[Recorded by Electronic Apparatus]
Tuesday, December 12, 1995
.1530 
[Translation]
The Chairman: Pursuant to Standing Order 108(3)(d) we will proceed today with consideration of chapter 9 of the October 1995 Report of the Auditor General of Canada, more specifically Information for Parliament-Deficits and Debt: Understanding the Choices.
Our witnesses today are Mr. Thiessen, the Governor of the Bank of Canada, accompanied by Mr. Noël and Mr. O'Regan. I will give the floor first to Mr. Thiessen, who will make his opening statement. We will then proceed as usual and you may address your questions to our three witnesses.
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Mr. Thiessen.
[English]
Mr. Gordon G. Thiessen (Governor, Bank of Canada): Thank you, Mr. Chairman. I would like to begin by saying that I found the Auditor General's statement on public deficits and debt to be a very good statement of the issues. It is only in dealing with the role of interest rates in the persistent accumulation of the public debt that I may have something to add for your consideration.
[Translation]
The main issue that the Auditor General raises for discussion and resolution in this chapter is the appropriate level of federal public debt relative to the size of our economy. He points out the deterioration of the government's financial position over much of the past 20 years and the likely further accumulation of debt in the future unless the government runs substantial primary surpluses.
[English]
We at the Bank of Canada have commented, particularly over the last couple of years, on the need for all governments in Canada to put their fiscal positions onto a more sustainable track. At a minimum, this calls for actions to stop the ratio of public debt to gross domestic product from rising. Evidently, public debt ratios cannot continue to rise over long periods without encountering impossible pressures on debt service costs, deficits and debt financing. But if one begins with a low level of debt to GDP, a rising ratio can be sustained for some time, as we have seen. However, once very high debt levels are reached, just stabilizing the debt-to-GDP ratio may not be sufficient; lower ratios may be needed.
Unfortunately, economic analysis on its own does not provide a simple answer on what is an appropriate debt-to-GDP ratio. We would probably all agree with the Auditor General that our society needs to sort out its views about acceptable levels of taxation and the size of government, and those views can influence the amount of debt our society can afford to carry. However, when you reach a high debt-to-GDP ratio, what is sustainable is also very much influenced by the willingness of investors in financial markets to hold your debt.
[Translation]
I do not mean to imply that financial markets might suddenly decide to stop lending to Canadian governments. What happens, as recent experience has shown, is that at very high levels of debt, there may be an increasing nervousness among lenders so that they would only continue to hold Canadian government debt at much higher interest rates.
[English]
That brings me to the matter of interest rates, and I would like to put their role in the debt and deficit problem in a broader context than the arithmetic calculations included in the Auditor General's report.
The main point I want to make is that the interest rates in Canada are influenced by the economic policies we pursue, including the debt and deficit policies of governments. This is part of the explanation as to why, in the Auditor General's chart on page 11 of the English version, interest rates were low relative to the growth of the economy before 1980 and higher subsequently. The other part of the explanation is an increase in international interest rates.
Thinking about economic policies, for example, there were regulatory policies in the 1950s and the 1960s that imposed a ceiling on the interest rates that banks could charge, as well as other restrictions on lending, which meant that governments were not subject to the same competition as now from private sector borrowers in obtaining funds. Beginning in 1967, many of these regulations were removed to give private sector borrowers, and especially households, better access to credit. With more competition among borrowers, an increased level of interest rates was needed to balance the supply and demand for credit. Thus, governments had to pay more to borrow when they began to allow their deficits to rise in the 1970s.
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[Translation]
Inflation also had an impact on interest rate levels. When inflation first began to rise in the 1970s, many savers and lenders were caught by surprise. And for some time they believed that inflation was only temporary. Thus nominal interest rates were low relative to inflation and the growth of the economy, making debt-service costs easy for governments to carry, but at the expense of savers. However, from the late 1970s on, high inflation came to be expected. Because high inflation tends to be unpredictable, savers, investors and lenders came to demand interest rates high enough to cover expected inflation, plus an added premium for inflation uncertainty. This risk premium raised the interest rates faced by all borrowers and meant that debt-service costs of governments began to rise more rapidly than the growth of the economy.
[English]
However, the fiscal position of the government sector would have worsened from the 1970s onward even without the higher debt service costs. As I mentioned, once debt-to-GDP ratios reached high levels, investors became nervous about the capacity and willingness of governments to service their debts in the future. So even as our inflation rate has come down, our interest rates have remained relatively high. While inflation uncertainty probably remains a cause of risk premiums in our interest rates, those risk premiums are now related much more to concerns about fiscal debt and deficits.
A good indication of the size of risk premiums is provided by the interest rate differentials between Canada and the United States for medium- and longer-term maturities. These differentials are currently relatively wide, and they imply interest rate levels that are costly to Canada over time. High interest rates discourage investment in improved productivity that could help raise Canadian living standards in the future, and to the extent that our debt is owed to foreigners, the present risk premiums in our interest rates raise the debt service costs we pay abroad and make us poorer as a country.
[Translation]
Moreover, at our current debt levels, each time a piece of negative news comes along, such as higher international interest rates or political uncertainty in Canada, investors become even more worried about the capacity and willingness of Canadian governments to service their debts in future. As a result, investors demand still higher risk premiums for holding our governments' debt, and interest costs, deficits and the accumulation of debt rise still further. In these circumstances, a government can potentially find itself in a vicious circle of rising interest rates and rising debt. These were the sorts of pressures the government encountered for a time following the rise in U.S. interest rates beginning in early 1994 and again early this year following the Mexican currency crisis.
[English]
Because of the measures taken by the federal government and most provincial governments this year to address fiscal imbalances, some of the nervousness in financial markets about the fiscal situation has eased. I believe this was helpful in the period of political uncertainty during the referendum campaign.
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However, judging from the relatively wide spreads that persist today between Canadian and U.S. medium- and long-term interest rates, we remain vulnerable to any shocks that may come along that increase investors' worries about the capability of Canadian governments to keep on their fiscal track. What this suggests to me is that if we want to reduce our vulnerability to financial market volatility and to high interest costs, we need a debt-to-GDP ratio for Canadian governments in total that is lower than it is now.
Thank you, Mr. Chairman. My colleagues and I are ready for your questions.
[Translation]
The Chairman: Thank you, Mr. Thiessen. We will now proceed to the question period. We will begin, as usual, with Mr. Laurin.
Mr. Laurin, you have ten minutes.
Mr. Laurin (Joliette): Governor, given that our interest rates are influenced, as you were saying, by the credibility of the federal government, and that it also seems to be recognized by many people that not defining a long-term schedule for the reduction of the debt partially undermines this credibility, could you tell us what the impact on interest rates is of the fact that the government does not define a long-term schedule for the reduction of its debt?
If I may explain, Governor, this was also mentioned by Moody's rating firm when it lowered Canada's credit rating from AAA to AA1 on federal government bonds. The New York agency justified its downgrading by referring to the government's lack of clear deficit reduction objectives beyond 1996-97. Mr. Martin continues to make projections that do not go beyond two years. That is why I am asking you this question.
