FINA Committee Meeting

37th PARLIAMENT, 2nd SESSION

Standing Committee on Finance

EVIDENCE

CONTENTS

Wednesday, October 22, 2003

¹

1535

The Chair (Mrs. Sue Barnes (London West, Lib.))

Mr. David Dodge (Governor, Bank of Canada)

¹

1540

The Chair

Mr. Monte Solberg (Medicine Hat, Canadian Alliance)

Mr. David Dodge

¹

1545

Mr. Monte Solberg

Mr. David Dodge

Mr. Monte Solberg

Mr. David Dodge

The Chair

Mr. Monte Solberg

¹

1550

The Chair

Mr. Monte Solberg

Mr. David Dodge

The Chair

Mr. Monte Solberg

The Chair

Mr. Monte Solberg

The Chair

Mr. Monte Solberg

The Chair

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

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Mr. Pierre Paquette (Joliette, BQ)

Mr. David Dodge

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1555

Mr. Pierre Paquette

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

º

1600

Mr. Pierre Paquette

Mr. Paul Jenkins

Mr. Pierre Paquette

Mr. Paul Jenkins

Mr. Pierre Paquette

The Chair

Mr. Pierre Paquette

The Chair

The Chair

Mr. Roy Cullen (Etobicoke North, Lib.)

Mr. David Dodge

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1635

Mr. Paul Jenkins

The Chair

Mr. Roy Cullen

Mr. David Dodge

º

1640

The Chair

Mr. Tony Valeri (Stoney Creek, Lib.)

Mr. David Dodge

Mr. Tony Valeri

Mr. David Dodge

Mr. Tony Valeri

Mr. David Dodge

º

1645

The Chair

Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.)

Mr. David Dodge

Mr. Nick Discepola

Mr. David Dodge

Mr. Nick Discepola

The Chair

Mr. Scott Brison (Kings—Hants, PC)

º

1650

Mr. David Dodge

Mr. Scott Brison

Mr. David Dodge

Mr. Scott Brison

Mr. David Dodge

Mr. Scott Brison

Mr. David Dodge

º

1655

Mr. Scott Brison

Mr. David Dodge

Mr. Scott Brison

»

1700

The Chair

Mr. David Dodge

The Chair

Mr. Shawn Murphy (Hillsborough, Lib.)

Mr. David Dodge

Mr. Paul Jenkins

Mr. Shawn Murphy

Mr. David Dodge

»

1705

Mr. Shawn Murphy

Mr. David Dodge

The Chair

Mr. Walt Lastewka (St. Catharines, Lib.)

Mr. David Dodge

Mr. Paul Jenkins

»

1710

Mr. Walt Lastewka

Mr. Paul Jenkins

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. Bryon Wilfert (Oak Ridges, Lib.)

The Chair

»

1715

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Ms. Judy Wasylycia-Leis

Mr. David Dodge

Mr. Paul Jenkins

Ms. Judy Wasylycia-Leis

Mr. Bryon Wilfert

The Chair

Mr. Bryon Wilfert

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Ms. Judy Wasylycia-Leis

The Chair

Mr. David Dodge

»

1720

Ms. Judy Wasylycia-Leis

The Chair

Mr. Bryon Wilfert

Mr. David Dodge

»

1725

Mr. Bryon Wilfert

Mr. David Dodge

Mr. Bryon Wilfert

The Chair

Hon. Gilbert Normand (Bellechasse—Etchemins—Montmagny—L'Islet, Lib.)

Mr. David Dodge

»

1730

Mr. Paul Jenkins

Hon. Gilbert Normand

Mr. Paul Jenkins

The Chair

Mr. Rahim Jaffer (Edmonton—Strathcona, Canadian Alliance)

Mr. David Dodge

»

1735

The Chair

Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ)

Mr. David Dodge

»

1740

Mr. Yvan Loubier

The Chair

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CANADA

Standing Committee on Finance

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NUMBER 084

l

2nd SESSION

l

37th PARLIAMENT

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EVIDENCE

Wednesday, October 22, 2003

[Recorded by Electronic Apparatus]

¹  (1535)  

[English]

    The Chair (Mrs. Sue Barnes (London West, Lib.)): The order of the day is consideration of the Bank of Canada's Monetary Policy Report. We welcome Mr. David Dodge and Mr. Paul Jenkins. Thank you very much for joining us. As always, we look forward to hearing your comments. Then I'm sure the members of this committee will have their questions ready for you.

    We may or may not be interrupted at some time. If we are, we're going to come back to finish whatever has to be finished here, because it's important for Canada.

    Mr. Dodge, please go ahead. The floor is yours.

    Mr. David Dodge (Governor, Bank of Canada): Thank you very much, Madam Chair.

    Paul and I really, as always, appreciate the opportunity to meet with you following the release of our Monetary Policy Report. As you know, this morning we released our report dealing with economic and financial trends in Canada in the context of our inflation control strategy.

[Translation]

    The last time that Paul and I appeared before this committee was after the release of our April report. At that time, inflation was well above its 2 per cent target, and short-term inflation expectations had edged up. Although inflation was being pushed up by special factors, there were also signs that strong domestic demand was working to broaden pressures on prices.

    Since April, our economy has been hit by a number of unusual shocks, including SARS, BSE, the Ontario electricity blackout, and the severe forest fires in British Columbia. Because of these and other factors, growth had been weaker than expected. We now estimate that there is more slack in the economy than we had projected in April.

    Both total CPI and core inflation have fallen faster and further than expected. And virtually all measures of inflation expectations have decreased since last April. The drop in core inflation reflects several unforeseen developments: first, a broad-based weakness in the prices of goods, such as automobiles and clothing; second, the substantial fall in the value of the US dollar; third, substantial reductions in the prices of tourism-related services because of the impact of SARS. As well, there has been a slightly faster easing of pressures from auto insurance premiums.

    The prospects for near-term growth in the global economy have improved since April, and geopolitical uncertainty has continued to decrease. The economic picture in the United States is much improved. Recent data indicate that the anticipated recovery there is taking place earlier than previously expected. The economy in Europe is still weak, but prospects for Asia look bright, led by China and India. And the Japanese economy is performing better than anticipated

[English]

    We expect growth in the Canadian economy to strengthen during the fourth quarter of this year and through 2004. On balance, the expansion should be above the rate of potential growth, supported primarily by solid household spending and increased business investment. Stronger growth abroad should boost foreign demand for Canadian products, but this will be dampened by the higher value of the Canadian dollar. Growth is expected to average about 3% in the second half of 2003 for the Canadian economy as a whole and about 3.25% in 2004. With growth above potential, the slack in the economy should be largely absorbed by early 2005.

