on the American market. It's not our only advantage, but it is one nonetheless.

Therefore, it is quite possible that the Americans are confusing the issues with regard to this matter, which led them, in the case of softwood lumber, to blame our forest management for our low lumber prices, when in fact the low prices are mostly due to the weakness of the Canadian dollar. Many companies do business with the Americans in US dollars. Is the Bank of Canada at least seriously considering various scenarios with regard to the creation of a common currency, including the process leading up to it?

Mr. David Dodge: The Bank of Canada has the mandate to study all sorts of issues relating to monetary policy, and these issues are constantly under study.

Malcolm, would you like to add something?

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

That is a very important issue. We always need to assess how monetary policy will be implemented. Under our current system, we have a target for inflation and a flexible exchange rate. In my opinion, this system works very well because the inflation target provides a benchmark to economic decision-makers. Since there is no volatility in terms of inflation, it reduces economic uncertainty.

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But unexpected events can occur anywhere throughout the world. The exchange rate is very flexible in our economy and we can make the necessary macroeconomic adjustments depending on the situation.

We are conducting analyses in this area, but we are convinced that the status quo represents a good system in today's world.

Mr. Pierre Paquette: Do I have the time to ask another question or to make a brief comment?

A few months ago, I attended a conference organized by the Raoul-Dandurand Chair. The conference was on the conditions with regard to a common currency of the Americas. Participants came from Japan, Asia and from throughout the United States, but there was no representative from the Canadian government, and this shocked me. People who do business with us had travelled from the four corners of the earth to find out about this possibility, but there was no representative from the Canadian government. I find it completely irresponsible that we should stick our heads in the sand.

The 2% target is mentioned frequently in your documents. But the target range varies between 1 and 3%. I must say that I am very satisfied with this. I am an economist and I used to work for the CSN. At the beginning of the 1990s we denounced the Bank of Canada's policy countless times, because at the time we were in a recession and our interest rates were very high, whereas Americans were lowering their rates. As a result, their job-creation figures were much higher than ours. In Canada, the unemployment rate was artificially high because of the overly restrictive monetary policy.

No one knows what the future holds, as was evidenced by the events of September 11. Within this target range of 1 to 3%... The economy was slowing down, we expected the target to be below 2%, but if at a certain point oil prices surged because of activity in the Middle East or for whatever other reason, and inflation rose above 2%, would you be willing, to promote economic recovery and save jobs, to accept an inflation rate above 2% in the interest of growing the economy?

Mr. Malcolm Knight: In fact, we have already done so. Since March of 1999, energy prices have risen considerably. The rise of energy prices was a marked influence on our inflation rate in terms of the overall index. At the beginning of this year, from January to May, the inflation rate as measured by the overall index was above the ceiling of our target range, but we knew that economic activity was slowing down and we were able to lower interest rates as of January. We were able to do so because we use the trends index for our operations when we implement monetary policy.

Depending on the circumstances, our system allows us to temper fluctuations in the level of activity. This is one of the reasons why we have a target for inflation.

[English]

The Chair: Mr. Pillitteri.

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

Governor, it's good to see you again.

Governor, I want to ask you something a little different from what some of my colleagues are going to be asking you. Being a businessman—an entrepreneur—most of my life, I recall in the 1990s interest rates at 9.5%. I recall unemployment at 11% and 12%. Of course, I also recall a very high Canadian dollar and lower interest rates in the United States.

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Today, I want to send a message, not only to myself but even to those businesses like me—a small business in which we employ less than 50 employees—that, yes, I'm comfortable with the somewhere around 5% interest I'm paying today. That's a lot better than I could ever think of before.

But as of September 11, automatically as we're on the border with the United States, the losses of income within the business, specifically in the tourist sector, have been immense. But we, as a business, are able to still carry on the burden of small business and say that we don't want to really have the balance and the thing that you can lay off some people and still stay in business. I don't think this has taken place. I think most of the people I've talked to are still carrying on their business, hoping that it would come in, let's say, six months or a year.

Governor, what can you assure us, or can you give us an idea of how long this will take before...? As I said, we're willing to take some of the losses as businesses, because still, as I see it, housing is not down, housing is still up, the auto sales are still up, big item tickets are still selling—all of those components that give us some assurance are still there. Can we continue to believe that this is only a short-term effect on us, or should we be making more plans in the long term?

Mr. David Dodge: I think all of us at the bank would wish that we could give you an absolutely definitive answer to your question. But I think we would be unwise to do so, simply because, well out of the bounds of economics and finance, we really don't have a full idea of how things are going to transpire in the world as a whole, and indeed how attitudes and confidence are going to transpire in the United States.

But what we can say is that Canadian confidence, Canadian sales, Canadian investment has held up better than across the border in the United States. The effects of September 11 in the United States really have been very large coming on top of an already weak manufacturing sector there, and we don't know how reactions—consumer and business—are going to go.

What we've said is that one can imagine the scenario where, if there are no further really big disturbances, confidence could return fairly early in the new year, and we could actually have relatively strong U.S. growth commencing sometime in the first half of 2002 and carrying on, in which case a lot of our problems would evaporate with that. But we don't know; it could be a lot longer.

The impact on Canada of that is direct in terms of lost sales for small business or large business across the border. But it also creates worries among our businesses that the border may get closed to them at some point or the costs of moving goods across the border may be closed.

So there is a degree of uncertainty here that stems not directly from the uncertainty of business and consumers in the way it does in the United States. But it is possible that Americans might take action to make movements across that border less free, and that is an additional worry and obviously something that you as parliamentarians are going to have to work on.

Mr. Gary Pillitteri: Thank you.

The Chair: Thank you, Mr. Pillitteri.

Mr. Murphy.

Mr. Shawn Murphy (Hillsborough, Lib.): Thank you, Mr. Chairman.