Mr. Thiessen: I don't really know... The objectives must be credible. Since Canada has had several governments that have set objectives they were unable to achieve, there is now a lack of credibility when a government sets objectives for reducing its budget deficit. I don't know exactly what the best solution is, but it would certainly be necessary that the government reach its targets, otherwise its credibility will deteriorate.
[English]
To make sure that I'm absolutely clear, you have to have credible objectives. If you don't set credible objectives, if they're not objectives that you're absolutely committed to and believe you can achieve, then it does more harm than good.
[Translation]
Mr. Laurin: I will put my question more precisely, Governor. What is the impact of this conduct of the government on interest rates, in your opinion?
Mr. Thiessen: I don't know. If the government establishes some objectives, but these objectives are not credible, the differentials between our interest rates and interest rates in the United States will increase, which will increase the risk premiums. Objectives are useful only if they are credible.
Mr. Laurin: I find it surprising, Governor, that you are unable to give us an opinion on this since Moody's rating service relies on this to evaluate the impact of this conduct. Moreover, since the Bank of Canada to some degree controls interest rates, how is it that you are unable to assess the impact of such policy behaviour?
Mr. Tim E. Noël (Deputy Governor, Bank of Canada): The important thing for the markets is not only having very credible objectives but also managing to achieve them year after year. That is what will have an impact on the risk premiums on the market.
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It is much more important to do that than to make, as governments have in the past, a five-year forward projection that they have not managed to achieve. So, to have some credibility, it is necessary to have credible objectives, but also to achieve these objectives year after year.
Mr. Laurin: Could you evaluate, in interest rate percentages, how high this risk premium is at present?
Mr. Noël: It is hard to say exactly how high the risk premium is.
One way to look at the risk premium on the Canadian market, at this point, is to look at real return bonds of the government of Canada which, at present, are rated at about 4.5 percent.
In the long term, we're at about 7.80 percent, which yields 3.30, but these are inflationary expectations. In fact, these are risk premiums that include all kinds of things, such as uncertainty about inflation and the fiscal situation of the Canadian government.
It is very hard to determine what part of the risk premium is specifically attributable to what you were saying in your question.
Mr. Laurin: But on a rate of 7 or 8 percent, you can't evaluate approximately how high the part attributable to the risk premium is?
Mr. Thiessen: We can say that the spread between Canadian and U.S. interest rates, in the long term, is about 175 basis points. That is very high. Normally, the spread is between 50 and 75 basis points. At present it is much higher.
But we are unable to say what the exact rate of the premium is. We can't be sure. What we do know, however, is that the differentials between our interest rates and the rates in the United States are excessively high.
Mr. Laurin: Governor, since the Bank of Canada controls the interest rate, do you think the Bank of Canada's monetary policy could be more flexible and adapt to a goal of reducing the ratio of debt to gross domestic product? In other words, is the Bank going to essentially pursue, in its monetary policy, an objective of controlling inflation, or can it become less restrictive and adapt to an objective of reducing the debt to GDP ratio?
Mr. Thiessen: I don't think that would be a good idea. To have the lowest possible interest rates, there must be a very, very low inflation rate. The only way the Bank can encourage the lowest possible interest rates is by having objectives for controlling inflation rates. That is what will help the government reduce its very high level of indebtedness.
I think it is really impossible for the Bank of Canada to have an objective such as the debt to GDP ratio. It doesn't really go with monetary policy. You can't have a monetary policy that can reduce the government's debt.
Mr. Laurin: Governor, I am not an economist, obviously, but I am always astonished when we talk about inflation. It seems to me that the interest rate is the cost we pay for the money we want to borrow.
Mr. Thiessen: Yes.
Mr. Laurin: So, if it is the cost we pay for the money we want to borrow, the interest rate is therefore itself an inflationary factor.
When we don't want the cost of goods to increase, we arrange to pay less for them, but you have control over interest rates, which correspond to the cost of money, which you yourself can set at a lower level. Wouldn't that be a step that would help reduce inflation?
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Mr. Thiessen: Not really. It is a very high level of aggregate demand which can cause inflationary pressures. With a restrictive monetary policy, we can reduce the pressure of aggregate demand on the capacity of the economy. That is much more important than the cost of interest rates.
[English]
To explain myself more clearly, monetary policy operates at the level of aggregate demand in the economy and the pressure of the level of that demand on the capacity of our economy to produce. It's when demand exerts too much pressure on capacity in our economy that you have persistent inflation. That is the fundamental cause of inflation over time. Interest rates, as a cost, tend not to be important because as a business person you cannot pass on higher costs unless you are faced with a very strong demand in the economy.
The Chairman: Mr. Williams, you have ten minutes.
Mr. Williams (St. Albert): Thank you, Mr. Chairman.
Good afternoon, Mr. Thiessen and gentlemen. I appreciate seeing you here today to give us some understanding about the debt and deficit. The Auditor General has pointed out that it is a matter of serious concern to all Canadians.
I note in your opening statement, Mr. Thiessen, that you say at a minimum this calls for actions to bring down the debt. Continuing on, you said:
- ...once the very high debt levels are reached, just stabilizing the debt to GDP ratio may not be
sufficient - lower ratios may be needed.
- ...we need a lower debt to GDP ratios for Canadian governments in total that is lower than it is
now.
Mr. Thiessen: I wish I could give you a simple answer to that. But I also say in my opening statement that economic analysis really doesn't provide a simple straightforward way of saying that I just happen to know the numbers should be such-and-such. What we do know is that at current debt-to-GDP ratios for total governments in Canada, now well over 100% of GDP, we encounter very high interest rates - interest rates with large risk premiums in them, wide differentials between Canada and the United States.
We also know that at these kinds of debt-to-GDP ratios we are subject to volatility in our markets, that when a piece of bad news comes along investors, both Canadians and foreigners, look at the Canadian situation and say it looks like governments are going to be in more trouble in servicing their debt in the future. Then you can get into a kind of nasty vicious circle, where people are more worried about lending to you, and they only lend to you at higher interest rates. That increases your debt service costs. It adds to your debt faster, and it makes them even more worried.
We know that at current debt-to-GDP ratios we are very vulnerable. So we need to aim for something lower. I'm afraid I cannot engage in an objective analysis and say that I just happen to know what the right number is.
Mr. Williams: In the debt operation report of December 1995, the Department of Finance indicates that individuals and small businesses are bailing out of government debt. There's a significant drop, $10 billion, a 17% drop in holdings by that category of people. Are Canadians losing faith in Canadian debt?
Mr. Thiessen: I don't know that I'd like to say that. It is certainly true that all investors, both Canadians and foreigners, show an unwillingness to hold our debt except at very wide differentials above external interest rates, particularly above American interest rates. That says they are nervous about the future; they are worried about the preservation of the value of their investment when they invest in Canadian government debt and indeed in the debt of Canada generally.
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Mr. Noël: I wonder if I could add something. Those numbers refer to the direct holdings of the debt by those kinds of holders.