    We expect core inflation to average just over 1.5% for the remainder of this year and to fall to just above 1% in early 2004 as the effects of the earlier increases in auto insurance premiums dissipate. But core inflation should return to 2% by mid-2005 as the economic slack is taken up. Total CPI inflation will continue to be importantly affected by swings in the price of oil and natural gas. If the price of crude oil eases to $27 U.S. per barrel next year, as futures prices suggest it will, then total CPI inflation would likely fall just below core inflation in 2004.

    Madam Chair, there are significant risks to this economic outlook. The risks relate primarily to the timing and magnitude of adjustments to global economic imbalances. In particular, there's uncertainty both about the likely changes in key global exchange rates and their effect on the Canadian economy. There's also uncertainty about the sustainability of U.S. growth beyond the latter part of 2004.

    We continue to assess the implications of all these developments, both those that have taken place to date and those that are going to take place, for future output and inflation in Canada and what they are going to mean for our monetary policy going forward.

    Madam Chair, Paul and I will now be glad to answer your and the committee's questions.

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    The Chair: Thank you.

    I'm advised we're on a 30-minute bell for a vote around 4:05 p.m. We'll split at about a couple of minutes past 4 p.m. It's apparently one procedural vote. We will return to finish questions, so I will do full rounds of questions before or after this vote.

    I'm going to do a 10-minute round. If parties would like to split—five minutes and five minutes—that's fine with me, but I'm going to be strict on it.

    Mr. Monte Solberg (Medicine Hat, Canadian Alliance): Thanks very much, Madam Chair, and thank you, Governor Dodge. We appreciate your being here.

    I think it's very timely that you've managed to come before the committee when we're seeing a huge increase in the dollar these days that's really causing a lot of problems for exporters. At the same time, in the statement you just gave us, you told us that inflation really is under control. But last week you had a chance to cut rates and didn't do it. I'm wondering why, given the impact the high dollar is having on exports. Aren't you concerned that if in fact the dollar ultimately continues to appreciate, its rise will actually start to undo some of the growth we're starting to see in the economy again?

    Mr. David Dodge: There are really a couple of questions here, so let me try to take them a piece at a time.

    First of all, let's be very clear: what we try to do is to set monetary policy appropriate for conditions in Canada. It's this that we focus on when we do it. That having been said, clearly there are a lot of factors that affect conditions in Canada, one of which—but only one of which—is the exchange rate.

    What has happened since April? Since April, what we've seen is a general depreciation of the U.S. dollar. What that means is we're up roughly 10% against the U.S. dollar since April. The question, and what's really important for us in trying to figure out how it is going to affect the Canadian economy, is what lies behind it.

    Some of what lies behind it is clearly a loss of confidence in the United States. What we're seeing is appreciation of most of the world's currencies, with the exception of the Asian ones, against the U.S. dollar.

    Second, and quite importantly, what we've seen, because of strengthening world economic conditions, is really a quite significant rise in the U.S.-dollar price of commodities, in particular non-energy commodities. Indeed, for most of these key exports, whether they be minerals, pulp and paper, or even industrial products, the Canadian-dollar prices of the products have been stable or have even risen because the U.S.-dollar price of a number of these products is up.

    Historically, strong world demand for these primary commodities or semi-processed commodities has produced a period in which what we've normally seen is an actual appreciation of the Canadian dollar. So partly what we're seeing is related to rather strong world demand.

    All that having been said, it is not so simple to analyze what the overall impact has actually been, looking out over 18 to 24 months. It's for that reason, first of all, that you'll note we're not saying we're sure, or think we are sure, that current interest rates are necessarily appropriate for demand conditions in Canada. We're going to have to continue not just to assess what happens going forward, because recent numbers have actually been quite strong, but we really have to go back to look at some of what's gone on over this last year, because it's not so easy to assess.

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    Mr. Monte Solberg: For years the Prime Minister talked down the dollar. He talked about how good it was to have a low dollar to help with exports. I would suggest that maybe the chickens are starting to come home to roost now, with the American greenback weakening and our dollar appreciating so quickly. It's really starting to hurt a primary sector of the economy. I'm wondering if you would comment on how rapidly the dollar has gone up and the resulting impact on business. Businesses sit down to prepare a business plan premised on the dollar being within a range. When the dollar appreciates 20% in a very short period of time, pretty obviously that devastates certain sectors of the economy.

    Mr. David Dodge: You're absolutely right that adjustment is difficult when it has to take place very quickly, or in this case to a very sharp appreciation—or depreciation—of the dollar. You'll recall about 18 months ago when we were here, what we were saying was that the low value of the dollar at the time—remember, it had depreciated from about 64.5¢ and was going slightly below 63¢—wasn't helpful to adjustment in the Canadian economy. Clearly, the speed of its change since April makes adjustment really quite difficult. There's no question about that; the speed is difficult to manage for any businessman out there.

    Mr. Monte Solberg: I want to go back to inflation for a second. Your report says that core inflation will be below your target until 2005. I want to return to the first question I asked you, which had to do with the fact that you had an opportunity to cut rates last week and you didn't do it.

    It seems to me odd, given that you're projecting that core inflation will be very low for a long time to come, that you missed the opportunity to reduce rates, especially if you're worried about future growth and you're talking in your report about uncertainty in the world.

    Mr. David Dodge: Our best assessment is that by the early part of 2005, demand and supply in Canada will be roughly back in balance. There are some special factors holding inflation down, especially during 2004, some of which I mentioned: the working off of the automobile insurance price increases; the fact that we do expect some reduction in energy prices, as I said, to about $27 a barrel; and clearly, the one-time effects of the rapid appreciation since April. If that continues, it will indeed feed through over that period.

    So there are some one-time factors, if you will, that will be holding the measured rate of inflation down, even though we do anticipate, according to our analysis at the moment, that we will be back approaching full capacity by the time we get to the first half of 2005.

    The Chair: You have about a minute forty-five.

    Mr. Monte Solberg: I hesitate to ask this, but I'm going to ask because you're going to get asked it anyway. This has to do with an issue that was raised in the House today. I'll broach it with you.