Just following up on the points raised by Mr. Pillitteri, does the Bank of Canada have projections going into the second half of 2002? What are your best-case projections for GDP growth? Do you expect us to return to normal by the second half of 2002?

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Mr. David Dodge: Let me say first that, based on the economics that we observe and the structure of the economy, when the recovery does start, we believe it will be fairly strong and that we will observe growth rates in a quarter in the order of 4% in annual rates. Whether that commences in the second quarter of 2002 or the third quarter of 2002 or the fourth quarter of 2002 is very difficult to say. As I said in response to Mr. Pillitteri's question, I wish we could say, but we would be misleading you and all Canadians if we were to try to give too definitive an answer to that.

We're working, as a working hypothesis, that we will begin to see that strong growth in the second half of 2002. But that still means that at the end of the year the level of economic activity—not the rate of growth, but the level of economic activity—is still going to be less than our potential level of economic activity, and we therefore expect prices to be increasing probably in the order of 1.5%, well below the target. And that is what we're looking at as we make monetary policy.

Mr. Shawn Murphy: I understand also that with a lot of the monetary interventions that are taking place now—your lowering of interest rates in the last month and a half—there is generally accepted a six-month lag in some of the stimulus effect.

Mr. David Dodge: There is certainly a lag. Whether that is six months or 12 months depends a bit on conditions, and even as we go back in history it's hard to sort it out. Certainly the full effects—but here I turn to my colleague—may only be felt as far out as 18 or 24 months.

Mr. Malcolm Knight: Yes, I think that's certainly the evidence we have from the research we've done. But following on from your question, I think one of the points the governor has raised is that the speed with which monetary policy or other policy actions operate on the economy depends a lot on the degree of confidence that consumers and business people have. That does create more uncertainty about what will be the lags in the impact of our policy actions over the next year or so.

Mr. Shawn Murphy: That leads to my last question, Mr. Chairman. This may not be a fiscal or a monetary question. It's perhaps more a psychological question. But is there anything in the literature or in the knowledge that indicates what has the greatest effect on consumer and business confidence? That seems to be the problem you're coming back to. You don't know, because you don't know the extent of where the business and consumer confidence is going. Is it fiscal policy? Is it monetary policy? Is it political rhetoric? What is the mix that causes the business and the consumer confidence either to increase or decrease in today's economy?

Mr. Malcolm Knight: That's a very good question. I wish I could give you a full answer. We do know that the biggest thing that affects consumer confidence really is employment prospects and what's going to happen to disposable income. Obviously the biggest thing that affects business confidence is expected profitability. The fundamental problem that we have in looking at the situation—and it's a problem that all economists have at this point—is that it's very difficult to translate the kind of uncertainty that has been created in the world by September 11 and its aftermath into a clear idea of how it's going to impact on profitability and employment. Those are the problems that businesses are experiencing right now.

The Chair: Thank you, Mr. Murphy.

Ms. Barnes.

Mrs. Sue Barnes (London West, Lib.): Thank you.

Welcome, both of you, and thank you for coming.

I'm going to follow up on some of these psychology questions, because I think they're more fundamental than a lot of the theories we've had today with the traditional academic economics. People do modify their behaviour as soon as someone starts talking about the word “recession”, and they modify it in a number of areas. They modify it in the way they spend, in the amount of debt they're prepared to carry, and in the way they save. It's all that different decision-making, and it's so much how people talk about everything happening to them when times are worse economically. They really become passive and wait in a reactive mode, whereas in their normal lives they go about making decisions and following through. They don't spend a lot of time making those spending and saving decisions as to, for example, whether they can afford to rack up their Visa bill or whatever. It's that psychology.

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How critical is it? Can the actions of individual Canadians on those three fronts, spending, saving, and debt load, have a larger effect as opposed to business than most people believe? I see the business as a reaction to the spending, saving, and debt thing whereby individual Canadians have actually changed their behaviour.

Mr. David Dodge: Let's be very clear. You're absolutely right. Consumers or households represent about 70% of demand in the economy, so if households go on strike in a sense, then no business is going to be able to sell very much. That's absolutely true, and household confidence is indeed extraordinarily important.

I think it is also true—although this is by observation and not by professional analysis—that in times like these, where we have very new circumstances, people tend to sit and wait, just as you have said.

What will trigger them to get moving again is very hard to say. What is particularly critical for our growth is what is happening to the American consumer, unfortunately. Our observation is that the Canadian consumer has not been—let me use a very unscientific word—as traumatized by the events of September 11 and their aftermath as has been true in the United States.

It's very difficult, because our economies are tightly linked. Eighty-five percent of the cars produced in Ontario are sold south of the border. Even if Canadians consume a lot of automobiles, it doesn't help too much in terms of additional production in Oshawa, Windsor, or Oakville.

The Chair: Mr. Nystrom, you have five minutes.

Mr. Lorne Nystrom (Regina—Qu'Appelle, NDP): Thank you very much, Mr. Chair. Welcome, Governor and Mr. Knight, here today.

I'd like to ask you questions in three areas if I could.

First of all, on dollarization, this is sort of a supplementary to Pierre's question. In 1991 Argentina decided to peg the Argentine peso to the American dollar, and we know they're now having an economic and financial disaster in Argentina. I wanted to know what the governor's view is about the Argentine disaster in terms of what it says about a single currency between Canada and the United States. Do we have anything to learn from the pegging of the Argentine peso to the U.S. dollar and the lack of flexibility in that economy in terms of what might happen in this country if we adopted dollarization? You said the bank researches everything.

Mr. David Dodge: Thank goodness the situations in Argentina and Canada are very different and were very different at the beginning of the 1990s. Currency boards are the regime Argentina adopted to provide some sort of anchor to their policy because they were not credible on fiscal policy and they were not credible on monetary policy. The currency board they adopted was to provide that anchor.