One of the things that is happening is that a number of the individuals are holding debt through mutual funds, and the mutual funds themselves hold the Government of Canada debt. So while they're not holding it directly, they're holding it indirectly. So the number tends to overstate the reduction in holdings by those people.
Mr. Williams: The government has a stated policy to move the long-term debt up to 65% of market debt from currently around 55%. Debt that is held abroad, which is about 25% of our debt, is moving more into T-bills and short-term instruments. They're moving away from long-term to short-term because of the vulnerability that you mention, Mr. Thiessen, which is counter to the government's policy of getting longer-term.
Are we able to patriate that foreign debt to try to meet the government's stated policy? Or how do we address the situation that we want to go long and foreign lenders are insisting that they go short? How do you resolve that issue?
Mr. Thiessen: I don't know that foreign lenders are insisting absolutely on going short. The attraction of going to a somewhat longer maturity level for Canadian government debt is that it stops some of the sharp ups and downs that you can encounter when interest rates go up and down at the short end. What that can do is dramatically affect your budget deficit from one year to the next, and that causes a good deal of concern and uncertainty.
So by having its debt somewhat longer, you can have rather smoother debt service costs, and that reflects less on year-to-year fluctuations in the deficit. That strikes me as indeed something that's very attractive to do.
But I must say that I'm not aware that foreigners are demanding that they hold only shorter-term instruments. I think it's certainly true that they are holding somewhat shorter instruments. My colleague Tim Noël is just pointing out to me that the ratio is indeed going up in the shorter-term end. But I must say in terms of listening to what people have said about Canada, I haven't gotten the sense that they say, well, we'd only lend to the Canadian government if it was very short term.
Mr. Williams: This is the second time that the Auditor General has written on debts and deficits, and he called for more information to the Canadian public and to Parliament.
I'm concerned about the hidden costs of the real return bonds that have a balloon payment after thirty years, at maturity, to represent inflation
[Inaudible - Editor] the accrued interest on Canada savings bonds, those that are paid on accrual basis, that are paid at maturity some years down the road. And just a year or so ago the government changed its accounting policy to amortize the front-end fees on issuance of the debt over the period of the debt instruments.
All those things are deferral of this year's costs or current costs. How much are we deferring on these real return bonds, compound-interest Canada savings bonds that are an actual cost in the current year but are being deferred to a future year?
Mr. Thiessen: I defer to my colleagues, who are a bit closer to that than I am.
Mr. Vaughn O'Regan (Adviser, Bank of Canada): As I understand it, the accounting procedures of the government do take into account on an annual basis the amount that is being amortized both with the Canada savings bonds compound interest bonds, as they're called, and with the real return bonds. At least it is my understanding that the accounting on an annual basis would reflect what is happening.
In terms of what portion, it is a case with the real return bonds that there is an interest payment, which has typically been around 4.25%, that is paid out each year. To the extent that inflation is paid out in conjunction with that interest payment, that takes maybe half of the pay-out. The other half stays with the bond and, as you suggest, is paid out when it comes due. It's an indexation of the principal amount.
It represents roughly half of the cost associated with those real return bonds that is being deferred. At this present time, there's only about $5.5 billion outstanding. As you know, the total debt is in excess of $500-odd billion, so it's a rather small portion that falls into the category you're referring to.
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Mr. Williams: I was thinking that if the inflation factor was around 2% to 3% of $5 billion, we're talking $100 billion to $200 billion this year, and as far as I can understand, these RRBs may take a larger portion of the portfolio, therefore becoming an increasingly important factor. If inflation does not remain contained in its low level today, it could actually be a hidden cost that is building up again for Canadians to pay in the future, much like the unfunded liabilities and the debt we have acquired.
The Minister of Finance stated that he is ``rock hard'' in meeting the targets he has set out. If we come to the end of the business cycle - and we've had a good run in this particular business cycle - and we see an economic downturn or slowdown that depresses revenues and perhaps puts pressure on expenditures, what's the Bank of Canada's policy going to be on inflation in that situation? Are you going to allow the minister to meet his rock-hard targets by maybe opening up a little bit of inflation or are you going to stay to your policy of keeping inflation within the targets?
Mr. Thiessen: As I said in response to an earlier question, monetary policy is geared to inflation control and it's certainly not geared to helping the government reduce its debt or its debt-to-GDP ratio.
The Bank of Canada is absolutely committed to holding inflation inside its 1% to 3% target band. If there is some weakness in economic activity, it will tend, on balance, to cause the trend outlook for inflation to be down a little bit. In those circumstances it allows the bank to pursue an easier track for monetary conditions that helps to support an economy that is in a weak state.
Our inflation control targets are basically as a set of automatic stabilizers. If the economy is very strong, if it's inflationary, that tends to encourage us to pursue tight monetary conditions. If the economy is weak and inflation is tending to fall to the bottom of our band or below, then that encourages us to have easier monetary conditions. That helps the economy to be smoother. But this is the objective of monetary policy. There would be no circumstances under which we would say it would just somehow suit the economy to have more inflation. Absolutely not. This is a self-defeating policy that just gets you into more trouble than enough. Out of all that you get much higher interest rates, you get much higher debt service costs, and you get a worsening of government deficits, unless they take some action in response to it.
The Chairman: Mr. Assad.
Mr. Assad (Gatineau - La Lièvre): Governor Thiessen, we have an opportunity here to discuss some of these issues. Ever since the Auditor General made reference to the fact that we needed a public debate on the debt and deficit, I also felt that maybe the time had come to look at the possibilities of having monetary reform.
Back in 1939-40 and right up to the early 1950s, the Bank of Canada made very substantial loans to the federal government at very low interest rates and, if I remember, it was as low as one half of 1%. These loans materially assisted our country to pull itself out of the Great Depression of the 1930s and to finance the massive war effort in the 1940s and the expansion of our economy in the post-war period.
My question revolves around the following. If the Bank of Canada could do that in the great emergency our country faced back in 1939, why could the Bank of Canada not respond to our present national emergency?
I don't think that's an exaggeration. We have a soaring government deficit, the permanent loss of hundreds and thousands of jobs, both in the private and in the public sector. In the private sector it is probably free trade that has contributed more to that than anything else. The inevitable decline in the standard of living of millions of Canadians and the great potential for the break-up of our country...the economic factors, as far as I'm concerned, manifested themselves in the referendum in Quebec a few weeks ago.
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Specifically, Governor, if any of the provincial premiers who are running large annual deficits, which in a large measure are being caused by the interest costs of servicing their own growing debts, came to the Bank of Canada and asked for very low interest rates - let's say, 2% - first, to replace their high interest rate loans as these mature, and secondly, to finance needed capital work projects by themselves and their municipalities, if the federal government approved, would the Bank of Canada approve and make such loans? If not, why not?
Mr. Thiessen: The answer is no. The Bank of Canada would not make such loans. The reason why not is that it is essentially equivalent to printing money. What we know is that if you print more money than the economy can usefully use, all you're going to do is cause inflation. You're going to cause interest rates to be higher, you're going to cause heavily indebted governments to be in an even worse position than they were before. It simply doesn't help.
