Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue No. 47 - Evidence - October 31, 2018
OTTAWA, Wednesday, October 31, 2018
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:18 p.m. to study the present state of the domestic and international financial system.
Senator Douglas Black (Chair) in the chair.
[English]
The Chair: Good afternoon and welcome, colleagues and members of the general public who are following today’s proceedings of the Standing Senate Committee on Banking, Trade and Commerce, either here in the room or listening via the web.
My name is Doug Black. I’m a senator from Alberta. I have the privilege of chairing this committee. I will ask my colleagues to introduce themselves to the governor and deputy governor.
Senator Wallin: Pamela Wallin, Saskatchewan.
Senator Day: Joseph Day, New Brunswick.
Senator C. Deacon: Colin Deacon, Nova Scotia.
[Translation]
Senator Verner: Josée Verner from Quebec.
[English]
Senator Tannas: Scott Tannas, Alberta.
[Translation]
Senator Massicotte: Paul Massicotte from Quebec.
[English]
Senator Tkachuk: David Tkachuk, Saskatchewan.
Senator Wetston: Howard Wetston, Ontario.
The Chair: Thank you very much.
I’m very pleased to welcome back Bank of Canada Governor Stephen Poloz and Senior Deputy Governor Carolyn Wilkins before the committee. You have been here a number of times before. We have always benefited from your presentations.
Our last meeting with the governor and deputy governor occurred last April, when we were briefed on the spring Monetary Policy Report. Today we are looking forward to hearing the brief on the fall Monetary Policy Report of October 2018, released last week. Senators, a link to this report was provided to your office . We have copies here today if you need.
Governor and deputy governor, thank you so much for being with us. It’s a privilege. We look forward to your comments.
Stephen S. Poloz, Governor, Bank of Canada: Good afternoon. Senior Deputy Governor Wilkins and I are pleased to be with you to discuss the banks’ Monetary Policy Report.
[Translation]
At the time of our last appearance in April, our message was about the considerable economic progress that we had seen. We explained that after a lacklustre start to 2018, growth would rebound in the second quarter, coming in at around a 2 per cent pace for the rest of the year, boosted by temporary factors whose impact would unwind over time, returning inflation to target in 2019.
Six months later, we have seen some very positive developments. The Canadian economy has solid momentum and continues to operate near its capacity. Growth is relatively broad-based across sectors and regions, and it is more balanced, as the composition of demand shifts toward business investment and exports and away from consumption and housing.
[English]
The economy will grow at a rate slightly above its potential over the projection horizon, supported by both foreign and domestic demand and favourable financial conditions. Meanwhile, inflation is close to target after running a little higher than expected in July and August, which was due in large part to changes in the way Statistics Canada measures airfares. While there could be further volatility and inflation in the coming months, our core measures all remain firmly around two per cent. Of course, the outlook remains subject to important risks and uncertainties. I’d like to highlight two issues: Trade and household indebtedness.
In April we said the most significant risk to our inflation outlook was the prospect of a large shift toward protectionist trade policies around the globe. We also reminded senators our forecast included the negative effect of increased uncertainty on the export and investment plans of companies. Naturally, we spent a considerable amount of time ahead of last week’s interest rate decision discussing the implications of the recent USMCA trade agreement. The USMCA is good news because it will reduce a considerable source of uncertainty which has been holding back business investment. We know from our latest business outlook survey, completed before the agreement was reached, that investment plans were already positive as firms looked to take advantage of a strong U.S. economy.
Given the agreement, we have reversed some of the markdown of our investment outlook. To be prudent, we did not remove all of it for two reasons: First, we want to see how firms adjust their investment plans. Second, we know that competitiveness challenges are also weighing on investment.
Protectionist trade actions, particularly those involving the U.S. and China, were also top of mind for us as they are already affecting the global outlook. We have incorporated in our forecast the expected effects of tariffs imposed to date, as well as the dampening effects on confidence from threats of additional measures. We estimate this will amount to a drag on the global economy of 0.3 per cent by the end of 2020. That’s a big cost. It adds up to more than $200 billion to date.
The U.S.-China trade issue represents a two-sided risk for Canadian monetary policy. The U.S. and China could find a path to ease or resolve that trade conflict, which would be positive for global trade and investment, and, of course, for Canada; or the conflict could worsen, jeopardizing key global value chains. This would surely reduce long-term growth and prosperity globally, albeit with uncertain implications for inflation.
For more information on the potential of the impact of U.S.-China trade tensions I refer you to box 1 in our MPR.
Turning to household indebtedness. We have been assessing how people are adapting to both higher interest rates and the changes to the B20 mortgage underwriting guidelines implemented earlier this year. Box 4 in our MPR goes into detail on the impact of these policy changes on mortgage lending. Overall, the data tells us that households are adjusting their budgets largely as expected. We understand this can be difficult, particular for those who are highly indebted. At the same time, employment and incomes continue to grow which can help cushion the adjustment process. Further, the quality of new debt is improving and housing activity is moderating to a more sustainable level.
All this is making our economy more resilient and reducing the chances of painful outcomes for many people further down the road. The rule changes also appear to have taken the wind out of the sails of speculators in some housing markets, reducing the pressure on housing affordability. While financial system vulnerabilities remain elevated, the fact they have stabilized and have edged down in a number of respects is positive.
Let me conclude by pointing out that, even with last week’s increase in the policy rate to 1.75 per cent, monetary policy remains stimulative. The policy rate today is still negative in real terms, once you adjust for inflation. Our estimate of the neutral rate is currently in the range of 2.5 to 3.5 per cent. The policy rate will need to rise to neutral to achieve our inflation target. The appropriate pace of increases will depend on our assessment, at each fixed announcement date, of how the outlook for inflation and the related risks are evolving.