It also really tied the hands of the Argentine authorities very much. While that was helpful initially in providing confidence, it certainly has made life very difficult in the last few years. I certainly don't think Argentina is a country whose example we would want to follow.

Mr. Lorne Nystrom: I'm glad to hear that.

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I have a second question. Last June the bank decided to privatize the administration of Canada Savings Bonds, losing one of our symbols of Canadian sovereignty. I've had a lot of constituents write me and call me about that in terms of the savings bonds, their value, the sovereignty, and the symbolism of the whole thing.

I wonder why you would do this. How much money did you save in doing that? Why would you privatize the administration out to a Texas company, ADS of Texas? Of course, the call centres are still in Canada. There's one, I think, in Mississauga, and there's one here in Ottawa. But why privatize the administration of Canada Savings Bonds to a company in George W's state?

Mr. Malcolm Knight: The first thing I should make clear is that we still oversee the administration of the after-sale service of Canada Savings Bonds. We're responsible for it.

Now, the people in the operation were very efficient and the software we were using was very efficient. However, we found that we were running an operation that was still costing more than it would have if it were being operated by a company that could leverage these very high-quality assets we had over other businesses. We believed that by outsourcing those after-sale operations while still overseeing the operation, we could significantly reduce the cost of administering the Canada Savings Bond campaign. Those are savings that ultimately flow to the Canadian taxpayer.

Mr. Lorne Nystrom: So merging the U.S. and Canadian dollar would be cost-effective. Would you recommend doing that as well?

Mr. Malcolm Knight: As the governor has pointed out, I think we're talking about a monetary regime. We have a very clear policy framework of inflation targeting with a flexible exchange rate. We think that works very well for the Canadian economy and the Canadian people. It's very interesting that it's a monetary policy framework that's being adopted by other countries as well.

While we weren't at the particular conference Mr. Paquette mentioned, we sponsored a conference in June of all the G-20 countries to discuss the types of exchange rate regimes that are best, given a country's circumstances. There were differences of view there, but I think in our country's circumstances it's quite obvious that we're doing the right thing.

Mr. Lorne Nystrom: My third and final question concerns the debt management strategy of the Department of Finance. The Bank of Canada now holds about 8% of the Canadian market debt. The Canadian debt altogether in terms of market debt is about $440 billion. Back in 1974 it held about 21% or 22% of it. Would the bank consider assuming more of the market debt as bonds become due?

One argument is, if the bank held more of the debt, there would be more money to spend on infrastructure and so on. We're still paying about $42 billion a year in servicing our debt. If you were to move another 4% of that to the Bank of Canada, it would arguably free up some extra cash to spend on things like social housing and helping the prairie farmers in my part of the world.

There are more and more people speaking this way, not just Paul Hellyer, but several others as well.

Mr. Malcolm Knight: There are two points I would make. First, you talked about Argentina a little earlier. One of the great vulnerabilities in Argentina is the high level of its public debt. Here in Canada, in recent years, we have brought the level of our public debt down very significantly relative to the size of our economy. That's an element of vulnerability that's being reduced.

On the actual amount of government debt that's held by the Bank of Canada, I have to say to you that the considerations there are primarily in terms of how we implement our monetary policy. When we are injecting liquidity into the system to enforce a lower level of interest rates domestically, we automatically tend to buy more government debt. At time when we're trying to tighten monetary conditions so we can slow down inflation, we tend to buy less government debt. The exact amount of government debt we're holding against any measure, in absolute terms or relative to the total debt stock, is not really a very important consideration except in that it helps us to implement monetary policy.

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The Chair: Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC/DR): Thank you, Mr. Chairman, and thank you, Mr. Dodge and Mr. Knight, for being here with us today.

The first question is with regard to the hollowing out or the gutting of Canadian corporate assets that has occurred in recent years and that seems to be accelerating. As the dollar drops in value, we see an increased level of foreign takeover of Canadian corporate assets, whether we're speaking about a West Coast Energy, a Canadian Hunter, or a MacMillan Bloedel. There's significant concern out there about this trend. Do you agree with most economists that in fact the weak Canadian dollar has helped create this fire sale and as such jeopardizes Canadian economic sovereignty?

Mr. David Dodge: I agree with most economists that the lower value of the Canadian dollar has had virtually nothing to do with it.

Mr. Scott Brison: So are you actually saying that the low Canadian dollar has not helped create this fire sale of Canadian corporate assets by comparatively devaluing our corporate assets?

Mr. David Dodge: First of all, let's be clear about what's been happening over the last little while. In fact, Canadians have been making more foreign direct investment than foreigners have been making in Canada. Our net international indebtedness has been falling. Indeed, if you go back—and I may not have the precise numbers, but this is roughly right—to the early nineties, what you will find is that Canadian net international indebtedness—that includes direct as well as portfolio—was in the order of 45% of GDP. Today it's in the order of 20% or just a little bit less; if you look over the past four years, Canadians have, just on foreign direct investment, been doing a lot more abroad than foreigners have been doing here.

Mr. Scott Brison: You disagree that there has been a trend of foreign takeover of Canadian corporate assets?

Mr. David Dodge: On balance, Canadians have been taking over more foreign assets than foreigners have been taking over assets in Canada. There is a consolidation going on around the world in terms of business assets. It is certainly true—you mentioned the oil industry—that in that process of consolidation a lot more of the Canadian assets have been purchased by foreign firms. That's undoubtedly true.

Mr. Scott Brison: The Bank of Canada has maintained a high-dollar policy for most of the 1990s if you compare inflation targets here with inflation targets of the Federal Reserve in the U.S. Yet we have a low-dollar result. You've described some of the fiscal structural issues that differentiate our economy from that of the U.S. Would you agree—and you've also mentioned productivity as an issue—with your counterpart, Mr. Greenspan in the U.S., when he made the following statement about capital gains taxes:

If capital gains taxes were eliminated, we would presumably, over time see increased economic growth, which would raise revenues for the personal and corporate taxes....