The kind of solution this involves somehow implies that you can fool people, that somehow with high inflation they're not going to respond, that savers will continue to save, and they will lend money at low interest rates that don't compensate them for inflation. We know that just isn't true any more. It just doesn't happen. Savers are worried about inflation. They're worried about the value of the money they save. So if they lend money to the government, they want to be sure they'll get it back in the end.
The Bank of Canada has a very small balance sheet relative to the size of government requirements. If we were to lend any significant amount of money, that would be a huge expansion of our balance sheet and that is essentially the modern-day equivalent to going out and printing money. It just cannot be a solution to our problems.
Mr. Assad: Fine, except that I've read this before in the past, and I would ask you again. You're assuming that the bank's concern in recommending against such a loan is the fear that there would be an inflationary effect. Obviously, the Bank of Canada has carefully analysed that possibility - no doubt. Let us assume that the bank makes such a loan to the provinces. The monetary result would simply be an expansion in the balance sheet of the Bank of Canada.
Why I'm referring to this, Governor, is that I realize it's not a simple solution, except that logically I thought that seeing we had done it during the war years and the post-war period...as I was saying, it would simply be an expansion of the balance sheet of the Bank of Canada. On the asset side, it would have a receivable from the provincial government concerned. On the liability side, it would be an equivalent increase in a deposit made with a chartered bank with whom the borrowing province would deposit its proceeds. The resulting very large deposits that the chartered banks would have with the Bank of Canada would, of course, greatly increase their cash reserves. If the bank chose to use that cash to make a huge increase in their loans to Canadian businesses and consumers, the result, of course, would be inflationary. That, I think, we understand.
Could you and the federal government not easily prevent this by imposing mandatory deposit reserves with the Bank of Canada by the chartered banks that would effectively freeze these deposits at the level that would prevent the inflationary effect that might occur?
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Now, I realize that we gradually faded away our reserves; we're one of three countries in the world, with the United Kingdom and Switzerland. What we're all searching for here is an alternative solution to the job-destroying re-entrenchment programs our government has had to impose on the provinces and its municipalities. The provincial governments have had no option but to adopt these policies if they are to get their deficits under control.
Governor, back in the war years and at the end of the Depression, these extraordinary measures were taken by the Bank of Canada. There was a crisis. God knows we have a crisis now.
Lately I was reading The Financial Post. In it there was your picture, sir, with I believe that of Alan Greespan from the United States reserve. There was a quote from some German international banker - he might have been with Germany's central bank - that one of the last tools left are the monetary tools.
Yes, we have to cut where there's waste, but we're going to have to look at monetary reform. Does it seem that far-fetched that these measures could not be looked at?
Mr. Thiessen: I'm afraid my answer is, yes, they do seem rather far-fetched to me. I must say, I'd have to go back and look at my history, but I don't have a recollection that the bank directly lent large quantities of money to the government during the war years. The bank was certainly very involved in helping the government finance its requirements during the war period, but I don't have a recollection that the Bank of Canada was making direct loans to the government. I will certainly check that when I go back to my office, but that is not my recollection.
The solution you propose whereby the bank lends to provinces.... Its assets go up and it does have to have a liability counterpart to that. As you rightly say, in the normal circumstance, when the bank goes out and buys assets or makes loans, the liability counterpart ends up being the deposits of chartered banks, of the caisses Desjardins, of the credit unions and the trust companies, at the Bank of Canada. The only way we could make significant loans to anybody would be to expand the deposits of these people. That would be very inflationary.
Now, you say, why not raise the reserve requirement? Reserve requirements are essentially a form of tax, a form of tax on banks, credit unions, caisses populaires. It's essentially a tax on deposits.
It seems to me if what you want to do is raise the level of taxation in order for the federal government to make loans to the provinces, then you should do it directly. Doing it via the Bank of Canada strikes me as just putting a kind of mysterious cloak around something that is essentially just an increase in taxation.
Mr. Assad: Governor, in my limited knowledge of this subject, obviously when there are deposits into the chartered bank - let's say I make a deposit - they can take that deposit...and what is their multiple, nine? It's the chartered banks who have the power to expand my deposit.
Mr. Thiessen: No, sir, it doesn't work that way. The chartered banks basically have to attract both borrowers and depositors. They constantly have to pay market rates to attract the depositors if they're going to lend to borrowers. There is no magic multiple.
The notion some of us learned in our economics textbooks way back when, that there is this wonderfully miraculous money multiplier - you put $10 in and it suddenly transforms itself into $1,000.... No, it doesn't work that way. But there are a whole lot of savers deciding whether they're going to save or whether they're going to consume. They look at the interest rates they can receive. On that basis they make a judgment about whether they want to save or whether they want to spend that money. You have borrowers on the other side who are also deciding whether it's worthwhile making a decision to borrow to invest or to consume.
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All of those together end up deciding what kind of interest rates we have in our economy. We're also very much influenced by what goes on in the rest of the world.
But, no, there is no magic money multiplier whereby the banks can somehow create credit and money out of nothing. No, sir.
[Translation]
Mr. Fillion (Chicoutimi): I am going to put myself at the level of a constituent in my riding and ask you the questions he normally asks when I meet him.
Our constituents tell us that the government's debt problem is attributable to two things: the government's spending power and also, in large part, the very high interest rates policy of the Bank of Canada. That is how our constituents analyze it. These people are asking us what is the degree of responsibility of the Bank of Canada in the country's high deficits. Does government planning, as we know it, based on some two-year targets, affect the Bank's monetary policy?
Mr. Thiessen: I am not certain I clearly understood your question.
Mr. Noël: You are saying that in fact a major share of the increase in the Canadian government's debt is attributable to the monetary policy of the Bank of Canada, because you claim that it is the Bank of Canada that controls interest rates.
Mr. Fillion: Exactly. Those are some of the questions that our constituents put to us and those are the answers they get. They end up with the view that the present indebtedness is attributable to those two aspects, especially the high rates determined by the Bank of Canada.
Mr. Thiessen: But the Bank of Canada cannot determine interest rates arbitrarily. We cannot decide today that we will have a 3 percent interest rate. Things don't operate like that. Monetary policy can have some effect on the government's budget situation via the rate of inflation. If the Bank of Canada could control the rate of inflation, we could have lower interest rates and that could reduce the government's financing costs.
If the Bank pursues an inflationary monetary policy, interest rates will rise, the government's debt servicing will rise and the government's budget position will deteriorate.
Mr. Fillion: Would the monetary policy be different if the country's indebtedness was less?
Mr. Thiessen: No, not really. It would help implement the monetary policy, because we could avoid volatility in the financial markets, which is often the case at present. Even if the budgetary situation were much healthier than it is now, the Bank of Canada would pursue a policy of controlling inflation, because that is the best contribution we can make to the proper behaviour of our economy.
Mr. Noël: If we had a healthier budget situation, we would of course have lower interest rates all along the curve, because the risk premium would be lower.
Mr. Thiessen: Yes, exactly.
Mr. Fillion: As we speak, are you controlling inflation?
Mr. Thiessen: Yes.