In particular, we’ll continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt, and whether strong consumer confidence builds on solid job and income growth leading to greater than expected consumption. We will also pay close attention to global trade policy developments and their implications for the inflation outlook. Again this risk is two-sided.
We will be happy to answer your questions.
The Chair: Thank you very much, governor. We have a list of questioners. Before doing so I want to introduce Senator Bellemare who has just joined us and Senator Mockler from New Brunswick who has joined us as well.
Senator Tkachuk: Welcome, governor, and thank you.
Governor, you mention in your report that firms are continuing to expand capacity in response to strong domestic and foreign demand, except in the oil and gas sector where transportation constraints remain an ongoing challenge. I’m worried this challenge will not disappear any time soon. These resources remain a large portion of our economy, especially in Alberta and Saskatchewan.
Can you tell us how much of an impact these transportation constraints are having on our economy? Can you quantify it? How much of an impact will this have if it continues? Perhaps you can talk about the difference and the world price of oil versus what Canadians are getting for our export oil?
Carolyn A. Wilkins, Senior Deputy Governor, Bank of Canada: I’ll start off with talking about the difference between the different prices of oil. Everybody has observed WCS is at a level below where we see WTI. A large part of that is due to capacity constraints. It costs more to ship by train. On top of that, particularly right now, there are some plant shutdowns in the U.S. for retooling that have come earlier and in larger amounts than we would normally see. Demand for that oil is also lower.
To the extent those firms come back online, demand goes up and rail capacity goes back up, we expect the differential to narrow. Of course, that underlying transportation constraint is still there. It does have an effect on producers. We should keep in perspective that about 93 per cent of the oil that’s shipped is shipped by pipeline. It is that marginal barrel that gets the lower price. To the extent the transportation fees through rail are going to Canadian companies, again, that’s a bit of an offset. Overall, the lower price for WCS is a factor that is not only causing less profitability in that sector, it’s also a constraint on investment, which gets to the second part of your question. We look at where those prices are and, relative to a business case, would make new investments in that sector profitable.
If the case isn’t there, you’ll see in our forecast that while we see the profile for business investment outside of the oil sector increasing at a reasonable pace, we see very slight declines in the oil sector.
Is there anything you want to add to that?
Mr. Poloz: Just a footnote, if I may. We also need to keep a broader perspective in mind. You’ll remember well, I’m sure, during the 2010 to 2013 period when, in fact, the oil sector was attracting very high levels of investment because oil prices were bordering on and then became triple digit prices.
During that time, the Canadian dollar was rising, of course, as it does with oil prices. What we had was a two-track economy: an economy being hit pretty hard in manufacturing and other sectors by the rising dollar and higher energy costs; and a rapidly expanding energy sector. That two-track economy was a feature for those five years or so.
The return of oil prices to a lower level — and in this case, WCS, to a much lower level — is giving rise to a reversal of that two-track economy. What it means is, longer term, we would expect to see the oil part of the economy grow more slowly than the average of the total economy, whereas previously it grew above the average.
In terms of its share, it’s likely to be smaller when this is over than it was at its peak. That feeds into the underlying investment proposition. We need to keep that perspective in mind, as well.
Senator Tkachuk: I’m not sure what you’re getting at here. Are you trying to say that not getting a market price for our oil is good thing? What are you trying to say?
Mr. Poloz: I’m trying to explain how the dynamics of the economy will react to the prices it is presented with. Yes, it is true the WCS price would be much closer to WTI were the transportation constraints fixed with more pipeline capacity, et cetera. That would be an unambiguously good thing for Canadian economic growth.
Senator Tkachuk: Of course.
Mr. Poloz: However, $60 oil is quite different from $100 or $110 oil at world pricing. We have to bear in mind the economy will not go back to where it was in 2013 before oil prices declined. That’s what I’m trying to underscore.
Senator Tkachuk: I think we know that. I’m not saying we should get over $100 for oil, because that is not the world market price for oil. You mentioned in your report there is strong foreign demand helping our economy. Where is that strong foreign demand coming from? What countries?
Mr. Poloz: Most of the world economy is behaving about the way we expected it would be about a year ago. The difference is the U.S., which is stronger because of the fiscal expansion underway there. In the sense our forecast has been revised, it’s coming from the United States.
Senator Tkachuk: Thank you very much.
Senator Wallin: I have a short and a long question.
To the deputy governor: A couple of weeks ago I think you were talking about the better quality debt given the stress test for mortgages on the housing market; people who are in debt can’t pass the stress test, so they are not getting further in debt. The counter to that is they’re going to private lenders and paying increased rates, which will not deal with their indebtedness. Are you concerned about that?
Ms. Wilkins: We do watch that closely. In fact, there is the possibility, given that the B-20 guidelines only cover a certain portion of the mortgage market — most of the mortgage market, in fact, but still not all of it — that you could see people will try to go to other lenders.
When we look at the data, the part we see that is positive is of the new mortgages being written — not just because of the last changes on B-20 that applied to low-ratio mortgages, those that didn’t get insured, but the high-ratio mortgages that were treated the year before — the share of new loans to people who would have had more than 450 per cent of their income tied up in loans has gone, in the case of high-ratio mortgages, from around 20 per cent to under 10 per cent.
That is a positive development. We see that curve also coming down. I think that positive outcome is difficult when you are the one who has to wait longer or you need to find a less expensive house, which we think about half of the people are doing.
They are getting a house; it’s just less expensive. It’s not an easy adjustment, but one that will stand the test of time because of the rising interest rate environment we are in.
Are people going around it? We see across all lenders that mortgage originations have declined over the last year. Private lenders have declined by less.