    Some people are concerned about the fact that you were a deputy minister in the Department of Health during the time of the problems with the Virginia Fontaine centre. Some people are calling into question your abilities as a result of that. I guess I'm giving you a chance to address that now, before you get asked it in a couple of minutes.

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    The Chair: Under the rules, the consideration of the day, as you know, is the Monetary Policy Report. I will invite you to stick to the subject matter, if you can.

    Mr. Monte Solberg: Well, I've asked the question, so I'll leave it to the governor to decide whether or not he wants to answer it or address it later.

    Mr. David Dodge: As the chair said, I think there are probably other fora to deal with that. As every member will appreciate, this is an issue that is before the courts, and one always has to be extraordinarily careful not to prejudice proceedings in front of the courts.

    The Chair: Governor Dodge, I'm going to say I could do a ruling on this.

    Mr. Solberg, I gave you an opportunity to ask another question; I'm still holding that out for you. If you would like, I will do a ruling on your question.

    Mr. Monte Solberg: This is Parliament, Madam Chair.

    The Chair: Well then, it is out of order.

    Mr. Monte Solberg: If we can't embrace free speech here, then where can we embrace it?

    The Chair: Your question is out of order.

    Mr. Monte Solberg: He was answering the question, Madam Chair.

    The Chair: The subject matter of the day is the Bank of Canada's Monetary Policy Report, and anything to do with that is totally in order.

    Go ahead, Ms. Wasylycia-Leis.

    Ms. Judy Wasylycia-Leis (Winnipeg North Centre, NDP): I have a point of order.

    Madam Chair, I think we need to have a bit of a discussion on this, because I think my colleagues in the Alliance—

    The Chair: I've just given a ruling, and with rulings there is no discussion. If you wish, you can appeal my ruling.

    Ms. Judy Wasylycia-Leis: Well, Madam Chair, I would certainly appeal your ruling based on the fact that we're talking about the confidence we have in this monetary policy.

    The Chair: Excuse me, I have the floor.

    Under the rules of this House, that's non-debatable. If you wish to appeal the ruling, we can appeal the ruling. It is the procedure.

    Those in favour of sustaining my ruling? Those opposed to the ruling? It is sustained.

    So we will move on. Your time has now expired.

    Monsieur Paquette.

[Translation]

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

    Mr. Dodge, you will not be surprised that I should deal with the decision of the governor of the Bank of Canada on October 15 not to lower the key interest rate and keep it at 2.75%. There is a pretty wide spread between the Canadian and American rates. At this time, the American interest rate is 1%, when the Canadian rate is 1.75%, which is a fairly important spread.

    You mentioned that since the beginning of this year, the appreciation of the Canadian dollar compared to the American dollar has been roughly 20%. It seems that this change is not the result of the lower value of the American dollar only, because our dollar has also appreciated against the euro, the British pound and most other currencies except the Australian dollar.

    It was announced today that the inflation rate was on the rise. In September, it stood at 2.2%. You said that there is some slack in the economy, and the unemployment rate has risen in several provinces. In Quebec, it is almost 10% and it averages 8% throughout Canada. I would like to know whether this higher inflation rate in September, a continued appreciation of our currency in terms of the American dollar, and an economy which does not seem to improve substantially could bring you to lower the policy interest rate by a quarter of a point or half a point next month. But I do not want to anticipate your decision next month.

    Mr. David Dodge: What matters, when we make our decisions, is not the figures of a single month, but our analysis of the impact of all the developments in the economy, like inflation and the real strength of the economy. We always have to evaluate or project the situation 18 months ahead, because there is a lag in the response to monetary policy changes. That is why we take into account not only the rate of inflation at a given time, but all the factors at work in the economy. The future rate is what counts.

    Second, we never know whether the exchange rate at a given time will stay the same. There is always a degree of uncertainty.

    Third, we should consider the fact that the impact on the economy of appreciation of the dollar in the past takes a certain time to materialize.

    Fourth, we should take into account what is happening on foreign markets for our products.

    Fifth, and this is extremely important—and then I will yield to my colleague—we should take into account the fact that in the future, domestic demand will have to increase in order to stimulate economic growth.

    In the 1990s, there was a time when the governments contributed to the slowing down of the economy. Today, with budgets that are more or less balanced, this impact no longer exists. It is important to keep domestic demand up, be it corporate and business demand or household demand.

    So many factors have to be considered.

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    Mr. Pierre Paquette: I know, and that is why I am asking you not be overly concerned by a slightly higher inflation rate. I am asking you to take into account the whole situation, because I feel me need lower interest rates.

    Mr. Paul Jenkins (Senior Deputy Governor, Bank of Canada): I would simply like to add that, like the governor said, many factors have an influence on the exchange rate. The American dollar is now being depreciated, for several reasons, against all major currencies. Other fundamentals are also at play. The price of our commodities are now nearly 15% higher than a year ago. It means that international markets for some of our commodities are strong.

    Several other factors have an impact on the exchange rate, but it is also important to have a sense of what will happen in the future. The goal of our monetary policy is to have an inflation rate which is both low and predictable. The spread between the American and Canadian rates is not the only determinant of our monetary policy. We also have to take into consideration the inflation rate in order to support the economy in general.

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    Mr. Pierre Paquette: This is exactly my point: high interest rates in Canada contribute to a higher Canadian dollar. I think there is a consensus on this. Even if it is not the only factor behind the appreciation of the Canadian dollar, such a spread between the interest rates in both countries is attracting money in Canada and pushes the Canadian dollar higher. I am not suggesting it is the only factor, but it does have an impact. The appreciation of the Canadian currency necessarily lowers the price index, because imported goods are cheaper. We import a lot of goods, especially from the United States. Because of that, the economy slows down. I think my colleague has already mentioned it. Every day, we hear about businesses closing down, and that is a new phenomenon. For example, the manufacturer Bas Iris recently announced that it was filing under the Companies' Creditors Arrangement Act, partly because of the very high value of the Canadian dollar and because this makes its products less competitive with foreign goods. This pushes the prices lower. Some economists suggest that if only the goods were taken into account in the consumer price index, the inflation price index would probably be negative and not positive.

    In your analysis, if the value of the dollar remains very high, could the short term impact be deflation, if we consider just the goods component—I am not talking here about services—of the consumer price index?