Indeed its major impact is to impede entrepreneurial activity and capital formation.

Would you agree with Mr. Greenspan, your counterpart in the U.S., that one of the features or structural deficiencies of the Canadian economy is our capital gains tax regime?

Mr. David Dodge: No.

Mr. Scott Brison: So what structural deficiencies would you like to see addressed fiscally? You've referred to them, so what are those deficiencies? Are they solely debt? Are they tax-based? Do we need more government spending? Is that what you're saying?

• 1625

Mr. David Dodge: Obviously, we in this country are struggling to try to improve our productivity, and there are clearly some impediments to making that improvement on the part of business, and indeed on the part of government. It's up to us all to do better.

There are no simple answers, and I certainly wouldn't presume to come before you and provide simple answers to this. It really is quite a struggle, working away on a lot of fronts.

Going back to Mr. Nystrom's question, one of the ways we had actually hoped to get the productivity of these extraordinarily talented people we had running the Canada Savings Bonds up was to put them in an environment where they could take on more work so their work would be spread more evenly over the course of the year. So in part what we were really trying to do was create an environment where they could perform to their maximum potential.

Mr. Scott Brison: On the question of productivity, would you agree with many economists that in fact the low dollar actually reduces productivity, first by creating a false sense of security for Canadian exporters, in that they do not feel compelled to make the types of productivity enhancement investments they might otherwise, because they are, at least in the short term, insulated by the low Canadian dollar, and second, by increasing the costs of productivity enhancement equipment, which is typically imported and would be paid for in foreign dollars?

Mr. David Dodge: I don't think so.

Let's take the example that was raised earlier of the lumber industry. This is an industry in which Canadian companies, both medium and large-sized, have made tremendous investments over the past decade. The efficiency of Canadian mills is much higher than the efficiency of U.S. mills, and particularly higher than those in the southeastern part of the United States. Yet this is the very sort of industry you're pointing at, saying people may get lazy if there's a fluctuating dollar.

I don't think there's evidence to support the statement that somehow you get lazy in those circumstances. That's not to say some individuals, some firms, may not rest on their oars from time to time, but I don't think there's any systematic evidence that indicates that's the case.

The Chair: I have a question, Governor. In reference to page 12, “Technical Box 1”, “The Near-Term Economic Effects of the Terrorist Attacks”, in reading your report I noticed you basically addressed the economy in North American terms, and I can read you one line where you say “Given our proximity to the United States and the highly integrated nature of our economies, Canada is particularly affected”.

So there's no question in your mind, Governor, that we have a North American integrated economy, based on what is in your report. This North American integration does make some people uncomfortable, although they are living that reality every day. I'm just wondering what other areas we can look at and draw benefits from in the sense of integration. What other areas could we work toward achieving integration with? I gather we are in this North American economic unit because we are drawing benefits from it.

Mr. David Dodge: Mr. Chairman, I'm not quite sure how to respond to that.

Let's start with your first premise. Every economist is, by training, in essence a free trader and would like to do away with those barriers that prevent exchange, because there are real gains from exchange. We've been working away at that in Canada since 1947, certainly, and with the FTA and the NAFTA now we've pushed it further.

Obviously, as you go further and further, some of the gains become harder to get. If you have a 25% tariff and you eliminate the tariff, obviously there are quite a few gains that come right away.

• 1630

But yes, I think you are right, and it's not just the United States; it's around the world. There is going to have to be some degree of harmonization of rules and regulations as we work to facilitate trade over time, both trade in services and trade in goods.

The Chair: Earlier, in reference to a question related to common currency, you used the term “convergence”. When does that happen?

Mr. David Dodge: There are two important things. One is the issue of integration, which is how much flow takes place. The second is what the structures of the economies look like.

Our economy has quite a different structure from that of the United States. What that means is when we get big movements in relative prices of different goods, they affect the economies of our two countries very differently. Whether over time those structures will converge or diverge—i.e. greater specialization rather than less specialization—we don't know.

There are some areas where they probably can, where they're almost bound to diverge. We're going to develop more of our oil and gas reserves relative to the size of our economy than the Americans are ever going to. So to the extent we rely more on North American oil and gas reserves, we're going to become more concentrated and more unlike the United States. In other areas, we may in fact become more like the United States. But we don't really know.

That's the point I made earlier, that it could well be that in 30 years' time, the economic value of having that separate currency will be considerably less than it is today, because the structures of the economies will have converged. On the other hand, if they diverge, which is entirely possible, the value of having a separate currency would be even greater than it is today.

The Chair: Thank you.

Mr. Discepola.

Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.): Thank you, Chair.

Governor, I would like to ask you two small questions. I couldn't agree with you more that the biggest problem right now, as you mentioned in your opening remarks, is that our preoccupation should be with addressing the short term. I believe if we can get over the next five- or six-month hurdle, we'll probably go on to addressing the long and medium term also.

Consumer confidence is probably at an all-time low. I believe personally that the events of September 11 only exacerbated an existing condition that was mounting up before, because we had the likes of Nortel and other large companies laying off people by the tens of thousands before September 11. So I'm not convinced that by keeping interest rates low, for example, it's going to stimulate consumer confidence. I think that will happen only once the economy starts picking up again. I have a concern every time I hear your inflation targets. You seem to have a fixation with this 2% inflation target, and I'm wondering why 2% is so magical. Why can't it be 3%, 4%, 5%, or 6%, if that would stimulate consumer confidence?