Senator Wallin: It’s an increase.
Ms. Wilkins: What that means is there is a bit of market share going to these others. What could be going on, in the positive sense, is some debt consolidation. You can see something we did in June about what those loans look like. They tend to be much smaller on average and they come with a higher interest rate.
I guess the question is whether it is something to worry about right now. We are keeping an eye on it. From a financial stability point of view it’s not something we would say is a major financial instability issue today, but something to keep an eye on.
Senator Wallin: I have just come from two days of meetings. Over the course of the last couple of weeks I have been having conversations with business leaders and chambers. Circumstances have put me there.
You say you are waiting. I think the phrase was you want to see how firms adjust their investment plans. What they say in these meetings is they have made up their minds. Canada is not a good bet. They are not investing domestic dollars. We are not attracting foreign dollars. They cite tax rates, regulatory burdens and the prospect of more, the debt-to-GDP ratio and spending. They are pretty clear about it. I don’t know if you are talking to different groups, but what I’m being told is not good news: we are not a good risk right now for investment.
Mr. Poloz: This is what we were alluding to when we said we have not removed all of the negative judgment from our forecast that comes from this. Having a successful conclusion to the NAFTA negotiations does not cure everything.
Competitiveness challenges run a wide range and in our boss survey we get the list of things on people’s minds. At the same time, that’s a hundred firms carefully selected across the full fabric of the economy. We know from the actual investment numbers that, on a net basis, they are investing less than our models would suggest they would. We attribute that gap to the uncertainty around NAFTA and, of course, these other things you are mentioning.
We are not suddenly closing that gap. We are waiting to see how they respond. The Monday after the USMCA was announced, I was in New York with the Business Council of Canada. The feeling of relief in that room was palpable. That was the top 75 or 80 CEOs in the country. I think it has to have a positive spillover effect, but that may not be the whole thing.
Senator Wallin: These comments are post-USMCA.
Mr. Poloz: Our survey showed strong investment intentions, and that was before the thing was resolved. It’s relative to where you are. That’s why we need to see the numbers. We are not going to assume it’s all rosy. We need to see the response.
Senator Wallin: My sense is you are sounding bullish given this uncertainty.
Mr. Poloz: I’m not discounting anything you are saying. In fact, I am taking it fully into account, and still the numbers add up to a strong picture for Canada operating at potential, growing at potential, with inflation on target and unemployment at a 40-year low. All these things add up to the next positive surprise is going to result in inflation pressures. We are at that stage of our analysis.
Could it be better? Of course, because more investment would mean more potential and more non-inflationary growth for the economy. It’s always a good idea to reduce those competitiveness challenges if we can.
Senator Wallin: Thank you.
[Translation]
Senator Massicotte: Thank you for being here, Mr. Poloz and Ms. Wilkins. We always learn a lot of things.
Your report addresses the issue of the relationship between China and the United States and the potential tariff war. In summary, this would have an impact of 0.2 to 0.5 per cent on the GDP. I’d like to talk about the assumptions. It seems that there will be further discussions and negotiations within a week. The President of the United States has made it clear that if an agreement is not reached soon, he will increase all tariffs on all Chinese imports. I know it’s not a very positive scenario, but I’d like to know what the worst that could happen is. Let’s say that no agreement has been reached and that a real war is being waged between China and the United States for months or even years, what would the consequences be for the Canadian economy and for financial stability around the world?
Mr. Poloz: For the moment, our analysis shows that the measures announced are quite serious. These are not tensions. A war really has begun. Investments have already been made in China and the United States. It is difficult to see it in the United States because they are also suffering a fiscal shock that has created a major delay. So, in this context, it is easy to see the effects on both economies. Growth will decrease over time.
The spillover for the rest of the world is also negative. There are opportunities for trade diversion. For example, companies in Canada are receiving contracts from China today rather than from the United States. It’s a case of trade diversion, but in short, it is negative for the world. The most important phase will be the next one. If it is a total war between the two countries, the future of our international system is in doubt. It’s difficult to evaluate. We haven’t mechanically analyzed the effects because it is not officially announced, but I assure you that it would be serious for the global economy.
Senator Massicotte: “Serious” is a word that lacks definition. The report talks about 0.2 to 0.5 per cent. Would 0.5 per cent be the worst case, or is it a slightly optimistic scenario for negotiations?
Mr. Poloz: As I mentioned earlier in my remarks, there are two sides to this coin. It’s true that this would be very serious for global growth. It is difficult to see who will be affected, but in principle it would be everyone. It’s also possible to solve the problems between the two countries, and it would be a new upward shock for the world.
For commentators or investors themselves, they can choose a preferable scenario that consists of positioning themselves to take advantage of the situation. It is their choice, the central bank doesn’t have this option because both scenarios are possible, and if we position ourselves in between, it is a kind of risk management. For the time being, both options remain possible.
Senator Massicotte: I’m trying to see what could be worse. You’re telling me that it’s serious. I think that’s the only answer you’re willing to give me today.
Mr. Poloz: For instance, for the International Monetary Fund, we have done a progressive analysis for both countries, and economic growth for the world as a whole gradually decreased at each stage of the process. In the end, instead of around 4 per cent, it was 2.5 per cent. It’s serious.
Senator Massicotte: It’s serious.
Mr. Poloz: It’s a global recession. For example, in 2008, it was 2 per cent of global growth. For the other countries that depend on foreign trade, this will be a very serious situation. I think the American economy will also be affected. So, it isn’t rational to have a war like this.
