FINA Committee Meeting

37th PARLIAMENT, 3rd SESSION

Standing Committee on Finance

EVIDENCE

CONTENTS

Wednesday, April 21, 2004

¹

1535

The Chair (Mr. Roy Cullen (Etobicoke North, Lib.))

Mr. David Dodge (Governor, Bank of Canada)

¹

1540

The Chair

Mr. Monte Solberg (Medicine Hat, CPC)

Mr. David Dodge

Mr. Monte Solberg

Mr. David Dodge

Mr. Monte Solberg

Mr. David Dodge

Mr. Paul Jenkins (Senior Deputy Governor, Bank of Canada)

Mr. David Dodge

Mr. Monte Solberg

Mr. David Dodge

Mr. Monte Solberg

Mr. David Dodge

Mr. Monte Solberg

Mr. David Dodge

Mr. Monte Solberg

¹

1545

Mr. David Dodge

Mr. Paul Jenkins

Mr. David Dodge

The Chair

Mr. Pierre Paquette (Joliette, BQ)

Mr. David Dodge

Mr. Pierre Paquette

¹

1550

Mr. Paul Jenkins

Mr. Pierre Paquette

Mr. Paul Jenkins

¹

1555

Mr. Pierre Paquette

The Chair

Mr. Pierre Paquette

Le président

Hon. John McKay (Scarborough East, Lib.)

Mr. David Dodge

º

1600

The Chair

Hon. John McKay

The Chair

Mr. David Dodge

The Chair

Mr. David Dodge

The Chair

Ms. Sophia Leung (Vancouver Kingsway, Lib.)

Ms. Sophia Leung

º

1605

Mr. David Dodge

Mr. Paul Jenkins

º

1610

The Chair

Mr. Paul Jenkins

The Chair

Ms. Judy Wasylycia-Leis (Winnipeg North Centre, NDP)

Mr. David Dodge

º

1615

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. David Dodge

º

1620

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Hon. Maria Minna (Beaches—East York, Lib.)

Mr. David Dodge

Hon. Maria Minna

Mr. David Dodge

º

1625

Mr. Paul Jenkins

The Chair

Mr. Alex Shepherd (Durham, Lib.)

º

1630

Mr. David Dodge

Mr. Alex Shepherd

Mr. David Dodge

Mr. Alex Shepherd

Mr. Paul Jenkins

Mr. Alex Shepherd

Mr. David Dodge

º

1635

The Chair

Mr. David Dodge

º

1640

Mr. Paul Jenkins

º

1645

The Chair

Mr. Werner Schmidt (Kelowna, CPC)

Mr. David Dodge

Mr. Werner Schmidt

Mr. David Dodge

º

1650

Mr. Werner Schmidt

Mr. David Dodge

Mr. Werner Schmidt

The Chair

Hon. Maria Minna

Mr. David Dodge

º

1655

The Chair

Hon. Maria Minna

Mr. Paul Jenkins

Hon. Maria Minna

Mr. David Dodge

»

1700

The Chair

Hon. John McKay

Mr. David Dodge

»

1705

Mr. Paul Jenkins

Hon. John McKay

Mr. David Dodge

Hon. John McKay

Mr. David Dodge

Hon. John McKay

Mr. David Dodge

Hon. John McKay

The Chair

Ms. Judy Wasylycia-Leis

Mr. David Dodge

»

1710

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

»

1715

Mr. David Dodge

The Chair

Mr. Massimo Pacetti (Saint-Léonard—Saint-Michel, Lib.)

Mr. David Dodge

The Chair

Mr. Massimo Pacetti

The Chair

Mr. Alex Shepherd

Mr. David Dodge

»

1720

Mr. Alex Shepherd

Mr. David Dodge

Ms. Judy Wasylycia-Leis

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Mr. David Dodge

The Chair

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CANADA

Standing Committee on Finance

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NUMBER 015

l

3rd SESSION

l

37th PARLIAMENT

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EVIDENCE

Wednesday, April 21, 2004

[Recorded by Electronic Apparatus]

¹  (1535)  

[English]

    The Chair (Mr. Roy Cullen (Etobicoke North, Lib.)): I'm pleased to welcome Mr. David Dodge, Governor of the Bank of Canada, and Mr. Paul Jenkins, senior deputy governor. This is our semi-annual visit from the Bank of Canada, where we look forward to your update on monetary policy and other matters economic.

    With that, I'd like to turn the floor over to you, Mr. Dodge and Mr. Jenkins, to give us a presentation. Then we'll turn it over to the committee members for some questions, and you can try to answer them.

    Welcome.

    Mr. David Dodge (Governor, Bank of Canada): Thanks very much, Mr. Chairman. As always, it's important for us to come here twice a year. We appreciate the opportunity to meet with you following the release of our monetary policy report. Because that report really contains the information for the purpose of this session, I'll have just a very short opening statement.

    The importance of this meeting is to keep you, as members of Parliament, and through you, all Canadians, informed about the bank's views on the economy, the goal of the monetary policy, and the actions we're going to take to achieve it. The Canadian economy at the moment continues to adjust to developments in the global economy, such as stronger world demand, higher commodity prices, and the realignment of world currencies, including our own. Emerging market economies, especially China and India, are contributing to intensified competition, but they're also creating new trade opportunities for us.

[Translation]

    These developments require shifts in activity among sectors and create a need for adjustments by many businesses. Monetary policy is facilitating these adjustments by supporting aggregate demand, with the goal of keeping the economy near its full production potential and inflation on target.

    When Paul and I appeared before this committee last October, we told you that economic growth in Canada was weaker than expected and that there was more slack in the economy than we had projected six months earlier. As you know, the Canadian economy was affected by a number of shocks in 2003. Thus, despite a broadening of the global economic recovery and higher commodity prices, it turned out that the economy at the end of the year was operating well below the level that we had projected in our October Report.

    Preliminary indications are that growth in the first quarter of this year was marginally below 3 per cent. Thus, the Bank's view is that the economy is still operating significantly below its potential.

[English]

    Our outlook for growth in inflation is essentially unchanged from that contained in our January monetary policy report update. That is, the economy is expected to grow about 2.75% in 2004, picking up to about 3.75% in 2005--both year-over-year rates. This stronger growth is expected to come from private domestic demand, reflecting the current monetary stimulus in the economy and high levels of business and consumer confidence. Such growth would return the economy to close to its production potential by about the third quarter of 2005.

    Core inflation should average roughly 1.5% over the remainder of this year, and as excess supply in the economy diminishes, core inflation is expected to move back to 2% by the end of 2005.

    The main uncertainty for the outlook continues to relate to how the Canadian economy adjusts to global developments, but to us overall, the risks to the outlook appear balanced.

    Paul and I would now be glad to answer your committee's questions.

¹  (1540)  

    The Chair: Thank you, Mr. Dodge.

    Mr. Solberg, do you want to start with a seven-minute round?

    Mr. Monte Solberg (Medicine Hat, CPC): Thanks very much, Mr. Chairman.

    Governor, thank you very much for coming. I appreciate the chance to ask you some questions.

    First, in your statement you acknowledge that the economy has been a little more slack than you were projecting six months earlier. Do you have some regrets about rate increases through 2002 and 2003? Has that been unhelpful?

    Mr. David Dodge: The rear-view mirror always gives you a little different view of the world than the windshield does. It's easier to be wise in hindsight than in foresight.

    You'll recall that at the beginning of last year we were seeing some tendency for some very specific price increases to come through, perhaps to get a little more generalized. That's why we moved, because after four or five months of this, with a little bit every month, a little bit higher than we had thought, we began to wonder whether our view of the output gap might be a little bit off.

    Second, we were a little worried that with the numbers coming in a bit higher month after month, expectations would start to move up in terms of what inflation would be. We were seeing some of that in our surveys, and that's why we moved. We'll never know how much of the fact that inflation then started to move down was due to our preemptive move, and how much would have happened anyway. You can never really totally sort that out.