    Mr. Paul Jenkins: Productivity is a factor that has an impact on the price of commodities, and productivity has improved drastically in several sectors. It is an important factor. Like the governor mentioned, it is true that changes in the value of currencies has an impact on the real economy, but there are also other factors now. An American economy which is stronger than we anticipated and the improvement of Asian economies are also positive factors. So, there are many factors we should examine to determine the general impact on the inflation rate and the economy.

    Mr. Pierre Paquette: Do you think there is absolutely no deflation risk for the goods component of the index in Canada?

    Mr. Paul Jenkins: In our analysis, the impact of the exchange rate changes is very low. It is not felt very much on the price of goods. It certainly has some impact, but productivity is what determines more the changes in prices.

    Mr. Pierre Paquette: May I ask one more question?

[English]

    The Chair: The time is up.

[Translation]

    Mr. Pierre Paquette: Already?

[English]

    The Chair: Oui, bien sûr.

    Now, I think it's the appropriate time to suspend, because we're going to get only a minute.... We will suspend and return after one vote. It'll be fewer than 10 or 12 minutes, and then we'll be back.

    I'll suspend.

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    The Chair: We will resume consideration of the Bank of Canada's Monetary Policy Report and a ten-minute round.

    Mr. Cullen, it's your turn, followed by Mr. Valeri.

    Mr. Roy Cullen (Etobicoke North, Lib.): Thank you, Madam Chair, and thank you, Mr. Dodge and Mr. Jenkins.

    I think you may have already touched on this, Mr. Dodge, but I'd just like to go over it again, if I could.

    Certainly the companies in my riding, and indeed across Canada, that are exporting goods and services are being hurt badly by the rapid pace of change in the appreciation of the Canadian dollar. You talked about diminishing confidence in the U.S. dollar as being one factor that's driving that. To what extent is the spread in interest rates affecting that relationship between the Canadian and U.S. dollars, and how important is the impact of the Canadian-U.S. dollar exchange rate going to be on Canadian businesses?

    I think you alluded to the fact that it could affect the growth in the economy. So I'm wondering about those relationships and whether that pushes you to the conclusion that a drop in interest rates is probably a desirable thing to do.

    Mr. David Dodge: Let me start with your question on interest rate spreads.

    First of all, I think it is important to note that the spreads at the moment are sort of normal between Canada and the United States. They're probably slightly narrower than normal at the very long end of the curve and probably slightly wider than what one might think of as normal at the front end of the curve, but the spreads that are there are not anything abnormal in either direction.

    Interest rates overall are very low, and so when I say the spreads are normal, we don't absolutely know whether that spread, at interest rates down in the 1% and 2% range, means quite the same thing as it did when rates were 8% or 9%. Nevertheless the spreads are about normal. That's number one.

    Number two, we have seen movements of capital both in and out. We saw a lot of foreign interest in Canadian bonds early in the year. On the other hand, in July and August we saw net selling of those, which doesn't indicate that what we have is a lot of capital coming in to take advantage of those spreads.

    Finally, if we look at our rates compared to other countries, alternatives to put your money in other than U.S. dollars or U.S. treasuries, our rates are sort of in the middle of the pack. They're lower than a number of them. They're a little higher than Germany's, and obviously quite a bit higher than Japan's. But Japan has a negative spread to the U.S., yet the yen has been appreciating.

    So these are currency movements that, at the moment, are largely driven not by spreads, but really rather by people feeling that over time this U.S. dollar had to come down against other currencies, as we discussed here. In fact, I think every time we've been in front of the committee we've discussed that. But it never happens smoothly, and it has happened in a very rapid fashion. So that's the issue on spreads.

    I'll start and then turn it over to Paul.

    In terms of impact on business, if nothing else, absolutely nothing else, changed--and that's a huge “if”, but start from that point--then over a period of two or three years what you might expect from a 10% appreciation in the currency is a 1% to 2% lower level of output in Canada. That's the historic range. But of course, everything else doesn't stay the same, and what we're going through now, as we have through some periods in our past, is that the prices in U.S. dollars of a number of products, where we are large net exporters, are moving up, and with the stronger growth in Asia in particular, as well as the stronger growth now in the United States, we're seeing demand being relatively buoyant.

    So there's a bit of optimism in the world about demand, and so it's not totally surprising that in those circumstances, even if there wasn't a downward play on the U.S. dollar, you would see some upward movement or upper pressure at work on the Canadian dollar, the Australian dollar, or whatever.

    Obviously that's not evenly spread across the country, and Paul, maybe you would like to pick up there.

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    Mr. Paul Jenkins: I'll just speak in terms of some of these other relationships the governor was referring to.

    These counterfactuals are difficult, but they're important to work through for us to understand the various factors at play. So yes, a higher Canadian dollar, all else being equal, would have consequences. It is an important price, and that price has a bearing on the demand for Canadian goods abroad and likewise on the demand for foreign goods here in Canada. But that's just one element of the many factors we're trying to come to grips with and analyze.

    On the volume side, if these foreign markets are expanding, you also see important effects for Canadian exporters. Again, to give you some order of magnitude, I'll point out that a 1% increase in the growth of the U.S. economy translates through to something like a 0.7% increase in output for Canada. It's a very immediate, very quick relationship, whereas the relationship on the exchange rate the governor was talking about is spread out over two to three years. That's another factor we have to consider.

    Likewise, we don't do a lot of direct trade with Asia, but we have a lot of contact through other channels, particularly commodity prices. That part of the world is doing very well. As I mentioned in my response earlier, commodity prices, excluding energy, for the basket of commodities we produce and sell in Canada have risen something in the order of 15% year on year. That increase in and of itself would also translate through into higher output for Canadian producers.

    There are a number of key relationships here we have to look at, think about, and worry about in terms of the orders of magnitude, as well as the timing effect. I guess the fourth one would be the price level effect. Again, coming back to Mr. Paquette's question, I'd say a higher exchange rate would have some price level effects, but they'd be a lot less than what we've seen in the past. There's this phrase economists use, the pass-through effect, where exchange rates have an effect on price levels. And there, yes, there is some effect, but it seems to have been a lot less in recent years than what we've seen historically, and I think there are a number of reasons for that.

    But let me just leave it there. I think that gives you the flavour of the sorts of issues we're dealing with.

    The Chair: Mr. Cullen.

    Mr. Roy Cullen: Thank you. That was a good segue to my next question.