Senator Massicotte: I would like to ask a technical question. After 2008, all countries, including Canada, were looking for a way to grow the Canadian economy. Central banks have made great efforts to reduce debt and lower interest rates. For the past six or nine months, the central bank, particularly the U.S. bank, has been selling its assets to balance the balance sheet, among other things. According to the U.S. bank, there was no significant impact on interest rates.
How do we see this in Canada and does it mean that interest rates will be higher than usual? How can we balance our budget in this regard?
Ms. Wilkins: You are right, some central banks have made the quantitative easing to avoid a recession such as we knew it in the 1930s. To the extent that these measures are believed to have had a downward effect on longer-term interest rates, estimates vary significantly, by about 150 basis points. When the Federal Reserve begins to reduce its balance sheet, or stops buying, and increases interest rates, portfolio adjustments can be seen, causing long-term interest rates to start rising again.
This hasn’t been seen often until now. This is done in a very orderly manner. Moreover, it is a bit deliberate, because what we see with this type of action is that the risk premiums, what we pay to the private sector, are lower because the central bank wants to encourage a little risk so that the economy can recover. So when this is reversed, the opposite effect occurs. In our projections, we expect these long-term rates to normalize from the United States. Canada will maintain much the same position over the long term because we are a global financial system.
We believe that this is normal and intended, especially if the U.S. economy, Canadian economy and global economy continue to grow. There may also be a risk. We mentioned this in our report. A too-rapid increase in interest rates would have significant consequences. We can imagine why this could happen, what could act as a catalyst in such a situation. Of course, China and the United States could face greater problems, not because we have disproportionate growth. It’s quite the opposite. The risk of growth is increasing, and the markets decide to react.
Of course, growth could be lower with more friction, but as the governor said, inflation could be higher at the same time because there could be value chains that are no longer there. So there are risks and there are other factors that could produce such a risk. However, there are other ways for China and the United States to improve their situation. We believe that the U.S. economy is on a path where the Federal Reserve could meet its inflation and unemployment targets. This is not our reference scenario, but there is a risk.
Senator Massicotte: Thank you.
[English]
Senator Tannas: Thanks for being here. I need a bit of a tutorial.
This is on capital investment in flows, outflows and so on. Foreign investment — is it positive or negative right now, in Canada — inflows?
Mr. Poloz: It’s positive but has diminished quite a lot. When we look at that, we can decompose it between the energy sector and the rest of the economy. It’s clear that, primarily, the decline we have experienced is because of reduced investment in the energy sector.
In fact, it has picked up in the rest of the economy; foreign direct investment in Canada in non-energy areas is picking up quite strongly.
Senator Tannas: In terms of domestic positive investment intentions you have, how do you ferret out how much is potentially postpone maintenance capex from all uncertainty versus new expansion capital that is committed for risk?
Mr. Poloz: We are attentive to that issue, because, of course, we’ve gone through a period where people were trying to save money. They were just barely keeping the lights on, in some cases. This is not just a little check-the-box survey; it’s usually an hour or more sit-down — a personalized interview. The vast majority of that information is folded into our statistics. The rest for us is anecdotal.
We are attentive to that. They are telling us the part that is for expansion is the strong part. We have to bear in mind not everybody depends on free trade with the United States in order to grow their business. We are trying to get a full cross-section. If you just asked exporters, the story would be slanted in one way.
They have been telling us all along they want to invest, but they are being more cautious than usual because of the uncertainty around NAFTA. They were still telling us that when we did this survey. If you’re running at capacity and you have no idea how long that uncertainty would last, you still need to decide if you are going to stay in business and satisfy your customers or not? Some companies told us they invested in the United States to hedge their bet. Other companies said they are waiting. We are interested to see how that group responds.
Unfortunately, NAFTA never changed. We now have something to replace NAFTA, which is not yet in law. The actual business conditions have not changed throughout, and yet it has cost us permanently, because decisions were not just delayed; decisions were made in a distorted manner. Those delayed decisions have meant lost export sales throughout that period, because we’re running at top speed already in many sectors.
If those companies invest now and add to that capacity, sure enough, they would be able to compete for the expansion of sales. They have to get in there and try to get those deals again — the ones they have lost during this hiatus.
Senator Tannas: I’m from around Calgary. We seem to be the least optimistic city in the world these days as opposed to being the most.
Mr. Poloz: I agree with that.
Senator Tannas: Maybe we are attracted to news that fits our circumstances. At the beginning of the second quarter, the RBC CEO said capital was fleeing the country in real time. At the Finance Committee and others we have heard accounting firms telling us their foreign capital flight tax planning for domestic clients has never been busier, never been better. Do you track private capital and where that is going? How much of that has an impact on the economy, anyway?
Mr. Poloz: The short answer is “no.” We track the macro phenomena we have discussed already. I can confirm for you that, given all my travels around, Calgary probably has the lowest sentiment I have come across.
I go back to Senator Tkachuk’s question earlier when I said it’s important to bear in mind the energy sector will not be as large and robust as a share of the economy when all this is over, given that oil is, say, $60 as opposed to $100. That backdrop means there will be less foreign investment. In fact, we have seen disinvestment in that sector. It doesn’t have to shrink but it needs to shrink as a share. That’s a prolonged period of adjustment, which we described back in 2015. We said it would be a three- to five-year period of adjustment to that lower oil price regime. Here we are, past year 3 now. We still think we would have a couple more years of that before we reached a steadier pace for everything.
Those adjustments are real for people. Wages are still sluggish and are likely to remain so, except in exceptional spots — incomes, the housing market, et cetera. Those stresses haven’t gone away. We don’t claim that everybody in Canada is doing perfectly. The macro numbers add up, because things have gone into a more heated area in other parts of the economy.
Senator Tannas: Thank you.