    If what happened would have happened anyway, and we were absolutely sure of that, then the moves we made up were probably not absolutely necessary, but we could not have known that at the time.

    Mr. Monte Solberg: I just want to assure you that I give my best predictions through the rear-view mirror, so I have some sympathy for what you're saying.

    Now I'm going to ask you to make another prediction. You are suggesting that growth this year will be around 3.75%, and I think Finance was saying 3.3%. The IMF this morning said 2.6%. Can you explain that discrepancy? Does that 2.6% this morning give you pause? Do you want to adjust your projection for this year?

    Mr. David Dodge: The difference between 2.6% and 2.75% is well within the statistical error of measurement, even long after the fact. Going forward, it's near as not the same view.

    Mr. Monte Solberg: Excuse me, I thought you said 3.75%.

    Mr. David Dodge: That's for 2005.

    Mr. Paul Jenkins (Senior Deputy Governor, Bank of Canada): We're at 2.75% for this year.

    Mr. David Dodge: The fund is about 2.6%. Next year I think they're at about 3.25%, and we're at 3.75%.

    Mr. Monte Solberg: Sorry, I have wrong information here. Pardon me for that.

    There is quite a big difference between what you're projecting for growth for the U.S. economy and what Finance is projecting--4.5%, and 3.8%.

    Mr. David Dodge: Do you mean for next year?

    Mr. Monte Solberg: Yes. You're saying 4.5%.

    Mr. David Dodge: For next year, we're a little bit above consensus. Consensus is about 4%, and we're a little above 4%.

    Mr. Monte Solberg: Yes, you're at 4.5%. Can you explain that? Do you just have a more optimistic outlook, and for what reason?

    Mr. David Dodge: In the details, I think we probably have marginally stronger U.S. investment carrying through next year than the consensus forecast.

    Mr. Monte Solberg: Okay.

    StatsCan said yesterday there was no statistical evidence that the softness in the economy last year was due to SARS, BSE, or all the other calamities that visited the country. They said they weren't a significant factor in the economic slowdown. Of course, a number of ministers have said that was the problem, and that's why we had to be extra prudent, etc.

    Do you want to comment on that? Do you buy that? What are you saying is the reason for the softness last year? Does it have to do with the rapid increase in the dollar, for instance?

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    Mr. David Dodge: Well, I think there are two issues here.

    When you do the technical work, the number that we published last time...right?

    Mr. Paul Jenkins: Yes, in the last report.

    Mr. David Dodge: The number that we published in the last report was actually not very far off from what StatsCan has published. That is, when you do the technical parsing of the factors, you can only parse the direct impact. So to the extent that these factors inevitably tend to have some impact on confidence and so on, you miss it. We recognized that when we did our own numbers. We felt that the tail would actually be a little bit longer than what the direct impact would show.

    It's very hard. We're actually talking about relatively small sectors of the aggregate economy. It's to the extent that it has impacts elsewhere, either for confidence reasons or whatever, that you intuitively end with a bit more of an impact, or at least an impact that has a bit longer tail.

    Probably the tourism industry is a good example. We're still feeling the impact on tourism from SARS. It takes a little while for those attitudes to fade and for the conventions, and so on, that were cancelled last year.... Bookings were made and cancelled last year, but the conventions would have taken place this year, or even next year.

    The Chair: Thank you, Mr. Solberg. We can come back later, if you like.

    Mr. Paquette.

[Translation]

    Mr. Pierre Paquette (Joliette, BQ): Good morning. Thank you for coming and thank you for your presentation.

    I met with some representatives of the Manufacturers Association not very long ago. They were complaining that your reports on monetary policy hardly take into account the drop in exports. Of course, they wanted to see interest rates drop more quickly, so that there would be an impact on the exchange rate.

    Consequently, the first thing I did when I received your Report was to check what it said about exports. I was quite surprised to read the following in Technical Box 1 on page 11 of the English version: "... exports of goods and services have been stagnant since early 2001".

    My first question—and I will have two other related questions afterwards—is whether, in hindsight, you would say that the problem of stagnant exports could have been overcome had rates dropped more quickly. Would a faster drop in rates have helped stimulate exports which, in your view—and it does seem correct—have been stagnant since early 2001?

    Mr. David Dodge: We will never know exactly what would have happened had we had a different policy. However, it is interesting to note that even when the spread between the Canadian and the U.S. interest rate is narrower, the American dollar becomes stronger and stronger. The fact is that many factors influence the exchange rate. The interest rate spread is only one of them.

    Mr. Pierre Paquette: I have looked at the 2001, 2002 and 2003 reports, and I noticed that there was always a reference to our export problems, chiefly with respect to the difficulties of the American economy and the fact that the Canadian dollar has been very strong. One point made in this Technical Box did not surprise me, because everyone is talking about it; however, it was the first time I had heard the Bank of Canada mention emerging countries. I would like you to expand on this a little for me.

    I studied economics in the early 70s, and it seems to me that in the last 25 years, every 8 or 10 years we hear about a new giant that is going to come along and destroy our industry. That gives rise to a great deal of fear. People always have examples of a firm in a particular region that had to close down because of competition—which is often described as unfair competition—from China, India or another south-east Asian nation.

    Since you adopted a more balanced approach—the reference in your report is only a few lines long—I would like you to tell us how you view the danger for the Canadian economy from these emerging economies, particularly with respect to the American market.

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    Mr. Paul Jenkins: First of all, there are a number of factors related to the emergence of countries such as China and India. As you said, there is definitely a higher level of competition for the manufacturing sector here and in the other industrialized countries. However, at the same time, domestic demand in the Chinese economy is also very high. That is why commodity prices rose very quickly. Consequently, there are some positive factors and some negative factors.

    In the medium term, the emergence of China, for example, represents many benefits because of the potential demand from the Chinese economy. Together, the population of China and India amounts to almost 40 per cent of the world population. As a result, there are benefits having to do with the domestic markets of emerging countries. However, they are a source of competition at the same time. For the Canadian economy and our monetary policy, the important thing is the balance between the positive and negative factors.

    Mr. Pierre Paquette: Has the drop in our exports of industrial machinery been caused by competition from emerging countries? I'd find that surprising. Is that what explains...?

    Mr. Paul Jenkins: No. That was probably caused, by and large, by the past weaknesses in investment in the United States. Following the problems caused by scandals such as WorldCom and Enron, there was some uncertainty in business decisions and this resulted in weaker exports in the industrial machinery sector. As the governor mentioned, we think that given the current American economic outlook for this year and next year, investment in American machinery and equipment will pick up. In fact, some very recent data show a recovery in our exports to the United States.

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    Mr. Pierre Paquette: Do I still have a little time left?

    The Chair: Perhaps on the next round.

    Mr. Pierre Paquette: I do not have any time left?

    Le président: No, the time is up. I am sorry, but you can come back on the next round.

    Mr. McKay.

[English]

    Hon. John McKay (Scarborough East, Lib.): Thank you, Mr. Chair, and thank you, witnesses.

    I have four questions, the first having to do with the IMF outlook versus the private sector and the Bank of Canada. In the fiscal year 2004, it appears there is a relative consistency among the predictors, both Canadian and American. But in 2005, there seems to be quite a discrepancy between your views on the growth of the economy, which is at 3.8%, versus IMF, which is a bit more modest at 3.1%, and the private sector at 3.3%. So there's a discrepancy of 0.5% between you and the private sector, and 0.7% between you and the IMF. The other predictions vis-à-vis the U.S. are fairly consistent.

    So you appear to be somewhat more bullish, if you will, on Canada for 2005. I'd be interested in that, I would say, arguably significant discrepancy between the private sector, the IMF, and yourselves, as to whether there's a difference in analysis there. That's the first question.