Mr. Fillion: It is currently between 1 and 3 percent. Is that your goal?
Mr. Thiessen: It is.
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Mr. Fillion: As we speak, are you controlling inflation?
Mr. Thiessen: Yes.
Mr. Fillion: Is it between 1 and 3 percent?
Mr. Thiessen: Yes.
Mr. Fillion: That is your goal?
Mr. Thiessen: Yes, that is correct.
Mr. Fillion: So, you are currently achieving your main objective, which is to control inflation?
Mr. Thiessen: Exactly.
[English]
Mr. Silye (Calgary Centre): Governor, I've read over your opening remarks. I'd like to concentrate on the last sentence here:
- ...if we want to reduce our vulnerability to financial market volatility and to high interest costs,
we need a debt to GDP ratio for Canadian governments in total that is lower than it is now.
One economist suggested, well, rather than concentrating on the deficit as a percentage of GDP, why not concentrate on the debt-to-GDP ratio, which is what you concentrate on as well? This economist - I forget the individual's name - suggested that rather than the current 73% we have, perhaps the finance minister should set 71% and move toward that as quickly as he can.
Having given that background to my question, I have three questions. I'll just lay them out for you to answer. Then I'll be finished my intervention.
Currently the debt as a percentage is 73% of GDP as presented by most financial people. My first question is, you suggest that this is one of the things the government should do - but how much lower? It's 73%. How much lower, and by when should we get there? Should it be 71%? Should it be 70%? I know it can vary, but what would you suggest?
Second, what level of debt can we afford? This whole discussion is about what this country can afford. Currently as a federal government we're at $568 billion. How high can we go? When this term is over we'll be over $600 billion if we project even the 2% of Paul Martin's budget. We'll be over $600 billion. Can we go to $1 trillion? What is our capacity to borrow? What is our capacity to get further into debt? How high can we mortgage this country?
Third, how long can we go? We've gone 30 years now without making one dollar of repayment on our debt. We've just added to it for 30 straight years since 1968. How long can we go before we have to make a payment on that debt?
Those are my three questions.
Mr. Thiessen: I'm afraid I don't have any nice, simple answers for you. As I said in my opening statement, economic analysis on its own really doesn't provide a simple, straightforward answer to the questions you've asked. There is not an objective analysis you can do that says, yes, we're at about 70% - or I prefer to look at it from my point of view, the government sector as a whole, well over 100% - and it should be thus and so.
It's certainly true there's a level of debt we can afford. It has to do with what kinds of levels of taxation we as a society, as the Auditor General has pointed out, feel are appropriate and what levels of government services we want to have. You put those two together and that says something about the kind of debt level you can carry as a country. But those end up being political choices, small ``p'' political, societal choices, people have to make.
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I must say, I find it difficult to offer you a suggestion. What I do know is that at the current level of debt-to-GDP ratios, we are vulnerable. We are vulnerable to volatility in our financial markets. We are vulnerable to high interest rates. We are paying dearly in terms of the risk premiums in our interest rates. As I conclude in this statement, that says to me the debt ratios should be lower.
I can't offer you a number that says exactly what it should be. I must say that from my point of view I think we should be aiming for getting those risk premiums down, and we should particularly be seeking to narrow the interest rate differentials between Canada and the United States.
Mr. Silye: You've answered my first two questions. Could you make a comment on the last one?
How long can we continue to add to our problem? How long can we continue to add to the debt? I don't care whether it's $30 billion, $10 billion, or $2 billion a year. When do we have to stop adding to it, and when should we be making a repayment on the debt?
Mr. Thiessen: That depends on what our economy is doing. If we have a productive, expanding economy, then the debt level, in dollar terms, can rise.
You can have a situation, for example, where you have, let us say, a debt-to-GDP ratio of 25% or 30%. With a productive, growing economy, you can have your debt level rising with the economy forever, virtually, because people will be absolutely convinced that you're capable of carrying that debt and of servicing it. Once you get to high levels, that is when you get into trouble.
It's very unlikely that there is a level at which all of a sudden nobody lends to you. I do not believe in the notion of the debt wall or the debt cliff.
What happens is that you pay more and more dearly, in terms of interest rates, and that gets you increasingly into the vicious circle I was mentioning before, where every time the slightest piece of bad news comes along, investors get worried about you and they demand an even higher risk premium. That makes your situation look even worse, and that in turn makes them even more nervous than before. You don't want to get there.
Mr. Silye: Thank you for answering those three questions. I just thought of one more thing, and then I'll be finished.
Last night the Prime Minister was on a town hall show on CBC. He said that we have a debt in this country and we're making the interest payments on that debt; therefore we have no problem.
Are we borrowing money to make our interest payments, or are we borrowing money to meet our program spending?
Mr. Thiessen: I don't think you can really answer that -
An hon. member: Oh, oh!
Mr. Thiessen: - I'm afraid, because as they say -
Mr. Silye: We do have a problem, don't we?
Mr. Thiessen: - money is fungible, and you can't tell which money is going to do what.
Yes, I think we do have a problem. We have debt-to-GDP levels that are too high.
Mr. Silye: Thank you.
The Chairman: Mr. Telegdi.
Mr. Telegdi (Waterloo): Mr. Chair, thank you very much.
You know, this is sort of like a repeat sitting in the House. We have the minister, on the one hand, saying we're setting credible targets that we're going to meet, rolling targets. I'm glad to hear your comments on it, but we have seen these comments in the media before.
I'm concerned about two major issues. You mentioned the price of political instability and how that adds to the government's debt, as well to as the individual's debt, especially any individual who has a mortgage, because higher interest rates lead to higher cost. Perhaps you could address that.
The other concern I have is that during the last recession we heard much evidence in front of the industry committee that was widely reported in the newspapers. By arbitrarily cutting credits, cutting credit lines, the banks forced a lot of businesses into either recession or bankruptcy, which had an impact on the GDP. Clearly they helped deepen the recession.
When we deal with deficit and debt, I see two kinds of deficit and debt. The first is where you invest to get a return at some point, get a profit, which a business will do. They will borrow money with expectations that they will generate a profit. If they don't go into debt, they will not generate a profit.
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Governments make investments as well. They make investments in research and development, which is clearly different from making an investment in a national park, if you will, in terms of the economy.
If we fail to make investments, obviously there are long-term implications to the economy. The economy is not going to expand, or to grow.
Can you address those two points? And on the second one, can we differentiate between what is being spent to produce growth in the economy and what is being spent as deficit, obviously supporting some program that doesn't produce growth in the economy?
Mr. Thiessen: Well, certainly an argument can be made that governments should draw a distinction between current and capital expenditures, just as one does in the private sector, in businesses.
If you're going to invest in a capital project, which is going to yield you a rate of return over the next 15 years, then you can argue it's perfectly legitimate to borrow for 15 years and to spread the cost of servicing that debt over 15 years. And as long as the rate of return on your investment is higher than your borrowing costs, that's a good and sensible thing to do.
These kinds of distinctions are often difficult to make for governments. There's not as neat a line that you can draw between what is capital and what is current.