Senator Wetston: Thank you, governor and deputy governor. I’m just trying to understand the issue of household indebtedness. I know you have emphasized this a great deal over the last period of time. I wouldn’t want to put words in your mouth, but it’s been of concern to the bank. Just from the report, is household indebtedness increasing, stabilizing or decreasing?
I ask because I know we need to describe these things in a way which, for macro economists, they have a full appreciation of what improved quality-of-debt means. I never thought debt was something we’d want to carry. Can you assist me in understanding the relationship to where we are today with household indebtedness? If I interpret this statement you got to a moment ago, all it means to me is you have more debt and you have to buy cheaper homes. I’m hoping that’s not just what it means, but maybe that’s what it means.
Ms. Wilkins: It’s not just what it means; it means more than that. I’m glad you asked the question. I wouldn’t want you to have that impression for long.
How did we get here? Household debt as a share of income has been growing for quite a while. It didn’t just start when interest rates were low; it was growing before that. It might have had something to do with the environment for buying houses, particularly when some of the mortgage-underwriting and housing insurance rules were relaxed. It was over 10 years ago, before the crisis.
Household debt to disposable income has been an upward trend. By design, lower interest rates are going to give more incentives to do that, because it provides the opportunity for people to get into the housing market when interest rates are low.
Now that interest rates are rising and have risen five times over the last year and a bit, this question comes to mind: How sensitive is the economy to this higher debt? And do we see this vulnerability with high household debt getting even bigger? The answer is “no,” the debt-to-disposable-income ratio has stabilized. It has started to edge down. I use that word very carefully, because we still believe the vulnerability is there. We don’t heave this sigh of relief that we don’t need to think about that anymore. We do, and we will have to for a number of years.
It is encouraging to see the quality underneath of that stock index slowly will become better, because every new mortgage that is taken on will be more durable. The people who are taking them on will be able to withstand, according to the test and given their income, interest-rate variations, which can or may not happen. It’s nice to have that protection for the individual.
From the monetary policy point of view, it means we need to be very conscious of how interest rate increases are affecting the economy. From the individual’s point of view, it may today feel like, “It just means I can’t buy a house, or only buy a smaller house.” It also means we’ve put two things on a more solid footing. It’s our job to stabilize inflation, 2 per cent. Low, stable and predictable inflation creates a macroeconomic environment where you are less likely to have your income and job at risk. It’s also less likely we will get into a boom-bust scenario in the housing market, which is not great if you’re a homeowner and not great for affordability when housing prices are rising. It also means the people who take on mortgages are going to be in a more secure spot. What seemed like a great decision today to buy a house is still a great decision two or five years from now.
There are tradeoffs here; we understand that. It’s a difficult adjustment for many people, but being on a more solid footing benefits, I would argue, everyone.
Senator Massicotte: Have you sold your home?
Senator Wetston: I live in Toronto. I don’t want to talk about homes. Having said that, I’ll move on to my question.
I would like to get your sense here, because I know when you’re at governing council — I’ve never been, but when dealing with issues with respect to the interest rate increases, I recognize and I think you indicate that monetary policy instruments take some time to work their way through the system, maybe some a little more quickly than others.
I don’t completely understand how this would affect the economy overall or your capacity to deal with inflation and interest rates. I know in your statement you talk about the 0.3 per cent by the end of 2024, the $200 billion cost in the context of the U.S.-China issues. We have recently moved ahead on the TPP. We’ve also recently moved ahead with the European trade agreement. We continue to deal with issues in Europe, which may have a little less influence on Canada; Brexit, for example.
Governor, I don’t mean to get into a sort of foreign policy discussion. I wonder how you factor these issues in. The chancellor in Germany has just stepped aside. We have growing populist governments in Hungary, Poland, Italy, South America and Brazil. It’s of some concern to me personally, because I’m not sure how much instability that creates in the global economic environment.
I recognize my question is probably a little irrelevant to this discussion to some extent. I wonder whether or not you do consider those aspects in the context of its impact on Canada and the approach and position you are taking with respect to the macroeconomic issues facing the country?
Mr. Poloz: Well, we certainly do. To sum up, I think your question is: How do all these political dimensions find their way into the discussion? It would not be that different from how they might find their way into a board meeting or major company considering making significant investment of hard-earned money or borrowed money, either way. The board would be asking, “What happens if Brexit happens? What happens if CETA doesn’t do this or does that?”
Senator Wetston: Quality of debt.
Mr. Poloz: What I mean is there is nothing that unique about our way of grappling with that compared to how a business team or their board would wrestle with the same kinds of uncertainties when making a decision on dollars and cents.
For us, it usually takes the form of uncertainty and modelling of investment decisions, because those are the big decisions. You can even have periods where people pare back on spending because of uncertainties. It’s primarily companies where you see this.
It eventually becomes people, because companies that don’t expand, don’t hire. They don’t add to their staffing. Those jobs never arise. The population is growing, and the jobs aren’t there, et cetera. That becomes a consumption effect. It becomes more widespread.
What we have to do is given the risks we face, we have to ask ourselves, “What evidence is there? In NAFTA, we could see companies are still investing. Investment numbers are okay, but not as good as our model suggested. Are there other things holding it back? Let’s go ask them.” We got a pretty good reading on that, similar to how we did when the oil shock happened in 2014. “How much will you reduce investment?” They told us in dollars. We were able to add it up across 30 or 40 companies and came very close.
In the end, the intelligence from the street, if you like, can be very valuable in weighing the importance of those things. You try to correlate those things and make a judgment call about how important it is to the outlook.
Right now, we face a lot of certainties. Of course, it’s natural to think of them as negative. I go back three months ago when we did the July MPR. People, commentators, the media, everybody was almost certain NAFTA was about to be torn up and we’d be replacing it with various tariffs of all sorts.