    The second question has to do with U.S. growth, your comments on the fairly strong growth in the United States, arguably driven by deficits. That has been a pattern where, if an economy slows down, the government starts to pour money into the economy by running significant deficits. At one point or another, you have to pay the piper on this issue. What is your view on the U.S. economy in terms of when the piper gets to be paid?

    I don't know whether you saw Bruce Little's column in The Globe and Mail today, but I thought he was on to something.

    The third question has to do with The Economy in Brief, a Department of Finance document. It puts employment growth in January 2004 at 1.1%, pretty modest employment growth, yet in the last round of monetary cuts you were down to 2%, which is pretty cheap money as it goes. I would have thought that should have the impact of stimulating employment growth rather than leaving it as it is.

    Finally, the fourth question has to do with your emerging country argument. I appreciate that both China and India are potentially huge markets, but are we going to be faced with the problem that has become an election issue in the States, which is effectively a jobless recovery, that our only basis for growth will effectively be productivity rather than growth in employment? I'd be interested in your comments on that as well.

    Mr. David Dodge: Gosh, there's a lot here. Let me take the last two questions together, because they actually do relate to one another.

    Obviously, at this point in time, what we are seeing in this country is a rise in the relative price of primary materials, agricultural goods, industrial materials, and so on. That's being driven by very sharp increases in world prices. On the other hand, the prices of manufactured goods worldwide have been stable or, indeed, falling. So it is not surprising that what we should observe in this economy is some movement of resources—workers as well as investment—from those areas where there's intense competitive pressure, and a decline in prices relatively, into those other areas where there are rising prices. That is indeed for our own welfare, or exactly the change that you want to see take place in order to achieve rising incomes in the country.

    The problem, of course, is that you don't necessarily have in the same geographic location the displacement of those firms or industries that are going to shrink a little bit and the expanding industries. Secondly, the skills that are required in those that have to shrink a little bit are not necessarily readily transferable to those that are expanding. We've been through this lots of times in our history, which is what we refer to as the adjustment problem.

    So indeed, we would expect some portion of the fabrication or services that we have been performing domestically to be done offshore, either through the import of more of those goods and services directly or because pieces of the production are in fact done where it's cheapest. A good example is the fish-packing industry. We now see that it is a global industry and that the lowest-skill stuff is done offshore in China, and then the high end—the packaging, the upgrading of the fish, and so on—is done here. That is exactly what markets would tell you is an efficient way to carry it out.

    So that is the bit on offshoring, and it's a bit why we don't think employment growth is going to be as strong in 2004, and probably not as strong in 2005, as it was in 2002 and 2003, because we've got this process of adjustment. Our role is to facilitate that adjustment, to facilitate the new investment that has to be put in place, whether in human capital or physical capital, by having a fairly accommodating monetary policy. There are very few risks in the short run in doing that, because inflation is relatively low and because we have a fairly large output gap.

    So I think those last two really tie together, and I've tried to give an answer.

    Now let me—

º  (1600)  

    The Chair: Maybe, Mr. Dodge, we could come back to the other two, because we've run out of time.

    Hon. John McKay: I have another question.

    The Chair: We're going to have a second round, anyway.

    Mr. David Dodge: Sure.

    The Chair: You've made a note of the questions, presumably?

    Mr. David Dodge: Sure.

    The Chair: Okay.

    Ms. Leung, please.

    Ms. Sophia Leung (Vancouver Kingsway, Lib.): Thank you, Mr. Chair.

    Welcome, Governor Dodge.

    [Technical difficulty--Editor] ...especially in B.C., where...[Inaudible—Editor]...it's unbelievable. The market is so hot that people are lining up for hours to buy condos, towers--

    An hon. member: Leaky ones.

    Ms. Sophia Leung: Good ones, no leaky ones.

    [Technical difficulty--Editor]

    Ms. Sophia Leung: So I think it's good. I think we'll welcome that. But my question is this. There's concern because we know people tend to have this follow-the-herd mentality, so everybody rushes into the housing market, including many young people with limited income. There's a great deal of discussion about the fact that, if the market bubble bursts, they will really face a lot of tragedy and a lot of bankruptcy because they're unable to meet the payments. That's one part of the question.

    The other part is, what if the low interest rate...? You mentioned earlier that we will have to increase our competitiveness to create new trading opportunities for Canada in the emerging market in terms of China and Canada. Do you how see that will be related?

    Another question I have is this. I notice we are very closely related to the U.S. market and economy. Right now the U.S. inflation rate is pretty good; it's so low compared to Canada's. Do you see us following the same trend the U.S. is?

º  (1605)  

    Mr. David Dodge: Let me start with the housing bubble one, and maybe, Mr. Chairman, I could ask Paul to deal with U.S. inflation and the issue of our outlook for the U.S. together with the previous question, because they are linked.

    On the housing side, yes, this is clearly the one component of our price index we watch with some very real concern. New house prices in the index--the so-called replacement cost--are rising at about 5.8%, which is almost four times the rise in the core rate. So yes, this is something we watch very closely. Clearly, it's driven largely but not exclusively by three markets: the amazing market in Vancouver and Victoria; the strengthening, after a very long pause, in the Montreal housing market, where prices are still relatively low but have been moving up quite rapidly; and the downtown, central city part of Toronto. In those three we can see a fair bit of heat, although we are seeing a lot of supply response and are actually seeing rents decline. The market in that sense is working, but we will keep a very close eye on this.

    Our view, after quite considerable analysis, is that the word “bubble” is an inappropriate word to apply in the Canadian context because what we've really seen in 2002, 2003, and now again in 2004 is that we've had rapid price movements, but after a very long period where the real price of housing had actually been declining in most parts of the country. So in a sense we were having a bit of a delayed catch-up in this market. But yes, we are keeping a close eye on this issue.

    Let me now ask Paul if he could deal with the U.S. inflation issue, which is obviously tied to the outlook for the U.S. as well.

    Mr. Paul Jenkins: Thank you, Governor.

    I have a couple of points to make in trying to bring these questions together. First of all, in terms of the growth projection we have for the U.S. economy, yes indeed, it is a bit above the consensus, but the strength of our forecast for the United States reflects several factors in terms of our judgment and analysis of the factors at play in the U.S. economy. First of all, the degree of stimulus from the monetary as well as the fiscal policies in the United States are very supportive of strong growth in the U.S. going forward this year and next. As well, profits are rebuilding in the United States, and they've had that very strong growth in productivity.

    Of course, the productivity gains they've had have to go somewhere, and in fact that's one of the reasons profits have been improving in the United States. But some of that profitability also shows up in terms of real wage increases, notwithstanding the fact that employment has been rather soft. So when we look at both the U.S. corporate sector and the U.S. household sector, we do see reasons for continued strong growth in terms of domestic demand in the United States.

    Of course, the other factor at play--and this is a factor that's influencing us as well--is the strength of the global economy overall. That strength in the global economy, combined with the U.S. dollar depreciation, would be a contributing factor as well.

    So for a number of reasons we feel reasonably comfortable with that U.S. forecast.

    In terms of the inflation outlook, yes, U.S. inflation is quite low at the moment. When we link that to the growth scenario in the United States, the other factor that one needs to take into consideration is what we call the “output gap”. This is the difference between the level of activity or production in the U.S. economy relative to what it potentially could produce before sustained upward pressure on inflation takes hold. Because of the rather protracted period of sluggish growth--and indeed, by some measures a recession in the United States--there's a very large output gap in the United States. In fact, we would estimate that it's significantly larger than what we face here in Canada. So the U.S. economy has quite a bit of room to grow at a very rapid rate before it closes that output gap and begins to put upward pressure on inflation.

    Going forward, we think U.S. inflation will be, as Chairman Greenspan has put it, contained, and indeed, as you know very well, our whole focus on the inflation front is to keep inflation close to our 2% target. So again, looking out--and indeed, this is consistent with what we present in our report--we have inflation steadying out at around 2% towards the end of next year.