But, you know, once you get to very high debt levels all the room for manoeuvre that you would have in normal circumstances tends to disappear on you. Unless you're doing something to get that situation under control, you're going to end up by paying dearly in terms of interest rates, and the the whole country is going to pay dearly in terms of interest rates, because government rates tend to set the minimum interest rates that are available in our economy.
So you find yourself in a situation where you don't have much choice. The cost of doing nothing about the debt and deficit situation is too large. You simply cannot say, well, I'm going to live with it. It doesn't become an option for you any more.
Mr. Telegdi: One of the ways we deal with this is by buoying the economy, obviously.
In my riding we have the University of Waterloo. We have a whole collection of software firms. Their economic activity is growing by leaps and bounds. Their greatest worry over the next decade is whether they are going to have enough trained people to do those jobs. Obviously if they don't they'll have to move someplace else.
Clearly government has a role with universities and making sure that people who are required for those jobs get the training. If you don't do that, then we're in a terrible mess.
That's the kind of thing I'm referring to. I'm not sure whether it's capital or current when you get into R and D. It's not quite that neat.
Mr. Thiessen: No.
Mr. Telegdi: The whole software industry is a black box as far as banks are concerned, and their knowledge of it is pretty limited. It's not like buying a skyscraper and saying that has some value.
Mr. Thiessen: But if you're saying somehow that you don't deal with the deficit and debt problem because of that, then I say that's not the solution.
Mr. Telegdi: No, no, I'm not saying that at all. But if we were to cut off all those kinds of expenditures we have, then we'd be in a terrible mess, and the economy would not grow.
Mr. Thiessen: There's no question that there are difficult choices to be made, and I must say, as the head of the Canadian central bank, that I don't think I should be giving anybody in Parliament advice on the kind of choices you should make. Those are basically your choices. Those are societal choices we have to make here.
All I can give you are some of the financial implications of the situation we're in. In the end I'm afraid those hard choices about what you cut and what you don't cut are yours.
An hon. member: I want to go bankrupt.
An hon. member: That's why you have elections.
An hon. member: Oh, oh!
Mr. Telegdi: The Auditor General said we should have a debate about the deficit and the debt, and what we are willing to carry. I am saying that there are different kinds of debt.
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To use your terminology, if you have current accounts, if they're just supporting something that's not producing any growth in the economy -
Mr. Thiessen: Sure.
Mr. Telegdi: - then obviously that's something we can't sustain. But if we want the economy to grow, certainly we have to take some risks, as any businessperson will do, in making those choices.
Now, there's no question we're talking about having a balanced approach. We federal Liberals do have a balanced approach. But I think we need to recognize that there are different types of that, and at some point that is an investment as well.
Mr. Thiessen: Sure, but if you already start with very high levels of debt, unless you have capital invested that is a counterpart of all that debt, I think you're in some difficulty.
If you started from zero and you said, all right, it's a good idea to invest in this capital because it's going to be good for the economy and we'll borrow to do that, I think everyone would say that's perfectly legitimate. But if you've already accumulated a large amount of debt and you don't have productive capital that is a counterpart of that, then I think you start from a very uncomfortable place.
The Chairman: Mr. O'Brien.
Mr. O'Brien (London - Middlesex): Thank you, Mr. Chairman.
Governor Thiessen, I appreciate your opening remarks, and I apologize for being a few minutes late.
Mr. Chairman, I have a question on this whole issue of deficit and debt ratio. My riding is London - Middlesex, and we were the targeted city, if you will, in Ontario for a one-day strike in reaction and protest to the actions of the Harris government. Some would call them the slash-and-burn tactics of the Harris government.
But I think you've made the point very well that this kind of decision about how much debt and deficit we can carry...I think your term was small ``p'' political decision, and I would agree with that. I would submit it's also a big ``p'' political decision for governments to make. As I think you've rightly said and as the Auditor General has said in the past, it's certainly not a simple decision and not one for the bank or the Auditor General to make, but for elected governments to make.
In answering a question I put to him last year, the Auditor General did congratulate the Minister of Finance on the process of consultation, at least on the degree of consultation that had been taking place under this new government. I can assure my friends opposite that that is going to continue this year.
To that end I, along with my colleagues, held a town hall meeting in London last week to hear a wide spectrum of views of Londoners.
My first question about public consultation is this: what do you think is the role of the Bank of Canada in the area of public education, and is there room to expand that role, as you see it?
Mr. Thiessen: Yes, I certainly think there is room for the bank to do more in public education. We're already doing a lot more than we used to some time ago.
It's quite clear that public institutions have an accountability to the Canadian public. We have an obligation to explain what we're doing and why we're doing it. In order to do that, we have devoted more of our annual report to an accountability section on what the bank is doing.
We are also putting out a semi-annual monetary policy report, which tries to explain in a lot more detail than before exactly what we're up to and why. And we're trying to put it in a more forward-looking context so that it's not just backward-looking, but it also says something about our views of the future.
In addition to that, we go to every corner of the country to explain to people what monetary policy is, but also to listen to them because monetary policy has to be a national policy. But we know that the nation is made up of a whole bunch of areas, and we need to know what's going on in those areas.
That's what we are doing, yes, public education. Education has a kind of one-way-street flavour to it. I must say I prefer communication, because that seems to me to be two ways.
Mr. O'Brien: Right. I would second that comment, as I say, having just held our third town hall to communicate with our public.
Let me invite you to be constructively critical, if you will, of the government and of the current Minister of Finance, and suggest what ways you might think our consultation process as a government might be improved. Although, as I understand from objective observers, the degree of consultation by this government and this Minister of Finance has been apparently unprecedented, how could the government and the minister do even better?
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Mr. Thiessen: I think you're getting into territory that I really don't have any expertise on. I'm not close enough to this consultation process to really be able to comment.
Mr. O'Brien: My last question flows from my colleague Mr. Assad. Being a bit of a teacher of Canadian history, I understand that during the war the sale of war bonds, which was very vital to the war effort and a patriotic show by Canadians.... Is it not true that the Bank of Canada bought up some of those bonds and credited the government's accounts? Isn't that, in effect, a loan under another name, if you will? I think that was part of what my colleague was aiming to have you comment on.
Mr. Thiessen: Again, the bank always holds a certain amount of government debt. We have a balance sheet of some $28 billion, and virtually all of those assets are invested in Government of Canada treasury bills and bonds. We have done that since 1935, when the bank was established. But I don't have any recollection, in my reading of the bank's history, that there were special loans made to the government during the war. As I said, that's something I'm going to go back and check on to be absolutely certain. We were certainly involved in the process of helping to sell bonds to the public. That is absolutely true.
Mr. O'Brien: Thank you very much.
Mr. Grose (Oshawa): Mr. Thiessen, as is my wont, the question will be relatively simple. That way I have a good chance of understanding the answer. It might embody a recitation of my life, but fear not, colleagues, I used to run my life in fast forward so it won't take much time.