The question came to me, “How could you possibly consider raising interest rates when that is about to fall apart?” The answer is we have to deal with what we have. The way we look at it is that could be a negative risk for Canada if it happens, but if I’m reading the tea leaves right, they are making progress. What if it gets resolved? In that case, it translates into a positive risk.
As I said earlier, you can’t pick one of those and make monetary policy the basis of it. You have to take a path which balances those risks. You want to be as close to right as possible regardless of how it turns out. Of course, when the facts confront you, then you need to change in some way.
You mentioned it takes time. It takes time for these things to have their effects too. They don’t have their effects overnight. Tariffs go into place. For months people say, “I don’t think it’s permanent, so I’m not going to adjust. I will work out a deal with my suppliers,” and those sorts of things. That’s going on in steel and aluminum, to a degree.
If you used a model to predict what would happen, you would be wrong because people haven’t reacted according to the models yet. The longer it lasts, the more likely it becomes a matter for that.
On the other side is policy. It takes a year or longer for our interest rate effects to find their way through the decisions and affect the outcomes. In one to two years, we get the full impact of what we are doing.
Senator Wetston: It is not abrupt, such as what occurred 10 years ago when we were dealing with that huge recession.
Mr. Poloz: No. That was a unusual thing. It was a bubble that collapsed. It was a shock for everybody globally, all at once, and a freeze-up. You had an instant recession. The policy needed to be immediate and very large, which it was. I was not there, so I can describe it as masterful. It was very well done. It has taken us all this time to rebuild from that.
Senator C. Deacon: Thank you, governor and deputy governor, for being here. I agree with your summation of the work done 10 years ago.
I want to focus on the realities in many industries today that if you are not disrupting, you are being disrupted. You may not appreciate it as much as you need to, and the need for an acceleration in productivity growth in Canada. Your sense around what we are doing and not doing in that regard.
It worries me intensely we are not mobilizing our innovations and creating new value fast enough. In that regard, we have had some great success in some start-up communities, for sure. We have to move that up, the size of companies, to our medium and larger companies more aggressively than we have done so far.
I want you to speak around that issue a bit for me, please. It’s concerning to me.
Mr. Poloz: Well, for me too. I gave a speech dedicated to this subject in Moncton not long ago. I tried to offer an optimistic take on it for a number of reasons. There is a tendency to see it in negative terms because, obviously, we are not as successful as the United States on this front. At the same time, given our size, it’s always probably going to feel like that because you know well you need some scale economies for these things to work, hence the importance of trade deals and so on so you have the opportunity to take your ideas global.
Importantly, you talk about the concept of disrupt or be disrupted. Many people think of that as new because of technology, but as a student of economic history I can point to a continuous process for a good 200 years during which it has always been true. One of the things many people don’t realize: they think of growth as being like yeast so you grow everywhere by a steady amount and it’s visible in every nook and cranny.
In fact, Harberger, who is a famous economist, said growth is more like mushrooms because, when the innovation happens, it pops up and it takes all the nutrients out of that area and no other mushrooms grow right there. Normally, what happens is the process of creativity destruction, and that means that thing creates but, of course, puts someone else out of business.
The lesson from history is there has never been a technological improvement that has not created more jobs than it destroyed. It’s very hard for someone to embrace when, of course, they are the ones being knocked out of a job. You have to be sympathetic to that adjustment process. Then it will often be cast in the media, for example, with someone with great skills in the manufacturing sector, a lot of machine skills et cetera: how on earth is that person supposed to start writing code?
That is not at all what the transition requires because the wealth created by those mushrooms becomes income that people spend on all the usual things. They don’t spend it on iPads; they spend it on houses, vacations, cars and clothes. They create jobs throughout the entire economy as that grows. If you have tried to get something fixed in your house recently, you will know there are shortages of skilled workers in that sector. We know that across the economy there are over 500,000 job vacancies, and lots of them are in manufacturing or construction where the skill sets are not worlds apart from those being lost because of technology.
There is no doubt our big growth is in the top end, in the technological jobs. What we call the IT jobs is our biggest growth sector for job creation and for export sales. These are very high-paying jobs and good for the economy overall.
That’s to sum up as a positive thing. The real question, and I’ll end on this, is: When does it start showing up in our productivity statistics? When you talk to companies, there must be lots of new productivity out there because they all have great stories to tell. I’m confident it’s coming. It was always the case when a technological wave goes through, it takes longer than we expect for it to get into the productivity statistics.
I will give one example. Today, in a company that has half a dozen servers and a little IT team taking care of their internal IT systems, someone could walk in tomorrow and say, “I can move all that onto the cloud for you. Just give me a cheque for this much per quarter and you are all taken care of.” That is a huge saving in money, a huge increase in productivity for the firm, and yet we don’t even count that as an investment.
It’s a difficult thing to wrestle with because they are not buying servers anymore; they’re just paying out of their regular costs to cover a cheque for the services. If they do it in-house, developing new apps and so on for your iPhone, they are just on payroll and that’s not necessarily seen as an investment.
Investment is something that just got revised up by StatsCan historically for these kinds of reasons and they are adapting their methods to catch up. I can show you we are behind in the actual evolution in the economy.
We expect that productivity is going to show up soon in our forecast. It shows up not for magical reasons, but because there is more investment happening. It will probably show up more than what we have built in. We are being cautious about assuming a rosy outlook, and that will be important for the wage series as well. The wages will track that upwards.
Senator C. Deacon: I agree with you this has happened through time. I think the acceleration is probably the big difference now. It’s happening at such a fast pace. Does that change, in your mind, the rate of disruption and the pace at which it’s happening,? Does that change how we should be responding in our economy?