    Now, the other point I should note--

º  (1610)  

    The Chair: I'm sorry, Mr. Jenkins, could we come back to that later?

    Mr. Paul Jenkins: I was going to come back to the deficit situation in the United States.

    The Chair: Maybe we could do that in the next round.

    Ms. Wasylycia-Leis.

    Ms. Judy Wasylycia-Leis (Winnipeg North Centre, NDP): Thank you very much, Mr. Chairperson.

    Thank you again, Mr. Dodge and Mr. Jenkins. I'm sorry I wasn't here for your opening remarks or the questions. I hope I'm not repeating anything, although I probably am not, I would guess. And I apologize, but I'll have to run back and forth to the public accounts committee.

    I want to follow up on the question of inflation targets and the flip side of that, unemployment targets. I think you told the Senate committee yesterday that low interest rates are on the way out, if I'm not misinterpreting what you said, and there is certainly media speculation that last week's 0.25% rate drop will be the last. You've talked a bit about the inflation targets and how we're roughly on target. In fact, it certainly would seem you've won the battle against inflation, yet unemployment remains steady at about 7.5%.

    So my question really is, do you think we can apply the same enthusiasm used for dealing with inflation to reducing the unemployment target, or do you even think the unemployment target should be reduced? And as part of the whole monetary policy for Canada, do you see the merits in trying to get more Canadians at work in full-time, well-paying jobs?

    Mr. David Dodge: Yes. You've expressed in slightly different words exactly how we're trying to operate. We operate symmetrically around that 2% target, and we are now sitting at about 0.7% in the overall index. Probably a better gauge is the core, which is sitting at around 1.3%.

    So we are easing policy, running a more accommodative policy, precisely for the reason you've said, that we think we have a gap there that needs to be filled in order to come back up to the 2% target. Hence, while many other countries are in fact tightening policy, we have actually been easing it.

º  (1615)  

    Ms. Judy Wasylycia-Leis: Fair enough.

    Mr. David Dodge: So what you said is exactly right. We do operate symmetrically around the target and now we are running a very accommodative policy because we see this gap opening up.

    Ms. Judy Wasylycia-Leis: What I'm wondering is if you are considering a more flexible approach in terms of the interest rates if it seems to be necessary in terms of tackling the unemployment situation and trying to reduce the unemployment target.

    Mr. David Dodge: Yes, that's precisely the issue. As I said earlier, we don't see employment growth actually being very strong this year, not as strong as it has been in the last few years, when it's been quite strong. Hence there is capacity there in the economy that is unused, and that is precisely why we've taken the decisions over the last little while to reduce rates to try to provide support for aggregate demand. But adjustment is never particularly easy, and so we also feel that it's very important because of that to provide support for aggregate demand at this point in time.

    Ms. Judy Wasylycia-Leis: Another issue we've expressed some concerns about has to do with the focus that's being given these days to the reduction of the national debt. I think you've made it a fairly high priority to reduce the national debt. Certainly we know from the budget that the federal government indicated a target for reducing the national debt to 25% of debt-to-GDP ratio in 10 years.

    My question is, is this an appropriate target, in your view, and is it a high enough priority to pursue a hard target like that, as we've heard Paul Martin, the Prime Minister, say, come hell or high water?

    Mr. David Dodge: I think this is one that is really important. It's not necessarily a question of reducing by very much the nominal amount of debt out there, but if we can reduce the burden of the debt, the ratio of the debt to GDP, over time, we reduce the fraction of tax revenues that go to paying interest on the debt, and any given level of taxation then can provide more real goods and services for Canadians. I think that's particularly important, as I've said before, as we look forward into the next decade, when there will begin to be some pressures on the expenditure side just to maintain the level of services that we have.

    So, yes, I think it's very important and it's not a statement that applies only to Canada, because if Canadians can have confidence that those services will be there and will be there without imposing extraordinarily high burdens of taxation on a shrinking portion of the population that is in the workforce--so we don't want to tax all the young workers to pay for it--then I think it is absolutely the right thing for this country over time and clearly it enables us to work with the monetary policy that can adjust more quickly to the changing economic situation.

    Ms. Judy Wasylycia-Leis: I know that publicly you've said that you believe debt reduction is important or vital because of the aging baby boomer population and the need for baby boomers' security. But I'm not convinced yet in terms of your recommended approach, because in fact it seems to me we could end up accumulating a greater debt in terms of human issues by putting so much emphasis on reducing the debt-to-GDP ratio and not ensuring that the programs that will help the baby boomers in their old age, like health care and social services, survive.

    Do you not see the importance of putting at least as much emphasis on restoring funding for some of those key health and social programs for meeting the needs of an aging population and the baby boomers' security?

    Mr. David Dodge: Yes, although I think we have to be a little bit careful here. We have a pay now or pay later issue, and who pays now is actually a different group of the population from who pays later.

    What all of us worry a bit about is that even if we have increasing participation rates of people 60 years of age and over--and I think we will, even if not in the market sector, in the voluntary sector we'll see it as people are healthier--nevertheless, what it does mean is that for the same level of service for everybody it will require a greater share of national resources to go into the programs. It's a lot better if we can provide for that by reducing the burden of debt service payments, because no one gets up in the morning and says, Prime Minister, that was a great bit of debt servicing you did for me yesterday. It's the real services that are so important.

    I think that particularly at this juncture in our history, it is important--this isn't just the federal government, this is the public sector writ large--that we continue to run a fiscal balance, which will, over time, reduce the burden of the debt on future taxpayers and our kids.

º  (1620)  

    The Chair: Thank you very much.

    Thank you, Ms. Wasylycia-Leis. Good luck with your work on the public accounts committee.

    Ms. Judy Wasylycia-Leis: I might be back.

    The Chair: Good.

    Ms. Judy Wasylycia-Leis: I have one more question.

    The Chair: Maybe you'll find some answers to the vexing questions of the public accounts committee, who knows?

    Ms. Judy Wasylycia-Leis: Thank you.

    The Chair: We'll go now to Ms. Minna.

    Hon. Maria Minna (Beaches—East York, Lib.): Thank you, Mr. Chairman.

    First, I want to congratulate you, Mr. Dodge, on a speech of yours that I read in the newspaper, where you were saying that if we were to make an investment today in terms of getting the best returns, it would be to invest in early learning.

    I must admit I'm partial to that particular issue, so I'm glad to hear that the Governor of the Bank of Canada is of the same opinion, at least. Who knows, it might give a little bit of impetus for us to put some real effort in that direction in this country.

    Mr. David Dodge: It's just good economics.

    Hon. Maria Minna: I know. I've been saying that to all of my colleagues. Thank you for saying that. It seems every time I talk about this, they say, Maria, the social issues.... And I keep saying, social and economic issues are really not that different, especially when you deal with some of the.... Anyway.

    In your statement today, Mr. Dodge, you mentioned that the preliminary indications are that the growth in the first quarter of this year was marginally below 3%, and that in the view of the bank, the economy is still operating significantly below its potential at this point. I wonder if you could tell us why exactly that is.

    Also, in addition to that, in an article in today's paper, you're quoted as saying that the interest rates are likely to be going up 2 or 3 full percentage points at this point, that this is what the research shows. My question then is, apart from the first, why the softness, but the other is, given the softness of the economy, wouldn't the increase of interest rates make it that much worse, especially with small and more vulnerable businesses? Would that not, in fact, create a further problem with the economy?

    Mr. David Dodge: Maybe I could deal with the second question first, which is actually an easier one to answer than the first.

    What we have worldwide is actually a lot of liquidity in the system. Or putting it differently, interest rates in nominal terms and in real terms right around the world have been really very low over the last couple of years. That's because, in large part, we've been trying to facilitate some adjustment around the world to get growth going again.

    What we expect to happen and we are seeing now--and this is worldwide; this is not specific to Canada--whether it's in the United States, in Latin America, or in the good performance we've been seeing in Asia, is world demand picking up. You can see that in the IMF report that came out this week.