    When we talk about the export markets for Canadian goods and services, a big export market is, of course, the U.S. market. I think you allude in your remarks here to the fact that in the near term that's one issue, but in the medium term we have some fiscal challenges or problems with the United States; we have some current account problems. I'm a little concerned that in the medium term we've stayed insulated to some extent from the changes in the U.S. economy. Is this going to come home to roost? How bad will it get, I guess is my question, in the U.S. economy? I don't want to be overly pessimistic in my question.

    Mr. David Dodge: First, the very brief answer is that we don't know, but I can tell you a couple of factors that are going to be important. If world demand is strong, then indeed we can get a correction of this U.S. current account problem without actually having to see demand in the U.S. slow down. That's number one.

    Number two, it is quite clear the U.S. is going to have to take action at some point in the not-too-distant future to correct their fiscal imbalance, and that will impose some degree of fiscal drag on the United States. If, on the other hand, the world is growing strongly at that point in time, then we could see this work through reasonably smoothly. If not, it could be tricky.

º  (1640)  

    The Chair: Thank you very much.

    Mr. Valeri, you have up to 10 minutes.

    Mr. Tony Valeri (Stoney Creek, Lib.): Thank you, Madam Chair. I may not take 10 minutes. I may pass it on to one of my colleagues.

    I just want to focus on the area of inflation targets. I don't think anyone has covered that off, and I know members will have a number of other questions to cover off in different areas. I want to look at the issue of inflation targets in the context of using interest rates to deal with inflation where, obviously, that has an impact on the dollar as well. How do you respond to the argument that the Bank of Canada target range for inflation is too low? What's the actual gain from focusing on a 2% midpoint rather than a 3% midpoint?

    Mr. David Dodge: Well, let's start with the gain that comes from having a low target regardless of what the particular number is. The gain that comes from that is that you anchor expectations in the country, and with expectations well anchored, then movements in prices are relative movements in prices, which we want in a price system to encourage the appropriate movement of capital. You don't get the boom-bust type of syndrome we've had in the past, where you get inflation running way up and expectations mount. Then the Bank of Canada--or any central bank--has to come in with a sledgehammer to beat it back down to prevent the thing running away.

    So there's a tremendous advantage in having an anchor. Now, the question is, ought that anchor to be 2%? That 2% is quite a common anchor for inflation-targeting countries. Should it be 1.5%? Should it be 2.5%? We did a lot of work on this the last time we renewed our agreement on the inflation target with the government, and quite frankly, we couldn't find any substantive, good, hard analytic reason to pick 2% over 1.5% or to pick 2.5% over 2%. Once we started to get rates up at 3.5% or 4%, it was quite clear that wasn't as advantageous as picking a central rate of around 2%. But as to choosing among 2%, 1.5%, or 2.5%, I can't tell you one is better than the other. The great advantage of 2% is that it's the one that's there, people have become accustomed to it, and it has served as an anchor.

    Mr. Tony Valeri: On interest rates, is there an acceptable upper limit on the spread between Canadian and U.S. rates?

    Mr. David Dodge: No. It depends very much on the circumstances that prevail. Remember, though, what we're doing, and I go back to the point I made in response to earlier questions. What we are trying to do is to set our interest rates over the next 18 to 24 months to set an appropriate rate of growth in domestic demand, because interest rates affect domestic demand.

    Mr. Tony Valeri: I just have one final question on the inflation target side, and then I'll turn it over to my colleague Mr. Discepola. Now that we're locked into the inflation targeting mode of dealing with inflation, can you speak to any of the costs and/or benefits of actually abandoning this type of targeting, or are we locked in? I mean, are you doing any work on what would happen if we needed to abandon this approach?

    Mr. David Dodge: Let me deal with a supposition first. You said inflation targets to deal with inflation. The purpose of inflation targeting for a monetary policy regime is not inflation per se, but it's trying to maximize the rate of growth we can get in the economy over a long period of time and to try to minimize the booms and busts as we go along. The objective is a real economy objective, and what we have found over time and across countries is that the best contribution that monetary policy can make to that sustainable and rather steady growth is to concentrate on keeping inflation low and stable. That's how we got there, not from a fixation about inflation but, really, from a fixation about growth and what it is that monetary policy can do to get the best growth trajectory over time.

    Are there other ways to go at it? Yes, there are, and clearly, there are debates in the profession. You can see the debate that's going on in the United States at the moment, where they don't have an explicit inflation target but, rather, a general statement that they should set monetary policy in such a way as to have high and rising employment and to have low and stable inflation. They leave it there, and they leave it to the governors of the Federal Reserve to do whatever is appropriate. That's certainly a way to go at it, and certainly one cannot argue that it has been unsuccessful in recent periods in the United States.

    However, I think there is a tremendous advantage to the inflation targeting. No regime is perfect, but I think there's a tremendous advantage in that we can explain to every Canadian what it is we're trying to do. We can explain to everybody in the market and we can explain to everybody in the business community what it is we're trying to do. That clarity of purpose and the accountability that leaves us with, with respect to Parliament and to the people of Canada, I think, is extraordinarily important.

º  (1645)  

    The Chair: Mr. Discepola, you have about three minutes.

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

    Governor, over the past six months we've seen the dollar go from the 60¢ to 61¢ range up to the 75¢ range, and we've seen the opposition complain, when it was in the 60¢ range, that we weren't doing anything about it--“we” being the government. Now we see the opposition complain that at the 75¢ range we should be doing something about getting it down.

    You seem to have established targets for inflation, you seem to have established targets for appropriate interest rates, but do you have a policy on trying to set an optimal range where the dollar should be vis-à-vis the United States?

    Mr. David Dodge: The short answer is no, but it's no in terms of an acceptable range. But I go back to Mr. Solberg's question earlier about the speed of adjustment. Unfortunately, exchange markets don't always adjust in a nice smooth manner. They can move in very quick and jerky ways and, indeed, as we saw in 2002, can leave us for a period of time with a dollar range that is actually not helpful to trying to get the adjustments we really need in the economy.

    That's why we say we have no target, but yes, we certainly take exchange rate movements into account as we set monetary policy.

    Mr. Nick Discepola: Are you preoccupied with the dollar being at such a high level?

    Mr. David Dodge: No. I say no against the particular verb you used, which is “preoccupied”. Do we take it into account? Absolutely.

    Mr. Nick Discepola: Thank you, Chair.

    The Chair: Thank you. There's still some time remaining, but it's less than a minute, so we'll go to Mr. Brison for up to 10 minutes.