We mentioned the goal of zero inflation earlier on. I lived in zero inflation. I didn't like it. In the 1930s these were not good times. Came 1939, we invented a lot of money somehow and we went to war and we prospered. I'm given to understand that we also borrowed a lot of money. I'm not saying you loaned it to us, but apparently we paid it back. We got into this debt that we're in now for another reason.
As I said, I've lived through periods of non-inflation, mild inflation, relatively extreme inflation, and I like the inflationary periods a lot better. I lived a lot better, had a lot more fun, and people seemed to prosper.
In the long term, if you tell me that has caused part of the problem we have today, fair enough. But I'm wondering why we are so enamoured of this idea of zero inflation as a solution to all of our problems when it didn't solve our problems in the 1930s.
Mr. Thiessen: It's not a solution to all our problems - most certainly not. The 1930s was in fact a period of deflation. It was a period of falling prices. Our target is to hold the inflation rate within a range of 1% to 3%. If prices were falling on average, absolutely, in this country, I would regard it a criticism of monetary policy as much as if the prices were rising faster than 3%. This is a symmetrical policy. Deflation is not good for the economy; inflation is not good for the economy. Our objective is to hold inflation at an extremely low level and, by and large, to have more stability than we've had in the past.
I really believe that makes our economy grow better. When I started out my working life in the mid-1950s through the 1960s, it was a period of very low inflation. It was also a very prosperous period in which people made investment decisions without worrying about what price it would be in the future. People were prepared to save. People were prepared to lend money for 25 years. Nobody's prepared to lend money for that except to governments these days and then only at very high interest rates.
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What inflation has done is worried a whole lot of savers about the future. It led, through the 1970s and the 1980s, a lot of people not to engage in productive investments that raise the standard of living but to try to protect themselves from inflation, and indeed to try to prosper, to benefit, from inflation. You can see that in the speculative booms we had in the late 1970s and 1980s. Much of that speculation related to real estate.
Rising real estate prices do not make the Canadian economy better off. It's simply a transfer from one person to another. If all that energy had been devoted to productive investment, we would be a much more prosperous society today.
Mr. Grose: As a matter of fact, you have answered my question. It's one I get asked. I wanted your opinion, and this is the first opportunity I've had to ask you for it. I thank you very much.
So in other words, you would say inflation, although it's comfortable at the time, has a cost down the road.
Mr. Thiessen: Absolutely.
Mr. Grose: It's not obvious to the ordinary person who somehow benefits from it.
Incidentally, I agree with you. I had a 30-year mortgage at one time. If I'd stuck with it, I'd just be getting it paid off. You're right. I can't get more than a 2-year mortgage now. This means I have no idea where I'm going two years from now.
Mr. Thiessen: Exactly.
Mr. Grose: If that's what you're trying to do by keeping inflation at a low level, then I'm for it, but it's the best explanation I've ever heard, and I thank you for it.
Mr. Thiessen: That's the nature of it. Think about those savers who lent money at 3% and 4% for long periods of time when inflation went up. They were the ones who hurt. The borrowers gained and the savers got hurt. There was a substantial transfer of income. A lot of people found their retirements ended up being undermined rather badly by that process.
Mr. Grose: Mr. Chairman, I have one last short question.
Do you believe the inflation indicator is accurate, can be relied on, is realistic?
Mr. Thiessen: We've done some work on that. There is more work to be done. The work we have done to date says, yes, it is really quite accurate.
Our view is that probably the bias in the consumer price index is not more than half of one percentage point, but there is more work to be done on that. I know the Americans these days are worried that there is a much larger bias in their consumer price index. Some people even talk as much as two percentage points, which seems awfully high to me.
The work we've done suggests that Statistics Canada does a very good job on our consumer price index, but we're going to go at it again, especially when we see some of the studies our American friends are doing these days, to make sure that continues to be the answer.
Mr. Grose: Thank you very much.
Thank you, Mr. Chairman.
[Translation]
Mr. Laurin: Governor, you said earlier that some decisions were political choices and were the responsibility of the government. Isn't the struggle against inflation in itself a political choice to make?
Mr. Thiessen: Our goal of fighting inflation is based on an agreement between the Minister of Finance and myself.
Mr. Laurin: What is the government's influence on the decisions of the Bank of Canada?
Mr. Thiessen: When a target spread is set for inflation, it is the Bank of Canada that makes the decisions with regard to monetary policy.
Mr. Laurin: If we began to think that the anti-inflation policy was more favourable to Ontario than to Quebec and that we needed a decline in interest rates in order to create more jobs, who would decide that you are going to demonstrate greater flexibility on interest rates rather than on inflation?
Mr. Thiessen: Monetary policy is a national policy. When we make decisions, we look at the country as a whole. We don't look only at Ontario or Quebec, but at the country as a whole. It is a national policy. We are the ones who make the decisions.
Mr. Laurin: When you say we, it is the Bank of Canada.
Mr. Thiessen: Yes.
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Mr. Laurin: What makes you say that tomorrow morning, you will have to emphasize the fight against inflation rather than job creation?
Mr. Thiessen: Personally, I think wrestling inflation is the best contribution that monetary policy can make to the proper functioning of the economy. It will encourage employment more than a policy of higher inflation, which does not work.
Mr. Laurin: You say that this decision is made jointly by the Minister of Finance and the Governor of the Bank. Is that correct?
Mr. Thiessen: When we establish the target ranges for inflation, it is decided jointly by the Minister and the Bank of Canada.
Mr. Laurin: If we choose job creation rather than inflation, you have no further spread. Who makes the decision to fight inflation rather than promote job creation? Is it you or the Minister of Finance?
Mr. Thiessen: The Minister can always issue a directive to the Bank of Canada requiring a change in monetary policy, but it is the Bank of Canada that must make the day-to-day decisions with respect to monetary policy.
It is not true that there is a trade-off between employment and inflation. There is no such thing.
Mr. Laurin: Earlier, I asked you if there might be some advantage in the government's setting a deadline for the elimination of the deficit. During the pre-budget consultations, a number of witnesses came and told us that greater flexibility in interest rates could be advantageous. Do you agree with those witnesses?
Mr. Thiessen: I really don't know. As I said earlier, it is really a question of credibility. If you can establish some credible objectives for budgetary policy, it will help a lot. If you establish some objectives that are not credible, it will not help.
Mr. Laurin: In your experience, is establishing a program for the next five years likely to improve credibility for a borrower? Is that more worth while than presenting a one- or two-year program?
Mr. Thiessen: It depends on whether you achieve your objectives.
During the 1980s, lots of five-year goals were set, but they were not achieved. Now governments throughout Canada lack credibility with regard to objectives such as that.
[English]
The Chairman: Mr. Williams, you have three minutes.
Mr. Williams: Thank you, Mr. Chairman.
Mr. Thiessen, you said you do not believe in the debt wall or the debt cliff. However, if we go back to 1987, we didn't think there was a stock market crisis in the offing until after it happened. The same kind of thing happened in 1989. Of course we had the great one in 1929. We can't predict these things coming down the pipe; we can only see them after the fact.
Is there a possibility that we could have that with our high debt and deficit today, that we wake up one day and find out we did hit the wall?