    What would normally happen, then, is that we would start to see price pressures around the world, and whether central banks have monetary targets, like we do, or like the U.K. does, or Australia, or whether they implicitly have an idea of where they're going, like the United States, nevertheless that is a signal that over time those rates are going to have to go back up to something like a more normal level. So barring something that would interrupt this rather strong world outlook for growth, one would expect rates to be going up around the world. That was the point I was making yesterday in the Senate.

    The issue for us is that we're going through a bit of a different adjustment here. We had strong growth through the period when growth in the rest of the world was faltering, we've had an appreciation of our exchange rate, and we're having some changing trade partners, all of which mean we have an adjustment process to go through here, and so we are right now trying to support that adjustment process by pushing the economy closer to its potential through relatively low interest rates.

    So that's the second question, which as I said is relatively easy. Why is it below potential? Why has the gap opened up? I have to say, as you can see from my report a year ago, it has opened up much more than we had expected.

    There were some one-off factors, but obviously part of it last year was, as you can see in our report on page 25, that exports were actually a negative contributor to growth last year, and that's part of the adjustment to the appreciation of the Canadian dollar.

    That's part of it, and part of it is that we've had changes in relative prices in the economy, and as I said earlier, generally when that happens the adjustment on the downside takes place a little bit before the adjustment on the upside. We have to release the resources before we can redeploy them.

    Paul, you watch this even closer than I do.

º  (1625)  

    Mr. Paul Jenkins: I think you've touched on the key points, Governor.

    Certainly if you go back to this time last year and a bit before that, we thought the economy was operating at quite close to full capacity, and then we had that series of shocks that affected us through the second and third quarters, where we virtually had no growth in the economy. Together with this international adjustment, I think those are the main factors that led to a somewhat weaker performance than we'd been anticipating. Now the objective is to reabsorb that excess supply, and consistent with that opening of the output gap, inflation is a bit below our target, so the objective is to get us back on target, with the economy back to full capacity.

    The Chair: Thank you, Ms. Minna.

    Mr. Shepherd.

    Mr. Alex Shepherd (Durham, Lib.): Thank you very much.

    You touched briefly on emerging economies. We read in the business press and so forth about the impact China has had on oil pricing and so forth. I'm told that the average wage in China is something like 67¢ U.S. an hour. You also touched very briefly on the concept of outsourcing. You described an orderly process whereby there's the dislocation of lower-skilled labour to these economies, and presumably we're replacing them to some extent with higher-skilled labour. I'm just wondering how orderly that really is. We see this emerging economy, and China seems to be getting its act together in some real ways, but there are also some clouds on the horizon. I just came back from Taiwan. I noticed that a large part of their computer sector had gone to the mainland. So China seems to be sucking these resources out of just about every economy.

    We talked about this jobless recovery. Do you think an orderly process is going to take place in the dislocation of labour?

º  (1630)  

    Mr. David Dodge: It never appears very orderly if you're one of the people directly affected. I think we have to recognize that. As I said earlier, in Canada the industrial mix of our regional and provincial economies is quite different, so that we have manufacturing concentrated in Winnipeg, southern Ontario, and the Montreal plain, whereas we have resource production in northern Ontario, Alberta, and so on. So the adjustments are always a bit tricky. But remember that the value of those products, where we would like to be able to produce more but we're supply constrained, is adding enormously to the income of Canadians. We have a distribution problem, both the geographic and the division across corporations where profits are occurring.

    We've been through this before. It's not a movie that we haven't seen. What we think we've learned is that it's important for monetary policy, when this output gap opens up, to be supportive, and we can do it because we've had sensible fiscal policy for a period of time, both at the federal and provincial levels, so that there's confidence in the nation's public finances.

    Mr. Alex Shepherd: Years ago everybody talked about money supply. When they talked about inflation, the next thing they mentioned was money supply. I open your book. You talk about inflation, but there's no mention of money supply. I was always one of those dumb economists who couldn't figure out why it was that you had 2% inflation but you were expanding the money supply by 10% every year. Could you give me some comment on that? What is the expansion of the money supply?

    Mr. David Dodge: There are two charts on page 27. There's one chart on M1 and then what's happening in terms of inflation. Quite bluntly, what we found over time is that the relationship between any of our monetary aggregates and inflation or output wasn't nearly as stable as we might have thought it was going to be. Hence, while we clearly continue to watch this--it clearly tells you something--the relationship in the short run between what's happening to money supply and what's likely to happen to prices in the near future is not all that tight.

    So yes, we do watch it. You will always see those numbers in our report. When we do our own presentations inside the bank, one presentation is always on what's happening to the aggregates and what the implication of that is for credit conditions. So it has not gone away, but the relationship isn't terribly tight.

    Mr. Alex Shepherd: You would say that the correlation coefficient isn't very strong between these two factors that we're seeing.

    Mr. Paul Jenkins: Right.

    Mr. Alex Shepherd: I have one more question. Talking about the popular pressure, I guess, you were musing about the Canada Pension Plan. I think you were talking about the age of older workers and some of the things that you've raised today. I've always been fascinated by the fact that we allow people to access the Canada Pension Plan at age 60 and the impact that has as a fiscal issue.

    Mr. David Dodge: First of all, we started from the fact that we have this large baby boom cohort that is now moving to age 60, and that will be much more prevalent as we get into the next decade.

    Yesterday we were really talking about how—and I've talked at other places about it—one of the adjustments to this will be that we will have rising participation rates of the 60-year-old to 64-year-old cohort in the labour force. Indeed, we may get an increasing fraction again of the 65- to 69-year-olds who participate either in the market economy, maybe on a part-time basis, or in the voluntary sector. We shouldn't throw up barriers to that kind of voluntary participation, so I made two points.

    First, an artificial restriction where a firm lays everybody off once they reach age 65 doesn't make very good sense. Some people may want to work longer, some people may want to work less. We shouldn't have this artificial barrier.

    Secondly, with respect to the Canada Pension Plan, we actually do have a mechanism built into the plan where you can retire before age 65 on an actuarial reduced pension, or if you wait until later, you can have an actuarially augmented pension when you start to draw it. It's symmetric in that age 61 to 69 timeframe.

    I think the interesting issue that a number of people have raised is on whether we ought to allow people to partially contribute beyond the age of 65 or, if they're continuing to work, to draw partial pensions beyond the age of 65. It is an interesting issue. Ken Battle raised that issue a number of years back, but it is not strictly a financing issue, it is a flexibility issue.

    I really do want to make the point that the financing of the Canada Pension Plan, as it's currently set up, is absolutely sound. We're one of the very few public pension plans in the world that have sound financing. We may not like paying all the premiums, but the financing of it is sound.

º  (1635)  

    The Chair: Thank you.

    Thank you, Mr. Shepherd.

    We're going to move in a moment to a second round. Before we do that, I'd like to ask a couple of questions myself, if I may, with the indulgence of the committee, of course.

    I recently read about and saw some productivity numbers that indicated our manufacturing sector is lacklustre or not very positive. In the service economy, they are showing some strength. Could you comment on that?

    One of the things we hear about with a very rapidly appreciating Canadian dollar vis-à-vis the U.S. dollar is that, while it poses some problems or some challenges for exporters, it creates opportunities for the Canadian manufacturing sector to import technology equipment, which will presumably assist with productivity challenges. Are we seeing any evidence of that? Could you comment on that?

    My second question, if I might, has to do with the dispute, or some difficulties, between the United States and China with respect to the renminbi or the yuan. I gather they've set up some kind of working group to look at this. But when you have two economic giants—I guess we could call both of them that now—in some kind of dispute about the valuation of the Chinese currency, how do you see that resolving itself? Do you have any perspectives on the valuation of the yuan?

    More particularly, what does this mean for Canada, if anything? How do you see it resolving itself? Will it have any negative or positive consequences for Canada, depending on which way the discussions go?