Second, I believe as a government we have upcoming in the next budget an occasion that may present itself only once. When I see what's going on in Congress, where President Bush has passed through, what is it, a $100 billion government expenditure, I question whether that was wise. I want to know your opinion on it, because I wonder whether a fiscal stimulus is required in the upcoming budget. If so, what could it be, what should it be, and should it even be at the expense of creating a deficit? I heard an economist, I think as late as this week, admit that a $1 billion to $2 billion deficit wouldn't be the end of the world if we were able to stimulate the economy. I'd like your feedback on that, please.

And if you can't give the Minister of Finance advice—I know he can't give you advice—maybe you can give it through this committee.

• 1635

Mr. David Dodge: I'm loath to provide advice on specifics, although I would like to go back and pick up, very much, on your first point that we just have to get through the short run. I would hope that is not how we look at things. Indeed, there's great danger, I think, if we look at things only in the short-run perspective. I think we all have to be looking at what it is that is going to improve all of our chances for success down the road, and not just over the next little while, because if we get too short term in our outlook, then in fact we can make some very real mistakes that will impede our ability to serve Canadians down the road.

I would make a real plea here, in whatever Parliament decides to do in this regard, that it not be something that is done for the payoff over the next two or three months, but very much with an eye on what's going to be helpful down the road.

Beyond that, I think all I can say is that in respect of the impact over the short haul of different types of policies, we know a little bit from history. The little bit we know from history is that a fairly high percentage of temporary tax reductions tend to get saved and so their stimulative effect is not very high. Secondly, on the expenditure side, programs that take a lot of planning so that the actual impact only happens two or three or four years down the road, tend to actually provide the stimulus just at the wrong time.

It's very difficult, either on the tax side or the expenditure side, to actually arrange things so that the timing of the impact is right. It was extraordinarily good management that last fall there was a major permanent income tax cut, because that's having its effect exactly at the right time. But that was not done for timing reasons; that was done because of its long-term positive economic effects.

Malcolm, you've observed many countries as you've gone through your years at the IMF. Are there lessons from other countries that would be useful?

Mr. Malcolm Knight: I really did want to react to your question about why we are so fixated on maintaining inflation low and stable at 2% a year. You asked, wouldn't 5%, 6%, 7% give consumers more confidence and create better conditions for growth? I have to say that from my international experience that the governor just referred to, I couldn't disagree with you more on that.

I really think the problem with managing aggregate demand so that we get high inflation rates is that high inflation rates don't stay stable. It creates a tremendous amount of uncertainty, it causes a vicious circle with the exchange rate as well, and it ultimately doesn't strengthen consumer demand and consumer confidence. It does the opposite. And high sustained inflation, of course, results in much higher interest rates than would otherwise be the case.

One of the good things about the weak period that we're in is that whereas in the past we've gone in from a situation where inflation was too high and it was necessary to raise interest rates very sharply to cure the economy of inflation and that pushed down activity, now we are in a period of weakening but with very low interest rates, and ultimately that should contribute to both consumer and business confidence.

• 1640

Mr. Nick Discepola: Your policy always seems to be just to watch what the federal government does in the United States, what the Federal Reserve does down there, and usually adjust in reaction to it. I'm saying, does interest rate reduction really stimulate consumer confidence, which is what's needed at this stage?

Mr. David Dodge: First, there are two questions, so let me take them both very briefly. What we do is what we think is right for Canada in the circumstances. We will from time to time move in the same direction as the Federal Reserve, other times we may not, but we're doing what we think is right for Canada.

This report concentrates on how we see the outlook in Canada and hence what is the appropriate policy for us. Obviously, we're affected very much by the rest of the world as a hugely open nation. That would be my first point.

The second issue is that it's not the precise number around the interest rate but where we are that's very important. If you look at where we are today compared to where we were in the early 1990s, or where we were in the early 1980s, in fact because we've had low and stable inflation, because expectations are firmly focused on the fact that people have confidence that they can only expect 2% inflation over the medium term, what we're able to do is push interest rates down so that even though consumer debt is considerably higher today than it was in the early 1990s, the cost to households of carrying that debt is just a little over 8% of their income today versus a little over 12% of their income back then.

Now that we've gone through the difficult period of adjustment, there are very large advantages to being there, and that tremendously does support consumer confidence. It's not necessarily the sole source of providing it, but it certainly supports it.

The Chair: Mr. Solberg, and then we'll go to Dr. Bennett.

Mr. Monte Solberg: Thank you, Mr. Chairman.

Governor, we have the dollar flirting with an all-time low today, and of course we have interest rates that are at lows we haven't seen in a long time. I'm wondering what would happen if we had another terrorist attack in North America, especially if we had one in Canada. Obviously, in that scenario you'd see a flight of capital out of this country. And we have a concern, of course, about protecting the dollar.

What capacity does the bank have to ensure that the dollar doesn't plummet below 61¢ and itself start to become an issue of consumer confidence and start the spiral downward? How do we deal with a situation like that? I don't think it's beyond the pale that something like that could happen. You must have plans in place. How do you deal with it?

Mr. David Dodge: First, let's go to the major premise of your question. It's not at all clear that in such a circumstance people would necessarily panic about being here in Canada.

Mr. Monte Solberg: We've seen the dollar drop fairly substantially since September 11, and I think there is concern that the Canada-U.S. border would close up. Investor confidence would be shaken by that. Anybody who has money in here and tried to export into the U.S., or people who were thinking about investing here, would be concerned about that.

Mr. David Dodge: The premise there is slightly different from what you initially gave. I think you put your finger on what we at the bank, from an analytic point of view, would see as a major problem that has stemmed from September 11 and continues to be there, and that is the fear on the part of Canadians, Canadian businesses, and the fear on the part of foreign businesses, that Canada's ability to move goods and services across the border would somehow be shut down, and would be shut down by the American authorities. And I think you are absolutely right that this is a potential contributor, or is now contributing, to the hesitancy that we observe on the part of firms to make investments.