I have one favourite example because everybody gets it: 10 years ago the Chronicle-Herald in Halifax had $1 million a month in revenue in classified ads. Now it’s zero. The change is so rapid in some sectors, and maybe some of the most profitable sectors in our economy will be facing that onslaught. Do we have to become more responsive to that historical pattern?
Mr. Poloz: Yes, I agree the speed has picked up. For every bit of creation, if there is destruction, then those problems add up because they don’t come in little bits at a time. They accumulate quickly. We need to be stress-testing our safety nets and the things that help people adjust to that new reality, like the training and retraining types of schemes or other support mechanisms that ensure people are not left behind by this.
This is way outside of monetary policy: I would say we have an active research agenda on the technological change in the digital economy. We have created a team that’s on that full-time and, indeed, it began hiring not economists, but data scientists who are working in this area.
I probably shouldn’t talk more about it, because it’s Ms. Wilkins’ responsibility. She could talk to you all afternoon about that. But to give you a sense we are dedicating resources to it.
[Translation]
Senator Bellemare: Ms. Wilkins, I have a question along the same lines as Senator Deacon’s regarding your comments in Le Devoir on productivity. We know that productivity isn’t just about investing in physical capital, but also in human capital. As you both said in your recent statements, there is no labour shortage because many people would be ready to work, but there is a skills shortage. This is what prevents companies from adapting.
Would it be possible to calculate human capital investment in firms in a different way than is currently done? Would it be possible to consider investment in human capital in training as a capital expenditure rather than a regular expenditure? We could write it off. Canadian companies are lagging far behind in terms of investment in training their employees. They spend less than American companies, which are also behind international standards. Do you think it would be worthwhile to explore this idea? If not, why not? If this seems to you to be an irrelevant accounting game, can you explain to me why?
Ms. Wilkins: I’m not an expert on business taxes, but you mentioned incentives for companies to invest more in training. It is clear that when we talk to them about digitization or just the labour shortage in general, especially for SMEs, they have difficulty because the return isn’t necessarily there. They tell us that they are investing in an employee’s training and that everything is fine, until the employee leaves the job to work for another company. It is a question of making this investment profitable. Clearly, any new tax or incentive measures could help in this regard. It’s not just a matter of investing with the company alone.
In Trois-Rivières, I had the opportunity to meet with people from the university and industry who worked in partnership so that students could put what they learn in school into practice in a real company. We often hear that today’s young people can read and write, but when they have to roll up their sleeves to accomplish something concrete in a company, it is not necessarily a given. It is not only a question of investment, but also of having appropriate investments for these young people. In my opinion, we need a closer partnership between schools and businesses. This relationship must continue throughout a person’s career. It is unlikely that a person, once they have finished their studies, will keep the same job for 10 or 15 years, because things change quickly. There are many areas for improvement in our system, but any incentives would be welcome.
Senator Bellemare: The issue of productivity was discussed. If Canada had the same monetary policy mandate as the U.S. Federal Reserve, a dual mandate with a link to employment and a link to price stability, would that change anything about the conduct of Canadian monetary policy?
Mr. Poloz: I would say no, because we are talking about the trend of sustainable inflation. When inflation is stable and remains stable, it happens at the same time as economic growth, on its potential as well as on the unemployment rate, which remains around its natural equilibrium rate. All these things coincide, in my opinion. Historically, too, the stabilization of inflation over a period of more than 25 years shows that this policy has reduced real fluctuations in the economy.
So it is a product of this policy. This will have the effect of introducing “trade-offs,” which are not necessary between the two and are not real. This leads to a debate that will bring many points of view to the fore. At the same time, variants must be added, not reduced. In my opinion, this may be a little harsh because it’s possible to apply broader monetary policy rules.
We aren’t closing the door to other possibilities. We’re preparing for the next renewal of our agreement with the government. Ms. Wilkins is in charge of this.
Ms. Wilkins: Yes, 63 economists proposed that we change the mandate to make it broader. I think that’s a good thing. This encourages people to discuss it. Sometimes our studies on the monetary policy framework do not attract much attention, although this is important. Since last year, we have been participating in conferences, including one tomorrow with outsiders to discuss several other forms of mandates, including the dual mandate. We will first do some research on several aspects. There will be transparency and discussions with the public about trade-offs between executives.
Sometimes you think you can win here, but you can lose something else elsewhere. We must make the link between what we want to accomplish and where we want to use arbitration for the well-being of Canadians. Our next step is the conference we will hold tomorrow with people from academia and outside. Part of this conference will be public. I will give a speech at McGill University in November where I will present our thoughts and approaches. As the governor said, there are similarities between what is being done now and what could be accomplished with the dual mandate, but there may be small differences. It is worth discussing and reflecting on other monetary policy frameworks.
Senator Bellemare: Will tomorrow’s conference be televised?
Ms. Wilkins: Not completely, but in part.
Senator Mockler: I’d like to thank you, Mr. Governor and Madam Deputy Governor, for coming to share your vision for the future of the best country in which to live.
[English]
I have to say that I’ve had the opportunity as Chair of the Finance Committee to, as late as three weeks ago, do round tables with industry leaders across Canada. I come from New Brunswick in Atlantic Canada. I want to touch on two things. You have alluded to it, governor, but you did not pronounce it openly: I want to talk about Brexit. Next, I want to talk about, as a question, the impact on the interest rates on housing in Atlantic Canada.
Reuters reported in August that British real estate investment trusts have underperformed their European counterparts by more than 20 per cent since the referendum.
Notwithstanding the fact we know that uncertainty does not guarantee economic stability, here in Canada we’re preoccupied about the negotiation of Brexit, especially since our third trading partner, the U.K., is struggling.