    Mr. David Dodge: Mr. Chairman, maybe I can try to answer your first question and Paul can try to answer your second.

    First--and you've heard me say this before--the productivity estimate is arrived at through the division of two very large numbers, and small errors in either of those numbers can move that estimated productivity around a lot. Of all the numbers that get produced, it is the one that is subject to the largest revisions over time.

    Second, when you look at how you construct that number, generally speaking, we in this country use the estimates of the amount of labour from the labour force survey. The Americans tend to use the establishment survey. At the moment in both of our countries, the establishment estimates of employment are running considerably below the labour force estimates of employment. So when we do our division, we're dividing by one type of number; when the Americans do theirs, they're dividing by another.

    Nevertheless, it is undoubtedly true that over the past three years productivity in the American private sector has run ahead of productivity in the Canadian private sector. But that is exactly what you would have expected, because--and I'm sorry Judy's not here--we had a lot of excess labour in the mid-1990s in this country, and that would get even worse after the Asian and Russian crisis, which altered the price of commodities quite dramatically. So in fact, the depreciation of the exchange rate that took place, which changed the relative price of labour and capital, encouraging employers to use relatively more labour and relatively less capital than their American counterparts, was exactly appropriate, given the labour market situation we had in this country.

    Fast-forward to the end of 2003. What we have is an employment-to-population ratio that is back up to and even exceeding its previous high. So we've absorbed a lot of that excess labour. We have a change in the relative price of labour and capital in Canada that's come about through that exchange rate movement. That will encourage some economization on labour, and the working of the market ought to generate over time--and it takes time--some improvement in productivity.

    Third, in this country our enterprises are somewhat slower adopters of new technology than their American counterparts, in part because we have a lot of small and mid-sized firms, relatively speaking, which in the United States are also slower than the larger firms. So we expect over the first half of this decade, or maybe out to 2007, to reap latent productivity gains as some of these technological advances that have already been exploited in the United States are exploited here. In that sense, what we're seeing is textbook adjustment of a sort you would expect.

    Now let me turn it over to Paul for that very interesting second question.

º  (1640)  

    Mr. Paul Jenkins: I can't, Mr. Chairman, comment on whether there is or isn't a U.S.-China working party, but I can confirm that there's a lot of attention internationally on the issue you've raised, the Chinese exchange rate being fixed to the U.S. dollar. I guess my first point would be that this is broader than just the China-U.S. dollar exchange rate, because a number of other countries in Asia either implicitly or explicitly are tied to the yuan. So it's really a broader Asian issue you've raised.

    It's getting a lot of attention for two main reasons. One is linked to the global imbalances that currently exist. On the one hand you've got a large U.S. current account deficit, and on the other you've got that deficit largely being financed by the accumulation of reserves in Asia, and that's China, Japan, Korea, Thailand. In fact, the latest numbers suggest that the accumulation of these reserves is now at close to $2 trillion. So there's the issue of the resolution of these global imbalances, and I think the sense internationally is that there needs to be greater exchange rate flexibility in Asia to help the adjustment of that imbalance situation we're all facing.

    The other reason is that when you look forward at the sort of growth China will need, of the order of 7%, 8%, 9% per year, to absorb the 25 million workers moving from a rural to an urban environment, they're going to need sustained growth. It certainly would be my view that they're not going to achieve that through a fixed exchange rate. Their economy needs more flexibility to provide the measures whereby it can manage its own economy going forward.

    So I think, for those two reasons, there's a need for greater exchange flexibility in China, and I think the Chinese authorities understand that. Then the question is how they move to greater flexibility and how quickly, but I think there is a sense this will have to happen at some point.

º  (1645)  

    The Chair: Thank you.

    Mr. Schmidt.

    Mr. Werner Schmidt (Kelowna, CPC): Thank you very much, Mr. Chairman.

    Thank you, gentlemen, for appearing before us this afternoon.

    I have two questions. The first has to do with the reduction in the value of the Canadian dollar. It's dropped roughly 2.5% since January 1. Does this cause you to worry that perhaps it may cause too much stimulus for the Canadian economy?

    Mr. David Dodge: The exchange rate is going to move around from week to week and month to month. It actually has been trading fairly consistently, though it's a tiny bit lower today, in the 74¢ to 76.5¢ range. What we're seeing is not so much a Canadian effect as a U.S. effect. With a very weak U.S. dollar, we have very strong euro rates, Australian dollar rates, Canadian dollar rates against the U.S. All of them have come off, as I think the market's view is that some of the negative sentiment on the U.S. dollar that was there towards the end of last year may have been a bit overdone. But obviously, over time the exchange rate has an impact, and we obviously watch it in setting our monetary policy.

    Mr. Werner Schmidt: Thank you very much.

    I have another question, which has everything to do with monetary policy, but not with the exchange rate. It concerns the aging workforce in Canada and the implication that could have for our economy, the adjustments that need to be made in our economy and with regard to monetary policy. Could you address those two aspects?

    Mr. David Dodge: Our objective in monetary policy is to keep growth as close as possible to potential. The main impact that an aging population has is on how fast potential is growing over time. So the principles of monetary policy remain the same. But clearly, as you get out into the middle of the next decade, potential doesn't grow as fast, because we're not expecting the labour force to be growing as fast.

    Now, what is critical here, as we said earlier, is what impact this is going to have on participation rates, especially of older workers, in the labour force. If you scratch two economists you'll get three different views on what's likely to happen there, but I think there's good reason to believe those participation rates quite naturally will rise. So some of the immediate impact in the decade from 2010 to 2020 will be absorbed a bit through the rising participation rates of those older workers.

º  (1650)  

    Mr. Werner Schmidt: Well, I quite agree. By the same token, you might have three different approaches, but what will you use as your criterion, your guideline, to make adjustments, depending upon which of those opinions is actually going to take place? Because one of them will happen.

    Mr. David Dodge: At the moment, labour force growth contributes roughly 1% per annum to the growth of potential. By the middle of the next decade, it's down to about 0.3% or 0.4% or 0.5%, depending on what your assumption is about those participation rates. So to the extent that potential is governed by how many hands or how many brains you've got in the labour force, obviously we do take that into account automatically as we calculate potential.

    We'll have to watch and see what happens. Our time horizon is sort of 18 to 24 months ahead as we set monetary policy at any point in time. So we're constantly monitoring what's happening to those participation rates.

    Mr. Werner Schmidt: Thank you.

    The Chair: Thank you, Mr. Schmidt.

    Ms. Minna.

    Hon. Maria Minna: Thank you, Mr. Chairman.

    I'm going to go back to a question I asked the last time we met, I think. Some economists believe there is a non-accelerating inflation rate of unemployment, or NAIRU. Last time we talked about it, as I recall, I think you suggested that the bank uses this concept, although I think you declined to reveal the bank's estimate, or how one even gets to it, if one exists.

    You also said that the notion of giving it a bottom line of a NAIRU and actually making it public is complicated, and distilling it to an actual figure that could be announced by Stats Canada or what have you would be quite difficult, if not impossible. But measuring the core inflation is just as complex, I would think, and yet we do have a range or number that we make public.

    What does the Bank of Canada believe to be Canada's NAIRU, if we have one, and is this measure used in setting the overnight interest rates, when they are done? Wouldn't publicizing the NAIRU--in effect, the amount of unemployment the Bank of Canada believes must be tolerated in order to secure the inflation target--and being able to have that discussion increase the bank's transparency?

    I've always felt, and this is also according to some economists I know, that a certain level of unemployment must be tolerated. If you bring it too low, that then creates a different kind of problem. So I've always wanted to know what that NAIRU is and how we arrive at it. Has there ever been any discussion about the wisdom of having it?

    Mr. David Dodge: First of all, and this very much relates to the previous question, what you'll see is that we talk about potential and we talk about the output gap as being what's really relevant here. We think that is a more encompassing way to look at the issue of how close we are to capacity than focusing on the unemployment rate per se. That's for at least three reasons, maybe more.