    Mr. Scott Brison (Kings—Hants, PC): Thank you, Chair, and thank you, Governor Dodge and Mr. Jenkins, for being with us today.

    You've recognized that the spread between Canadian rates and U.S rates is not abnormal or historically high. Productivity rates haven't changed significantly. Our productivity as a percentage of U.S productivity continues to be...I think it's now around 82% as opposed to 92% in the 1970s. So there has been a secular decline, but there hasn't been any remarkable change in that in the last year.

    That leaves, I guess, psychological factors. I mean, in any market-driven valuation there will be psychological factors, and into that there would be political factors. To what extent is the rise of the dollar in recent months a reflection of the international market's enthusiasm over the Prime Minister's retirement?

º  (1650)  

    Mr. David Dodge: I know you don't expect me to answer that particular question.

    Mr. Scott Brison: No, of course, but there are political factors.

    Mr. David Dodge: Yes, and I think where you have seen that in particular over the last decade is that we had a period where there was tremendous, overweening faith, one might say, in the political management of the United States. There was just a tremendous confidence. It's more, I think, than any government could deliver—this is not a party political question; it's a small “p” political question, if you will—and at some point we knew that confidence was going to have to come off, in part because the real economy would act in such a way that it would be hard to sustain.

    What we've seen, really starting in early 2002, is that this tremendous confidence in the American political system has begun to diminish, and with it, the excess demand, if you will, to hold U.S. currency.

    Mr. Scott Brison: But the Canadian dollar is doing relatively well compared with other currencies as well; it's not just against the U.S. dollar.

    Mr. David Dodge: Well, no, that's not true, actually. You can pick any few-month period where it's true, but if you look at when it was that there began a general depreciation of the U.S. dollar, it was certainly in the first half of 2002, probably around the beginning of the second quarter of 2002. What you'll see, if you go back to before that period, is that the movement in the Australian dollar has actually been a little greater than the movement in the Canadian dollar; the movement of the Euro has been actually more than that of the Canadian dollar; the movement in the yen has been a little less than the movement in the Canadian dollar. But over that two-year period or so when the U.S. dollar began—when you look at it from their side—its depreciation, what happened is that we started to come in late and we have caught up over this eight-month period with what happened, say, over an 18-month period with respect to other currencies.

    Mr. Scott Brison: There's a pretty direct relationship between unemployment rates and the level of the country's floating exchange rate mechanism. When there is an increase in the exchange rate mechanism, there's an expectation that the other operative mechanism that could reflect it would be higher unemployment. Have you predicted what the impact will be of this surge in our exchange rates on our unemployment rates?

    Mr. David Dodge: That was the answer Paul was trying to give earlier. There are a number of factors operating simultaneously, and it's hard to distinguish. If nothing else moved around, the rise in the exchange rate, as Paul said, would have an effect; a 10% increase would have the effect of maybe a 1% to 1.5% diminution in Canadian output over a two- to three-year period. At the same time, a 1% increase in foreign demand has an impact, over about one or two quarters, of about seven-tenths of one percent. So a rise in demand for commodities has an impact.

    Unfortunately, you can't disentangle these things. What we're seeing is several things happening simultaneously at the moment, which is quite precisely our problem in trying to assess what's likely to happen over the next 18 to 24 months.

º  (1655)  

    Mr. Scott Brison: When the commodity meltdown occurred, it had a significant impact on the Canadian economy. You're saying the commodity price changes now are having an impact on the Canadian dollar. Yet Minister Manley and the Prime Minister have said there's a notion out there that we're hewers of wood and that this doesn't really reflect the realities of the Canadian dollar. Yet we continue to see a direct impact on the Canadian dollar of commodity prices and issues, which would indicate that the market believes we are hewers of wood. Where's the disconnect here?

    Mr. David Dodge: First of all, roughly 200%of our overall trade surplus is made up of the surplus on natural-resource-based products—that includes things like steel and so on, where there's some degree of manufacturing—and the strength of our current account balance comes from that. On the manufacturing side and on the service side, we are actually net importers, even though manufacturing and services account for more than half of our gross exports.

    So it's not surprising that the movements in commodity prices seem to have a disproportionate effect on our currency. Following the Asian crisis, you'll recall, we had about a 20% fall in commodity prices, which was cushioned by roughly a 7% or 8% depreciation of the Canadian dollar. The exchange rate does help to deal with these really marked swings in relative prices of commodities.

    Mr. Scott Brison: The low dollar over the last six or seven years has actually both reflected and also fostered lower productivity because of the disincentive to invest in productivity enhancement, whether for equipment or software or what have you. Now there's a significant incentive for Canadian industry to invest in productivity enhancement. I'd be interested in your reflections on what impact the higher dollar could have in improving Canadian productivity from that perspective, and whether it would be.... This is where you would put on your old Department of Finance hat briefly, and I'm asking you to draw on the expertise gained at that time. What type of tax and regulatory policy could a Canadian government pursue in the short term to increase incentives to invest in productivity enhancement?

    I'll give you an example. Roger Martin, dean of the Rotman School of Management, has proposed that one of the things the government ought to consider in terms of tax reform is a very aggressive approach to depreciation of capital investment, even potentially a 100% write-off as opposed to a more gradual write-off or depreciation. It strikes me as making some sense, given the current environment where we have to improve productivity quite rapidly in this country.

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    The Chair: I'm going to allow an answer to that question, but we're over time, so I'd like you to give a brief answer.

    Mr. David Dodge: Okay, I'll go really quickly, Madam Chair.

    First, productivity numbers are the most difficult ones to work with. We want to come back in a subsequent question to try to deal with that. We have to be very careful.

    Second, it is absolutely true that when the price of machinery and equipment goes down relative to labour—and that's what happens when you get an appreciation of the Canadian dollar vis-à-vis the U.S. dollar, or vis-à-vis the Euro, because those are the two places our machinery can come from—the normal price incentives for firms are to make greater investment in machinery and equipment than they would have had that price rebalancing not taken place.

    Similarly, of course, it was very helpful during a period when Canadian demand was quite weak that we had a depreciation of the Canadian dollar, so that in fact we employed some of the labour that would have been unemployed. We are now back at historic highs in participation rates. We've in fact come full circle on that one.

    As for the tax policies, I think I'd better leave that to the Minister of Finance's people to answer.