• 1645

That's not something, I'm afraid, that we at the bank can really deal with. That's an issue of more general policy for the Government of Canada and the provinces.

Mr. Monte Solberg: Right, but when the U.S. attack happened there was a liquidity issue. What kind of plans do you have? And what capacity do you have to move in a situation like that? Speaking generally, do you have to resort to driving up, overnight, interest rates to keep the dollar strong? Is it a concern? Do you even worry about the dollar? Do you allow it to sink? Do you buy dollars? Do you have to count on the Bank of England or the Fed to buy dollars? What would happen in a situation like that?

Mr. David Dodge: There are several different sorts of situations. I'll ask Malcolm, who was in charge when September 11 hit, because I was in the air over the ocean, to talk about how we dealt with that. We are very well equipped domestically and in terms of our relations with other central banks to try to deal with that sort of a situation.

In a situation where there is an absolute sudden loss of confidence in things Canadian—let's put it that way—and everybody rushes to the exits, it really is a question of the nature of that particular event. The answer is that we have quite a few tools at our disposal to deal with this. But generally speaking, it will be something that goes well beyond monetary policy, and it will require not just coordination with other monetary authorities but obviously for governments to take some action as well.

I think it is interesting, the question you asked, how we did deal with September 11. Maybe, Mr. Chairman, it would worth having Malcolm give you a couple of minutes on how we dealt, I think pretty successfully, in Canada and around the world with a difficult situation.

Mr. Malcolm Knight: Thank you, Governor.

I think it's very important to deal with two separate aspects of this. One is the very short-term financial conditions that arise when there's an unforeseen event. The other is the broader question of what impact will that event have on the economy going forward, and what does it mean in terms of the conduct of monetary policy and other policies?

In the case of September 11, we did have, of course, to make sure we had very close contact with the financial community, with the Toronto Stock Exchange, with the investment dealers, and with the large financial institutions. Broadly, we felt that experience went very well.

The big concern on Tuesday, September 11, was that as the unfolding of the horrific events took place, we did see a gridlock starting to develop in what we call our large-value transfer system. That would have been quite serious, because it's through this system that all the payments between the financial institutions ultimately go through the Canadian economy. So we took pretty active measures in the middle of the day to reassure cash managers that we would supply a very large amount of liquidity to the system overnight on a collateralized basis.

Normally, to give you an example, we would put into the financial system, towards the close of the day, about $15 million to grease the wheels of the financial system. But on those days we put in 20 times that. We put in $1 billion. We also took other measures that I think were quite important in helping cash managers manage their positions, such as through special repurchase operations and so on.

• 1650

I don't want to get into all the technical aspects of that. We've done a post-mortem on how we did on September 11. We've talked to the bankers, and we will continue to do that. Part of the work there will be developing scenarios along the lines you've suggested, to try to think about what other situations we might need to respond to.

The other element of this is the longer-term question of what to do in monetary policy. The fact of the matter is that although there is a great deal of uncertainty in the economy at this time, we have created a situation over recent years where we have sustainable fiscal positions at the federal and provincial government levels. We have low and stable inflation. We have a current account surplus. So the kind of loss of confidence you're suggesting might occur seems unlikely.

On September 17, the same day the Fed did it, we reduced interest rates by 50 basis points because we felt that was necessary to underpin confidence. Since that time, of course, we've taken another action to reduce interest rates. We think that's highly desirable in managing monetary policy and in managing the economy going forward.

So there are those two separate aspects. We're working very hard on both of them all the time, but they are in some ways quite separate.

The Chair: Mr. Kenney, you have one question.

Mr. Jason Kenney: Thanks, Mr. Chairman.

Mr. Dodge, you seem to be unconcerned about the fact that the Canadian dollar has lost 25% of its value over the past eight years. I understand and appreciate the fact that we have low and stable inflation. That's a great accomplishment for which Canadians paid dearly. Your predecessors were very important in achieving that objective. But aren't you and the bank the least bit concerned that we now have a dollar that was at 89¢ U.S. ten years ago and is now at 62¢ U.S.?

The second part of that question is, how low is low enough? You have an inflation band. At what point does the value of our currency become a concern for the monetary authority of Canada?

Mr. David Dodge: Obviously, we have a lot of concern about the currency, in the sense that for trade purposes and for investment purposes one would like it to be trading at a level that is more or less consistent with the fundamentals out there. At the moment it is probably fair to say it is below levels that would be consistent with those fundamentals.

Of course, the Bank of Canada is concerned in that regard, but let me be very clear that over the longer haul, if you chase the day-to-day values of a currency—and Mr. Knight can tell you a lot more about countries that have tried to do that—it only weakens the national economy and in the end weakens the currency.

The best thing we can do is focus on getting the job right, in having confidence in the future purchasing power of that currency. Obviously, exchange rates can't affect that, hence that has an impact on what we do. But to maintain that purchasing power, to maintain the faith that Canadians have that purchasing power will be maintained.... Part of the purchasing power is also the ability to buy foreign goods and services.

• 1655

So the answer is yes, we're very concerned. We express that concern by operating so that we hit our inflation targets.

The Chair: Ms. Bennett.

Ms. Carolyn Bennett (St. Paul's, Lib.): Thanks, Mr. Chair. I have two little ones.

First, in all of the discourse since September 11, there has obviously been concern around money laundering and what the role of the bank might be. What does the bank do to clamp down on this? What tools do you have, and how do they compare with the rest of the world? Is there more we should be doing?

My second question maybe comes a little bit on the heels of Mr. Discepola, in that in the conversation around the Canadian dollar, dollarization and stuff, people sometimes don't quite know what you do. In the grade 10 classes in the riding, they might want to know what you do, and whether having a separate Canadian monetary policy is necessary. How does it actually work when you change an interest rate? What does and should that do to the economy?