Governor, what advice do you have to the many Canadian companies that have invested in the U.K. as a gateway to the other 27 countries in the European Union?
Senator Tkachuk: Outside of “good luck.”
Senator Mockler: I want to hear the governor.
Mr. Poloz: This is, of course, an unfortunate outcome for those who have invested in the U.K. We have historically had a very strong investment flow between the U.K. and Canada, in both directions. It became enhanced toward the U.K. when, of course, the euro area was created. You’re right: It became a gateway, a gateway that’s about to be changed dramatically.
I have nothing more to say than that. There is no advice I can give around that. Brexit appears to be happening. It’s still a question mark. We analyze it as though it has happened, but it hasn’t happened yet. We need to see how that unfolds, what conditions are negotiated and how that affects business decisions. We don’t have insight into that.
For the U.K. economy, this is a classic structural change to the economy, which will mean a disinvestment phase. It’s got parallels with what we went through with the energy shock, because we get a disinvestment phase in part of our economy and increased investment in other parts. In the Brexit case, disinvestment is in the U.K., and we expected their currency to be weak during that transition. That causes inflation to rise.
It’s a very difficult transition to manage, from a policy and business point of view. But beyond helping people understand it, I don’t have advice on how to deal with it.
Senator Mockler: Do you talk to your vis-à-vis in the U.K. as to what he thinks about it?
Mr. Poloz: Absolutely. We meet easily a dozen times a year.
Senator Mockler: What does he say?
Mr. Poloz: That’s for him to say.
Senator Mockler: I’m from Atlantic Canada. I have had the opportunity to talk to financial institutions and contractors building houses. I have to admit I used to be the minister of housing for New Brunswick, prior to this life.
Governor, when you look at Canada, you know this — Atlantic Canada, Quebec, Ontario, Western Canada and B.C. When you look at your bank rates, which area of the country will be more affected by them? I’m thinking in order to help people buy their first house.
Mr. Poloz: You have your finger on an important issue, which is that Canada is almost never the same everywhere. The economy we are faced with is a macro economy, which is a weighted average. It’s a weighted average of all those places.
This is not to make it sound funny: I often characterize it as an economy that has its head in the oven and its feet in if freezer. The average looks OK, but it’s not very comfortable. It means when you’re setting monetary policy, you are setting for the average. This may not be appropriate for the part in the oven or the part in the freezer.
You asked a direct question, which is: Where will our interest rate change have the greatest effect? The answer is “in the parts of the economy where consumers and households have the most debt.” That is not Atlantic Canada; it is in Toronto and Vancouver, to keep it short. It’s where the housing prices went up enough that it became a highly indebted household sector in order to carry it.
We have partitioned the Canadian household sector into many parts: Those who have high levels of debt, those who have taken five-year mortgages versus one-year mortgages, et cetera. We have all of that mapped out. We mapped that out quite carefully in our July MPR. We’re tracking how those various segments are adjusting so we don’t just assume it’s simple — one number. It’s a much more complex analysis than that.
We take some comfort from something Ms. Wilkins mentioned a little earlier, that before all this began, we had some parts of the country where housing prices were rising rapidly. People asked, “How can I afford a house now when you have raised the rate, and I have to qualify for the stress test?” The answer is, as a result of various policies that were put in place, the speculative flows have stopped more or less, so house prices are rising much more moderately across the country. When a house price in Toronto goes up by 15 or 20 per cent, that hurts affordability a lot more than a 25- or 50-basis point move in interest rates. But if the whole situation calms down, we will be contributing to long-term affordability.
As for the stress testing, I was advocating that on individual levels for a long time before they were put in place simply because everybody knew interest rates were at historic lows. Everybody should be prepared for interest rates to be 1 or 2 percentage points higher, so self-stress test. Now it’s a reality. That assurance that people can manage through an interest rate cycle is really important. We had to turn it into a rule to make it actually occur.
The Chair: In the second round, we have one question.
Senator C. Deacon: Thanks again for the thoughtful, plain-language responses you’ve given in this section and that I see you give quite often. Thank you both.
Deputy governor, on productivity, does your group look at public sector productivity or just private sector productivity?
Ms. Wilkins: We look at economy-wide productivity and dig into different sectors. As you probably know, in the services industry, it’s very difficult to measure productivity. There are big measurement issues. That’s been something the bank, Statistics Canada and many countries have been trying to dig into.
You mentioned public sector productivity. One important thing is the public sector, including the Bank of Canada — so I’ll just talk about the Bank of Canada — kind of walks the talk. If we want industry to be more productive and adopt technologies, and we want to be in the position of setting the right framework in an intelligent way for that to happen, whether it’s regulation or supervision or a tax policy, it really helps if you understand it yourself. That’s why the bank, in its work plan, has a lot of research projects — the usual thing we would do — also, the new data scientists.
We are also developing partnerships through the Creative Destruction Lab at Rotman and HEC Montreal, we have a new program called Pivot where we can partner with entrepreneurs and small companies to try to solve our own business problems and understand where that frontier is, using AI and machine learning. Part of it is to learn, not to invent new things. It’s really so we understand it. Whether it’s internationally at the G20, the Financial Stability Board or even domestically, when we are looking at what rules we should change or adapt so they work well for supporting innovation — but it’s safe innovation — it’s difficult to do that without having a greater understanding of what you are talking about.
That kind of activity, hopefully, is an investment but will yield gains in terms of productivity of at least the central bank. We are not the only ones doing it.
The Chair: To the senators, thank you very much for your tremendous questions, well thought-out and well presented. Governor, to you and the deputy governor, thank you. You were very succinct, helpful and relevant.
(The committee adjourned.)