    The Chair: Thank you very much.

    Now we'll go to Mr. Murphy. I understand you're going to split your time with Mr. Lastewka. Go ahead.

    Mr. Shawn Murphy (Hillsborough, Lib.): Governor, just to follow up on that point, has your model been able to reflect with the higher Canadian dollar exactly what that would do to our level of productivity vis-à-vis the United States?

    Mr. David Dodge: I think the answer to that is no, but, Paul, you might explain what we can do on this.

    Mr. Paul Jenkins: The models we use certainly aren't constructed to be able to answer that sort of question, but certainly what we are looking for is that going forward with an economy operating at close to full capacity over the next couple of years, returning to full capacity by early 2005, we will have in place a series of momentums and incentives in this economy that are going to enhance productivity. We're looking at productivity growth over the medium term of about 2% in Canada, which is significantly above what we had seen through the 1970s and 1980s. That would be comparable, in our view, to what will transpire in the United States.

    So with the macroeconomic framework that we now have in place, the fiscal prudence, the emphasis on inflation control, structural adjustments that have taken place, we have seen through the second half of the 1990s and going into this decade a process that is really beginning to show some gains in productivity, and we think that will continue.

    Mr. Shawn Murphy: Governor, in this spike we've had in the Canadian dollar, I can see that there is a destructive factor to Canadian businesses, especially Canadian businesses that export to the United States. Assuming we've seen a spike, and then it came down the same way and went back up again, what would be the reaction or the position of the Bank of Canada if we started seeing that on a regular basis?

    I think a downward spike would be just as destructive.

    Mr. David Dodge: It certainly is true that whether we look at exchange markets or at fixed income markets, we have actually seen quite a bit of volatility over the last couple of years.

    One of the things that happens or that firms can do to deal with those sorts of fluctuations, of course, is to hedge their sales so that they are not exposed to unanticipated fluctuations. Those financial markets, certainly for larger companies, those forward markets for larger companies, work fairly well.

    We are doing some work right at the moment on the use of those markets through the chartered banks, largely for smaller and medium-size companies, but there certainly are ways for companies to deal with that.

»  (1705)  

    Mr. Shawn Murphy: Here is my last question, Governor.

    Mr. Brison asked you a couple of questions dealing with large “P” and small “p” political repercussions. Could it be that the increase in the Canadian dollar we've seen over the last six or eight months was caused wholly or partly by the sound and prudent economic policies followed by this government over the last five or six years?

    Mr. David Dodge: I think it is absolutely true that when people want to get out of U.S. dollar holdings, they look around the world for places, for countries, for currencies where they think the management of the economy is strong, and it is undoubtedly true that in a country like ours, the only one of the G-7 countries to have roughly a balanced budget, where the overall public debt as a share of GDP is now towards the bottom of the range, this makes Canada a more attractive place to invest in and to look at as an alternative to the United States.

    The Chair: You have nearly five and a half minutes, Mr. Lastewka.

    Mr. Walt Lastewka (St. Catharines, Lib.): Thank you very much.

    Mr. Dodge, I want to go back to some of the questions that were asked earlier about the fact of having a low dollar. I know some industries get lazy and don't do the work they should be doing at that time, but in the manufacturing area, while we've had a few notes on the manufacturing that a lot of areas have improved, but the manufacturing hasn't.... Exporting to the U.S. during the month of August, I think, was at its lowest since 2001. Among many months it was the lowest. Ontario is a high industrial and automotive province, and the fact is that the blackout was almost good for the automotive industry because it gave them time to adjust their inventory. I'm not saying they did that, but it seems that way to me, my having a little bit of experience there.

    My concern is not just about the fact that the dollar rose quickly, but the rising dollar now brings into effect the fact that in the trade between Canada and the U.S., amongst the auto companies in North America, it becomes a time to shift products. Do you have a concern in that area?

    I think one of the questioners tried to get at when it is that the paths cross, and that how high the Canadian dollar goes up would play a major role in that. For example, in the auto industry we make one million more automobiles than we use. That could now deteriorate as the dollar goes up. Could you comment on that?

    Mr. David Dodge: Yes, this is tricky. Because it's tricky, I'm going to let Paul do most of it.

    Before I turn it to him, though, let me say that it's very important not to put too much weight on any single month's figures or any quarter's figures. These numbers are estimates and they are actually quite volatile. So what you really have to do is look over a period of time.

    But let me turn to Paul on the specific question.

    Mr. Paul Jenkins: The question again is getting at the core, I think, of one of our messages, and that is that in looking at these exchange rate movements you can't just look at the exchange rate in isolation. You have to look at what are the factors behind the exchange rate movement and work through the implications of it.

    If I can, Madam Chair, let me go back post the Asian crises, where we had a set of circumstances very different from what we have today. We had a situation where the U.S. economy was growing very rapidly. We had a very weak domestic economy at that point in time. The movement in our currency at that point provided quite a bit of support. As the Governor said, it provided a little bit of additional support for commodity producers, but it provided a lot of support to facilitate further exports through the manufacturing sector, feeding a very strong U.S. economy. What we have today in Canada is a much stronger domestic economy at a time when the U.S. has been a little bit softer.

    What we are saying is that with the forward-looking perspective of continued growth in the U.S., we are still looking for exports to continue to expand because the global market is expanding. We're seeing a stronger U.S. economy going forward. We're seeing an Asian economy that's growing. So we have a market for our exports that is expanding and we expect exports to grow as those markets expand, but they will grow less rapidly than they would otherwise because of the higher Canadian dollar.

    These are excellent questions, but the point here is the analytics of it do require you to look at all these various factors and then add them up and ask what it means for the Canadian economy overall.

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    Mr. Walt Lastewka: You yourself have said that the uncertainty about the sustainability of U.S. growth beyond the middle of 2004.... In other words, you're being very cautious about projecting anything beyond six months, and since all of our manufacturing industry has to plan further out, we're going to start probably finding ourselves into shifts out and stuff like that in Canada because of the U.S. economy.

    The sales incentives is a good example. They're at a very extreme high, and that's the prelude of the next step. If you can't do the sales on incentives, you end up taking shifts out and our manufacturing goes down.

    Mr. Paul Jenkins: There are risks. There are always uncertainties, but our base case view is that we see the U.S. economy growing by 4% next year.

    The Chair: Thank you very much.

    Now we'll go to Ms. Judy Wasylycia-Leis. The floor is yours, madame.