It would be good for those in the classrooms around the country, and maybe even for some members of Parliament, to know why Canada needs a separate fiscal policy and a separate monetary policy from our big brother.

Mr. David Dodge: Let me take the first one. The Bank of Canada is not responsible for the international money laundering side. The Department of Finance and, on a day-to-day oversight basis, the Office of the Superintendent of Financial Institutions look after that. We are really responsible for overall financial stability, but not that particular part of the operation.

What does the Bank of Canada do? That's a good question and one that often gets asked. Our simplest product, of course, is the paper money you have in your pockets, on which Malcolm's signature and my signature appear. That is the product and we provide that.

In order for that product to be useful, people have to have confidence that its purchasing power is going to remain. In 1991, we adopted the inflation targeting regime to give you and every other Canadian citizen confidence that the purchasing power of that dollar would remain.

The greatest contribution monetary policy can make over the long haul is really that citizens have faith in the purchasing power of their money. Then they act in a way to maximize, as businesses, the real value of their investments, or as consumers, the real value of their consumption, rather than running around and finding ways to protect themselves against the depredations of inflation. Again, across time and space we have very strong evidence that that is the most valuable single thing we can do.

Ms. Carolyn Bennett: Just to follow up on Mr. Discepola's question, are there examples for the critics that say you really just follow the U.S. Federal Reserve? Are there examples where you've done it differently, for a different desired effect here in Canada?

Mr. David Dodge: Sure. Why deal with it? If we go back to 1997-98, during the Asian crisis, the impact of that was going to affect Canada really quite differently from how it was going to affect the United States. Everybody recognized that. Hence, to follow up on Mr. Solberg's question, we did use the tools at our disposal to deal with it and to allow Canada to adjust to a very difficult situation very quickly, and in the end at very low cost. So the answer is there are real advantages, given the structure of our economy, to be able to have those tools at our disposal.

• 1700

Malcolm, did you want to add something?

Mr. Malcolm Knight: As the governor said, if you actually looked at experience, even in recent years, going back to 1998, you saw some quite different movements in Canadian policy-determined interest rates than you saw in the United States, because the situation was different.

If you look over the longer term, there are two things that are also relevant.

Over the 1970s and 1980s we gradually built up a significantly higher level of public debt relative to the size of our economy than the Americans. Over that period we also had some very pronounced periods of high and volatile inflation. Other industrial countries did too, but our record was not as good as it should have been.

Since early in the 1990s our monetary policy has been dedicated to getting past that. Actually, over the past five years, in almost every month but perhaps two, we have had a lower inflation rate than the United States.

That policy has served us well, and I think it is reflected in the fact that we've had strong employment and output growth over the period since 1996, with a current account surplus.

Ms. Carolyn Bennett: As chair of the subcommittee on disabilities, we thank you for the tactile discrimination on the $10 bill.

The Chair: One of the interests of this committee, Governor, is the issue of productivity. In our study we found that investment really plays a major role. I want you to comment on foreign direct investment into Canada. What's the status, and is it something we should be concerned about?

Mr. David Dodge: That's a fairly open-ended question, Mr. Chairman.

You're right. The level of investment is extraordinarily important for productivity growth, both because it gives us more tools to work with and, perhaps more importantly, because it brings new technologies and new ways of doing things to firms. So it is extraordinarily important.

Whether that investment is carried out by a foreign entity or by a Canadian entity per se it really doesn't matter. What has been historically the case, it's fair to say, however, is that investment made by multinationals on the cutting edge of technology development tends to make a greater contribution to productivity than investment made by firms that are a little lagging in terms of being on the edge of technological development. Sometimes those are going to be Canadian firms.

So that's not Canada versus foreign, necessarily, but it's the issue of trying to encourage investment by those firms that are on the edge, because that is likely to be the most productive.

• 1705

So a broad sweep of history would tell you that this is the case. How you go about doing that is another story.

The Chair: Mr. Knight, any comments?

Mr. Malcolm Knight: Investment is clearly very important.

In the United States there was a rise in investment that began as early as 1992. And it was very much concentrated in machinery and equipment investment, which tended to carry with it the new technologies.

So this has been a factor over a large chunk of the last decade. It has helped the United States achieve very high rates of productivity growth, not just relative to us but also relative to everybody else.

We had a somewhat weaker real-sector performance in the early part of this decade, but after 1996 our investment ratio also rose sharply. And it's also been concentrated in machinery and equipment investment. So while that rise has come later than it did in the United States, I think it will have an impact on our productivity growth going forward. That's the first point.

The second point is that when we look around the world, the U.S. economy is really the place where innovation has been going on in what we think of as the high-tech industries.

There was a period when perhaps there was significant over-investment in that field, but because that sector was a larger sector of the U.S. economy than it was for most other sectors, and because it had a high rate of growth, of productivity, the whole U.S. economy looked better as a result.

We're not there yet, but compared to third countries, we're not doing too badly. There are certain niche areas, as we know living in Ottawa, where Canadian firms are in the forefront of technology advancement.

So while U.S. productivity gains have been fairly impressive over the past decade, we know some of the factors responsible for that and we see some of those influences also starting in Canada.

The Chair: Thank you.

We'll have Mr. Epp, followed by Madame Picard, and then we'll wrap up.

Mr. Ken Epp (Elk Island, Canadian Alliance): Pardon my anxiety, Mr. Chairman. I thought you were doing the wrap-up before.

Mr. Governor, thank you for being here. I wonder whether Canadians are getting the real picture on the inflation thing. You have this wonderful target and you're meeting it. And everybody is led to believe that it's 2%, and yet your measure does not include heating, the cost of energy for lighting our homes and our businesses, the cost of running our transportation. It doesn't include secondary taxes or incidental taxes, like municipal taxes and things like that, so we don't get that.