    First of all, we do know that participation rates in the labour force are actually fairly sensitive to economic conditions. What we're seeing as economic conditions have improved from the mid-1990s is that participation rates have gone back up. When they got worse after 1989, we saw the participation rates fall. We've seen an exact repetition of that story in the United States, where the participation rate has been falling steadily now, certainly for the past three years. It has peaked, I think, since 2000, but it actually fell quite precipitously in the United States.

    So there is more flexibility out there than is shown by the straight unemployment rate. When unemployment rates are high, it underestimates the amount of capacity that's there in the labour force. When unemployment rates are low, and hence participation rates are really quite high, then you probably have the other twist to it.

    So you have to be very careful here in how you use it. I think it always ought to come with a big sticker on it, “Handle with care”, because it's not the best single way to look at it.... Or sorry, it is a way. It is not totally unimportant, but it's only one way to look at it.

    The second issue, of course, is whether the structure of demand is matching up fairly well with the structure of the labour force. We're all too familiar in Canada with the fact that we can have very low unemployment rates in Saskatchewan or in southern Alberta, and you don't have to go very far away, to the interior of B.C., to have very high rates. Or if you look at the province of Quebec, east of Quebec City and west of Quebec City you would have very different rates. So the structure here is also important.

    Finally, we also have to think about the amount of physical capacity--machinery and equipment, plants, infrastructure. That is also very much a limiting factor.

    So all of those come together in this concept we have of what is potential.

º  (1655)  

    The Chair: Do you have anything more, Ms. Minna?

    Hon. Maria Minna: I think Mr. Jenkins wanted to say something.

    Mr. Paul Jenkins: Perhaps I could reinforce a couple of points the governor made.

    Researchers do try to get a fix on this. I think if there's one common feature of all the research, and this reinforces the governor's first point, it's that this concept of the NAIRU has an extremely wide confidence band. When you think about that from a policy perspective, there's not a great deal there that would give you confidence in being able to use that.

    For that reason, we tend to factor in much more information in terms of trying to get a measure of this concept of potential output, which includes all factors in the production process.

    Hon. Maria Minna: But is there a level of unemployment that an economy, in your view, has to tolerate in order to maintain the inflation rates and certain other things? And are the interest rates affected by the NAIRU, or however one defines it?

    Mr. David Dodge: Yes, there is. It's very important to remember that every month, roughly 2% of the labour force changes jobs. There's a tremendous amount of turnover. When you're talking about that much turnover, it's hard to think that everything would match up perfectly, that you would leave a job on Friday and start a new one on Monday. So yes, there obviously is a certain amount.

    That amount is affected very much by the structure of the economy. For example, as we have found ways of extending seasonal work or to keep plants in operation almost year round—even though the wood or fish products, or whatever is being processed, may not necessarily be delivered to the plant year round—we in fact are smoothing out some of that seasonal variation that always contributed to a higher unemployment rate.

    So I think we are making some progress. Nevertheless, it is absolutely clear that even under ideal conditions, the very structure of the Canadian economy would mean that we would run somewhat higher unemployment rates than the Americans would.

»  (1700)  

    The Chair: Thank you very much, Ms. Minna.

    Mr. McKay.

    Hon. John McKay: Thank you, Mr. Chair.

    I think you answered three out of the four questions I had asked, except for the one on the discrepancy. Perhaps I could add one more arising out of Mr. Jenkins's comments about the $2 trillion in reserves.

    I travelled in China and Japan a year or two ago with Minister McCallum, and I had an opportunity to meet some of the central bankers. My distinct impression of both countries was that those banks themselves were in deep trouble, with deep structural problems and loans that were uncollectable.

    Possibly the $2 trillion in reserves are independent of the troubles with the banks, but I somehow think they're related. So I would be curious as to your comment as to the fiscal soundness of both of those countries—in addition to the first question, of course.

    Mr. David Dodge: Let me start with the U.S. debt, because it will provide a segue into Paul's answer to your new question.

    Obviously no economy can go on accumulating ever larger amounts of public debt ad infinitum. At some point people lose confidence. They don't want to hold it, or they will only hold it at significantly higher prices, so that there will be a natural limit, maybe of very difficult circumstances, when one hits that wall and adjusts to it. We were very close to being there at the beginning of the 1990s, and it was not a particularly pleasant process we had to go through to deal with it.

    The U.S. has one great advantage we didn't have, and that is that at least up until now central banks around the world have been willing to stuff increasing amounts of U.S. treasuries into their reserves. As Paul mentioned earlier, our best guess is that there's about $2 trillion worth of treasuries stuffed into the reserves of Asian central banks alone. But central banks can get nervous about that, as they did in 1973 when the U.S. was forced off the gold standard when nobody really wanted to continue to hold U.S. dollars at that rate. Continuing creation of supply of U.S. treasuries at some point is going to drive up their price, because people are not going to be willing to hold them.

    Now, are we there? No, we're obviously not there yet.

    Could we get there in the foreseeable future? Yes.

    Need we get there? Probably not, because the amount of adjustment that has to be done to the immediate U.S. fiscal situation is considerably less than we had to do in the early 1990s. It is manageable, but the longer you leave it the less manageable it becomes. What we would all say is it's a bit like the publican's call: “Time, gentlemen, time.” It's time to get on.

    We're beginning to take the steps to reduce it, and that would actually be enormously helpful for the world economy.

    That leads right into the question about what's going on in emerging markets.

»  (1705)  

    Mr. Paul Jenkins: As the governor noted, the $2 trillion we talk about is for all of Asia. The size of the reserves in China itself would be in the order of $400 billion. Anyway you cut it, these are very large numbers.

    You're absolutely right, Mr. McKay, that the banking situation in China is one that needs to be addressed and is being addressed by the authorities.

    In theory—again, you're absolutely right—you could take these reserves and use them to clean up the balance sheets of the state-owned banks. But there is what I call a “stock flow” problem here. You could take those reserves to clean up balance sheets, but you also have to be concerned about the go forward—the flow part, if you like; the decisions that would subsequently be taken to funnel savings of the Chinese population through the banking system to investments that would be sustainable and provide rates of return that would support growth on a continuous basis.

    The issue of the reform of the banking sector is indeed very important, and it comes back to one of the earlier points we made, that part of what the Chinese are moving towards is putting in place policies and institutions that will help them sustain growth over time at what will be fairly high rates of growth, simply because of the size of the population and the flow of the population into the workforce that they'll be facing. That certainly is an additional challenge the Chinese have, and steps are being taken to deal with it in a number of ways.

    Again, there's the issue of how quickly all of this is actually going to come about.

    Hon. John McKay: The other question I had was this. You seem to be awfully bullish on the Canadian economy in 2005, more bullish than the private sector or the IMF, by a considerable amount: 0.7. I'm not clear why you think the Canadian economy is going to perform at a better rate than the IMF and the private sector think it will.

    Mr. David Dodge: Sorry, I didn't hear. Was that the Canadian economy next year?

    Hon. John McKay: Next year, 2005.

    Mr. David Dodge: I guess I don't fully understand why they aren't more optimistic.

    Hon. John McKay: They are less optimistic.

    Mr. David Dodge: No, I don't understand why they're not more optimistic than they are. We are now going through adjustments, and those adjustments, over time, once they're made, begin to yield real results. In fact, I would not have said that our projection in abstract would be considered a very optimistic projection. It's an 18-month trajectory to get barely back to closing an output gap. That is not particularly optimistic in the context of a world that is very strong.

    We have the world, in particular the U.S., a little bit stronger than they do, and I think the reason for that is that we have probably shared with the federal reserve a slightly stronger view on the rate of growth and potential in the United States than might be out there conventionally.

    Hon. John McKay: Good. Thank you.

    The Chair: Thank you.

    We'll have the last question now from Ms. Wasylycia-Leis.