Mr. Thiessen: You should never say never to anything, but I don't think so. I really don't.
Perhaps you can imagine a situation where debt levels are higher, where the deficit is obviously out of control, where the government is not capable of making the decisions necessary. Perhaps it doesn't have a majority in Parliament; I don't know. Perhaps you can imagine a conjunction of situations that might lead to this.
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If we're talking about the situation that we face in Canada or may potentially face in the near term, I just don't think that's a useful way of defining the situation. This is not to say it isn't costly not to deal with the debt and deficit situation. As I was suggesting earlier, what you end up doing is paying higher and higher interest rates.
Mr. Noël: Excuse me, but I think instead of hitting the debt wall you would find you would end up paying increasingly higher interest rates throughout the yield curve. In fact, if you look at what happens to many of the countries in the industrialized world today, it's those that have high debt-to-GDP ratios that pay substantial premiums compared to those who do not. There's quite a correlation between the debt-to-GDP ratio and the size of real rates paid by countries to finance this debt.
The Chairman: Mr. Williams, one last question.
Mr. Williams: I'm changing the line of questioning, Mr. Chairman.
We have a better part of $600 billion worth of debt. We also have about $650 billion in CPP unfunded liability, which I consider to be basically debt with a zero percentage rate of interest, because it is a liability, although it's not costing us to carry it on an annual basis.
You add these two together and you come up with about $1.25 trillion, plus provincial debt on top of this. That's working out to about $125,000-plus per working person in this country - maybe even more, just on very rough mathematics. How are we going to maintain our competitiveness in the international world if every worker is to carry $125,000 debt or more, before they think of car loans, mortgages, consumer debt and so on, without finding there is some strictures in the situation?
When the deficit is eliminated and the budget is balanced, we're only going to be able to return to Canadians 60% of every dollar collected in taxes, and 40¢ goes to pay the interest on the debt. If we think Canadians feel overtaxed today, they haven't felt the bite at all until we find the situation that they're only getting 60% return on their money invested.
How can you be sure you're going to be able to hold the line on your inflation targets under these scenarios where our competitiveness is eroded and the people are feeling squeezed with high taxation and low return on services and so on?
Mr. Thiessen: I think we can maintain our inflation targets in those circumstances, but they may certainly involve interest rates that are very high. If you don't control the situation, you are going to pay for it. We are going to have a poorer economy in the future if we don't get our debt and deficit under control. As long as we continue to pay high-risk premiums in our interest rates, we are poorer as a nation than we otherwise would be. The worse that situation gets, the higher the risk premiums get and the poorer we get. It doesn't stop you from maintaining a low inflation policy. Indeed, it's probably absolutely crucial that you do it in those circumstances, because this will be the only thing that gives investors any sense of comfort whatsoever in lending any money to anyone.
The Chairman: Mr. Shepherd.
Mr. Shepherd (Durham): I would just like to address the issue of inflation again, and also the thing I know you do control, and that is the value of the Canadian dollar. On my way to work today I heard that the Canadian dollar was under pressure and that you're in fact raising interest rates to support that.
I also look at some statistics I had from your bank that basically show a growth of money supply. If I look at M2, I see an annualized growth of 4.5% and so forth. To me, since it exceeds the increase in growth of the economy itself, it would lead some to think that this is inflationary in and of itself and possibly shows a hesitancy to support the Canadian dollar at higher than the current level.
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So I guess the question I'm asking is what is the long-term value of the Canadian dollar? I've heard many economists argue that it should be pushed downwards, which would support our export industries and so forth.
Mr. Thiessen: I think it's very difficult to say ``this'' is the long-term value of the Canadian dollar, because so many factors affect the Canadian dollar, and they change over time. There are some things that cause the Canadian dollar to be strong, such as relatively high primary commodity prices. The fact that our inflation rate tends to be lower than the United States' tends to cause the Canadian dollar to be strong.
What causes it to be weak tends to be those famous risk premiums, the ones I was just talking about, in our interest rate. The counterpart of those risk premiums tends to be a weaker Canadian dollar. Risk premiums make us poorer and that gets reflected in a lower Canadian dollar. That's basically the way the system works. I think it's very difficult to say you just happen to know what the right level is for the Canadian dollar. You don't know.
With respect to the money growth, those money growth rates may seems a little high relative to the growth of the economy, but that is typically the way that particular definition of money continues on. It tends to have a rate of growth that is somewhat higher than the growth of the economy. Indeed, what those numbers say to us is that inflation is under good control. Those numbers tend to be a good predictor of where inflation is going. What it says is inflation is going to stay very nicely near the centre or to the bottom half of our target range.
The Chairman: Mr. Shepherd, one final question.
Mr. Shepherd: One question that interests me - and it is related to government policy - is the seemingly tremendous increase in consumer debt, or at least in consumer debt relative to disposable income of people. It indicates that the private sector has just as much problem controlling their debts as do government. We're all living way beyond our means.
I guess what concerns me within monetary policy has been the ability for the banking sector and others to increase consumer debt. It's to the point now that it's up to 90% of individuals' disposable incomes. Recognizing that when individuals start defaulting on a debt they come back on government, isn't there an argument there to say we should be more restrictive in the expansion of consumer debt?
Mr. Thiessen: That's a good question, and it's a difficult question, I must confess to you. We don't have a good analysis that says what consumers can manage.
My recollection is that the consumer debt-to-income ratios in the United States are higher than they are here, for example. In other countries they are lower. What is a level consumers can afford? We're not sure. When you look at the rising consumer debt-to-income ratio, it causes you to be rather nervous.
On the other hand, if you compare the debt service costs to income, they've come down. They've come up a little bit recently, but on balance, those costs tend to come down.
The other comparison you can make is consumer debt to consumer assets. There again, you find the ratio hasn't risen all that much.
Where do you come down in all that? I'm not sure, actually. But I don't think we're on the verge of a situation where consumers are just suddenly going to be unable to manage in terms of debt. I don't think we're there.
But you know, I have to say people have worried about this, and the ratio just keeps on going up. So far most of them have managed. Indeed, if you talk to lenders they will not tell you there is a serious problem of consumer debt delinquencies right now.
Mr. Shepherd: Not yet. I just wonder about the intergenerational aspect of that. We're talking about an older generation with huge assets and no debts and a younger generation coming in here with significant debts and no assets. Where does that take us as a country?
Mr. Thiessen: You do expect some of that. That is a normal part of the life cycle. You expect younger people to take on debt, buy houses, buy cars. Older people tend to be savers paying down their debts. That's part of the economic process you would expect. Obviously you get worried when those debt levels get to the point where those consumers are so vulnerable that the slightest bit of bad news topples them into bankruptcy.
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I don't think we're there. It is my impression that after the recession of 1990-91 a lot of consumers certainly got caught. I don't have the impression that they've taken on debt quite as casually in the current period as they did in the late 1980s.
[Translation]
The Chairman: Messrs. Thiessen, Noël and O'Regan, thank you for coming and meeting with the members of the committee and answering their questions on the Canadian debt and deficit. It was very interesting.
The sitting is adjourned.