Furthermore, for the Canadian dollar to go down from 89¢ to about 63¢ in nine years, which it has done, is an inflation of 3.8% per year in terms of everything I want to buy in real terms. That's true for farmers buying machinery. It's true for manufacturers who are importing equipment from the United States or elsewhere. So that is also very inflationary, and I think the real degree of inflation in this country is far higher.

So I would like you to comment on how you measure inflation and whether that's accurate.

My next question has to do with the fact that in the past the bank used to defend the dollar by taking certain measures. Have you done anything? My impression is you haven't.

Mr. David Dodge: Let me deal with your first question.

First of all, of course, what we're looking at in the medium term is the total consumer price index, which is a measure of the total basket of goods, including foreign products, foreign services, domestic products, domestic services, heating oil through to toothpaste—everything.

However, in the short run, because there are some volatile elements in that—the ones that go up, as we've seen, and the ones that come right back down—we look at something that excludes some of these volatile elements to get a little better picture of the trend. That's our so-called core measure, which excludes heating oil and gasoline. It happens to include electricity costs, because they're not so volatile. It excludes fresh fruit and vegetables, which are highly volatile, but it includes most other elements of food.

• 1710

So that is what we use as core. Because it is less volatile, it gives us a better measure of trend. What we want to do is deal with the total consumer price index. That total, I'll just conclude, clearly includes on average what Canadians buy from abroad, whether they be foreign holidays, whether they be foreign automobiles, which we purchase, whether it be broccoli in the wintertime....

Mr. Lorne Nystrom: Cuban cigars.

Mr. David Dodge: Cuban cigars. That is all included, so it's your purchasing power on the average basket of what a Canadian consumes.

Mr. Ken Epp: The numbers are very, very inconsistent with reality, because, as I said, for the dollar to go down that much.... It's 3.8% per year, and yet you're saying to Canadians that we're keeping the inflation rate around 2%.

If you are actually including these inflationary prices due to the reduction of the value of our dollar, then I'm surprised you are telling us also that you have met your inflation targets of around 2%, because 2% is just a little over half of the 3.8% on the American part alone.

Mr. David Dodge: That is because over that period Canadians have.... It goes back in part to what Mr. Knight was just talking about. We are more efficient in what we produce, number one, and number two, we have driven down margins on the sale of goods and services in this country.

I have pretty good faith in Statistics Canada, which produces those numbers, that they are really pretty accurate over time and give us a very real picture of where we stand.

I understand what you're saying, but what it demonstrates is that the price of the Crunchie is one price among a number of others, and what we're looking at here and what we're concentrating on is the total basket of services and goods that Canadians consume.

Mr. Ken Epp: I guess in conclusion I would just simply say it's my distinct impression that a Canadian who has received an increase in their income of 2% per year in the last nine years is not now as well off as they were in 1992. I feel there's a gap there, and I don't know where it is. As you say, you took that in Canada, but I think there is a gap there.

Anyway, that's the end of my questions, Mr. Chairman.

[Translation]

The Chair: Ms. Picard.

Ms. Pauline Picard (Drummond, BQ): I would like to share my time with Pierre Paquette, if you don't mind.

Mr. Governor, you said in your presentation that "confidence could be restored quickly, and robust growth could resume, supported by the substantial monetary and fiscal stimulus". In your opinion, are the additional $3 billion support measures of which were taken by the Quebec government in its latest budget in the form of investment in social housing, infrastructure and improving the competitiveness of the Quebec economy, expansionist measures and do they go far enough?

Mr. David Dodge: They represent expansionist measures, similar to those taken by other governments, including the federal government when it reduced income taxes, for instance. So, yes, they are expansionist measures.

Do they go far enough? That is much more difficult to say. What is important, as I said, is that governments, be they federal or provincial, trigger automatic stabilizing mechanisms and implement measures to help the economy grow in the long term. I have not had the opportunity to study Ms. Marois' budget closely, but her government decided to retain the automatic stabilizing mechanisms and to temporarily reduce taxes a little through family tax credits.

• 1715

So, it is difficult to say whether the measures go far enough, but they are reasonable.

Mr. Malcolm Knight: I would like to add something. When we talk about monetary policy in the report and we say that the budgetary measures which were already taken have had an effect on the economy, we are not only referring to income tax reductions in Canada, which came into effect at the beginning of this year, but also to the fact that in the United States, the income tax cuts which came into effect at the end of July have had a huge effect on the economy, as have other measures passed in the United States. These measures will stimulate Canada's economy because we export our goods south of the border.

So, we are not only referring to Canada's budgetary policies, but also those of our southern neighbours.

The Chair: Mr. Paquette.

Mr. Pierre Paquette: We have a final question.

This afternoon, during question period, we made the point that Mr. Martin had said that he wanted to ensure that monetary, fiscal and budget policy should all be consistent. Some people interpreted this as though Mr. Martin was putting undue pressure on the Bank of Canada, which must remain at arm's length from government.

If you have already been subject to political pressure, what do you do to avoid it, and what makes you believe that the Bank of Canada is indeed independent from government policy, and more particularly from the Minister of Finance?

Mr. David Dodge: Certainly, it is important for us to maintain our independence, but at the same time, in order to develop the most efficient measures, we must consult with the ministers of finance at the federal and provincial level, to keep them informed of the general thrust of our policy and our philosophy, and so we can understand their position on the economy.

Therefore, this independence doesn't mean that we don't speak with the ministers of finance, the provincial premiers and the Prime Minister, and naturally with the authorities in the US or other countries, to collect information and their views and to obtain the help we can get to develop our policy.

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[English]

The Chair: Governor, on behalf of the committee, I'd like to thank you very much. You've certainly clarified some things in a very uncertain time—economically speaking—but, as always, you've given us insight that we benefit a great deal from. Thank you very much.

The meeting is adjourned.