    Ms. Judy Wasylycia-Leis: Thank you.

    I'm glad to have the opportunity to have another exchange with you, Mr. Dodge, because I'd love to have the chance to debate the whole notion of paying now and paying later when it comes to spending versus debt reduction. It seems to me that--

    Mr. David Dodge: Remember, I've been very careful to talk about fiscal balance as opposed to whether it's spending or taxation. That is for you and for the government to decide on. My comments relate to the fiscal balance issue.

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    Ms. Judy Wasylycia-Leis: I just don't know if we have that balance.

    I'll use the example of the government having set a 25% debt-to-GDP ratio target for 10 years and setting aside a minimum of $30 billion over the 10 years to contribute toward achieving that target. My question to the government is, wouldn't that $30 billion get us further ahead if we invested it in restoring some programs that have been cut, in meeting the needs of Canadians, as opposed to putting it against the debt, which would have us achieve our target one year sooner than we would if we hadn't put that money against the debt? That's what economists are saying. If you look at normal growth projections of 5% annual growth--3% real growth plus 2% inflation--we should be able to achieve the 25% debt-to-GDP ratio 11 years from now.

    So why wouldn't you recommend that to be the right approach, the balanced way?

    Mr. David Dodge: Sorry, we are talking about something, quite frankly, at the margin here. Whether it's 10 or 11 years, I quite agree with you, there is no magic. I think the answer here is that if everything turns out nicely and you never needed that $3 billion cushion--or $4 billion or $5 billion or whatever the Minister of Finance now builds in--you would in fact get there a little bit sooner. What will happen, I'm sure, is that some year we're going to need it and need it more.

    Ms. Judy Wasylycia-Leis: There are other cushions they have built into the budget. We've seen over the last six years the lowballing of the surplus, and all of that money, which has added up to about $80 billion over the last six years, has been going against the debt while programs have suffered. Wouldn't it have made more sense to have had a balanced approach all along in terms of surplus and where it goes?

    Mr. David Dodge: This is more of a tactical than strategic question. I personally--and here I don't speak for the bank; I'm just giving you my own views--think that with where we are now it is extraordinarily useful to have a debt target. Now, you can argue whether we should get there in 10 years or 11 years, but it is very useful, because some year we're going to miss--something is going to go desperately wrong and we're going to miss. What you don't want is for the government to have to all of a sudden jerk everything around to get back to a deficit target. If it's always below its debt cap, then you have a cushion so when something really goes wrong, you don't have to react in a way that exacerbates the problem--which was exactly what, unfortunately, we had to do in the early nineties. We exacerbated a slow-growth problem because we just had to deal with this monster that was on our back.

    So my own view is that it is a good tactic to set that ceiling, and then as long as you're below it, you have some room and you haven't violated anybody's confidence. Those are, I think, tactical issues. But I really think it's very important that as we start to head into those higher-expenditure years, as we get out into the middle of the next decade, we have left ourselves some cushion, if you will, so we don't in the end have to raise taxes on the then-existing workers to cover those expenditures.

    Ms. Judy Wasylycia-Leis: Fair enough.

    I think the extreme end of this debate is your counterpart, Alan Greenspan, at least based on what he said in his address to Congress in February. As I understand it, he really has made a strong case. He said that reversing tax cuts and making any increases in social spending should be discouraged and that in his opinion, those are deterrents to economic growth.

    I just find going down this path and getting to where he's suggesting is a problem, and I guess I'm wondering, do you concur with what Alan Greenspan is saying and his philosophy in terms of what creates a healthy sense of well-being in an economy?

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    Mr. David Dodge: I guess we have a very clear view at the bank, and that is that because the fiscal balance per se does very much affect our ability to conduct monetary policy, we think we should be saying something about fiscal balance. The structure of expenditures or revenues is not our province because it really doesn't affect how we do our job--that's Parliament's province, that's the government's province.

    So I don't think it's really appropriate for us at the bank to comment. Whether I personally do or don't feel like Greenspan does with respect to taxes and spending, I just don't think it's appropriate for the Bank of Canada to be on that side. But we certainly are on the fiscal balance side.

    The Chair: Thank you very much, Ms. Wasylycia-Leis.

    Mr. Pacetti had one quick intervention, and then we'll call it a day.

    Mr. Massimo Pacetti (Saint-Léonard—Saint-Michel, Lib.): I just want to know what your record is in terms of determining economic forecast. How close are you--not two or three years down the line, but let's say for the next 12 months?

    Mr. David Dodge: Our projection record is probably a little bit better than consensus, if you go back and look at it, but projection is a dangerous game all the time, and the one thing you know is that you are going to be wrong.

    Just before the honourable member leaves, Judy missed my response to your question, so I would just like to make it.

    Having said that I don't think it's appropriate for the Bank of Canada to comment on particular expenditures or taxes, I am clearly on the record as thinking that investment in early childhood development is in fact an extraordinarily good microeconomic investment to make.

    You didn't hear the exchange we had. I just thought that was important.

    The Chair: Was that enough, Mr. Pacetti?

    Mr. Massimo Pacetti: Yes, that's fine.

    The Chair: Mr. Shepherd wants to close it off with one short one. Then we will shut down.

    Mr. Alex Shepherd: We talked about the sustainability of our debt and the flexibility we would have as a government in reducing it. All the way through these documents I see this tremendous growth in credit card debt. I know you're going to tell me that based on income, it's somehow sustainable. Having said all that, it seems to me that a degree of risk is being built into Canadian household units today that didn't exist some years ago because we had a higher saving rate. Today we seem to be flattening out our saving rate. We seem to be living for today and forgetting about tomorrow. Doesn't the same analysis that you apply to governments also apply to individuals?

    Mr. David Dodge: Not quite. The net wealth position of households continues to rise, and the cost of servicing the debt they've taken on relative to their income has actually been falling. We don't think it'll fall any further, but it is well below the average of the past couple of decades. One always worries about the distribution of that household debt. Some people have been taking on an amount of debt that for their particular household makes it tricky. But if we look at the sector as a whole, we see that it appears to be in amazingly healthy shape. We do look at this very carefully for all the reasons you would think.

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    Mr. Alex Shepherd: But that's not really fair. When you look at the demographics of the Canadian population, many of us are of the baby boom generation, and you would expect that our household assets had increased. But for the younger people today, those from 20 to 35, that's an alarming problem.

    Mr. David Dodge: That's why I say it's important to look at where that debt is being taken on. A lot of it, of course, is due to the fact that finally, after six or seven years, the 30-year-olds can get into housing. We had quite a long period where we weren't building many houses because personal incomes were low, interest rates were high, and people couldn't afford those houses. We now have been building houses at a rate above the long-term rate we'll need to build them at. But we had quite a bit to pick up. It goes back to the question you raised earlier. It was not easy for Canadians to deal with the fiscal jam we got ourselves into at the beginning of the 1990s. We don't find this terribly peculiar or wrong or anything like that. We're now building the houses and putting people into them at a younger age than 10 years ago because we didn't have a very strong economy 10 years ago.

    Ms. Judy Wasylycia-Leis: Can I ask one last question?

    The Chair: I don't think so. We're going to let Mr. Dodge and Mr. Jenkins go.

    Ms. Judy Wasylycia-Leis: I have a point of order. Since the Governor of the Bank of Canada is here at the time when we're dealing with the other big issue of the sponsorship file, I am wondering if someone could ask him whether or not he has noticed any impact of this so-called scandal on the markets and on--

    The Chair: I think we'll leave that question for the next time.

    Mr. Dodge and Mr. Jenkins, thank you very much. These sessions are always very useful and informative. Thank you for sharing your views and insights with us today.

    Mr. David Dodge: Thank you, Mr. Chairman.

    The Chair: At 9:30 tomorrow we are going to be equally stimulated by a presentation by Mr. McKay on Bill C-30. That meeting is in Room 269 of the West Block.

    The meeting is adjourned.