    Ms. Judy Wasylycia-Leis: Thank you, Madam Chair.

    I want to assure you I'll be asking questions on monetary policy. I just want the parliamentary secretary to know he doesn't have to rush over and interfere with the line of questioning. Just stay calm and cool--

    The Chair: Ms. Wasylycia-Leis, we'll go to questions.

    Ms. Judy Wasylycia-Leis: To David Dodge and Paul Jenkins, my colleagues have said we appreciate your appearing before our committee. I certainly appreciated hearing your statement this morning and trying to understand the whole impact of the current level of the dollar on our economy. I know that the first part of all of this has to be confidence of the markets and confidence of Canadians in your ability, Mr. Dodge, as Governor of the Bank of Canada. Is that correct, that you need the confidence of markets and Canadians to do your job and to be the guardian of monetary policy in Canada today?

    Mr. David Dodge: Certainly, it is absolutely true that everybody has to be confident, and indeed we're accountable for doing what we have said we would do, and that is to try to run monetary policy in such a way that we hit our inflation targets over an 18- to 24-month period. Absolutely.

    Ms. Judy Wasylycia-Leis: Would you not want an opportunity to address any concerns raised about your management abilities in order to maintain that confidence in the market and to maintain your position in terms of guardian of Canada's monetary policy?

    Mr. David Dodge: Certainly I hope people would be confident in my integrity and in my ability to do my job, absolutely.

    Ms. Judy Wasylycia-Leis: I appreciate that answer.

    Since I know you attempted to answer an earlier question and that it was ruled out of order, I won't go down that path directly, but I would like to ask you, based on your comments this morning when you referred many times to the risk that must be assessed in your decisions, how do you plan to re-establish public confidence in your ability to assess those risks, given your reluctance to explain what happened while you were Deputy Minister of Health Canada when millions of dollars were bilked out of Health Canada and you were in charge? I think you--

    Mr. Bryon Wilfert (Oak Ridges, Lib.): On a point of order, Madame Chair.

    The Chair: I can say right now that we have already established a ruling, so I will give you an opportunity to rephrase, Ms. Wasylycia-Leis. Thank you.

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    Ms. Judy Wasylycia-Leis: Fair enough.

    Let me ask this. Wouldn't the appearance of being unwilling to answer a question from the finance committee or an inability to answer a question about your managerial abilities create lack of confidence by Canadians in you, as Governor of the Bank of Canada?

    Mr. David Dodge: Obviously I'm perfectly willing to answer any questions you have about the management of the Bank of Canada.

    Ms. Judy Wasylycia-Leis: Are you worried at all about the appearance of being muzzled by this committee when we ask about questions pertaining to other managerial responsibilities?

    Mr. David Dodge: No. I'm perfectly happy to answer any questions, and indeed this is the committee to ask them, about the way we manage the Bank of Canada. Absolutely.

    Mr. Paul Jenkins: That's what we're here for.

    Ms. Judy Wasylycia-Leis: Fair enough.

    In terms of that general willingness to address concerns about management at the Bank of Canada, what you've done in your other lives previous to this is important. That is why there is so much focus around what is happening in terms of the scandal at Health Canada, because you were the deputy minister and you have a reputation--

    Mr. Bryon Wilfert: Madam Chairman, the last question is out of order. Ms. Wasylycia-Leis knows for a fact that the governor is here on monetary policy, period.

    The Chair: Order. I'll chair the meeting, and I've already ruled on questions.

    An hon. member: Madam Chair, the parliamentary secretary is interrupting--

    Mr. Bryon Wilfert: I can ask for point of order, and if you don't like it you can ask the chair. Otherwise I would suggest you be quiet.

    The Chair: Order, please.

    Ms. Judy Wasylycia-Leis: All right, I'll rephrase it.

    The Chair: We'll take a second just to calm down.

    I have ruled about what is in order under the Standing Orders of the House. These are not my rules, colleagues, these are our rules that are the standing rules of the House. The order of the day is the Monetary Policy Report that was tabled. The governor is here to answer our questions concerning that report. That is the order of the day. Those are the rules of the House and I am simply enforcing the rules of the House in a consistent manner here. I have made my ruling.

    Ms. Wasylycia-Leis, I know you have an ability to ask questions on this report and I look forward to hearing them.

    Ms. Judy Wasylycia-Leis: Yes, thank you, Madam Chair.

    I want to ask generally--and please relax, Bryon--about the matter that relates directly to the issues we're dealing with in terms of the state of address you've given us today and your need to assure the markets that things are in order, that Canadians have confidence in your abilities. Obviously, anything that is in the news around you right now affects that confidence, it affects the credit rating, it affects everything about us. So you have to answer that, or in fact you are causing a situation, an unpredictable situation, a precarious situation, that has to be addressed.

    So I'm asking you about a matter that relates directly to your professional capabilities--to accurately advise us, as members of the finance committee, the Parliament of Canada, and Canadians about the state of affairs with respect to our economy, with respect to fiscal policy and monetary policy. I think you would want to answer this question, or you will in fact face ongoing questions in the media, and there will be doubts that will go on and on, and you will be in a very difficult position. I don't think you want to allow the committee to prevent you from answering such basic questions.

    The Chair: Mr. Dodge, you are free to do what you want. You've heard my ruling before, but this is your floor and your forum, and you are here to talk about monetary policy. I do not, and will not, constrain any witness.

    Mr. David Dodge: In response then, Madam Chair, to the honourable member's question, first let me say that there was no person more upset than I was to learn of allegations against employees in a department I was charged with managing, allegations of fraud and of breach of trust, and that as soon as those allegations surfaced, all of us in the department, on my instructions, took action to do what we could at that time. What was appropriate was (a) to inform the police of the allegations and request an investigation; (b) in respect of parties that were not in the department, outside, to request forensic audits; and (c) to ensure that the department was then functioning appropriately to investigate those allegations.

    Unfortunately, one action, or a series of actions on the part of very few people, I think, can have the effect of poisoning the public's confidence in the public service's ability--or indeed, if it happened at the Bank of Canada, in the Bank of Canada's ability--to do its job. My experience in 25-odd years of public service is that 99.99% of public servants are honest, hard-working, and trying to deliver in the best interests of Canadians. But every once in a while there is an alleged criminal activity, and that is now before the courts.

»  (1720)  

    Ms. Judy Wasylycia-Leis: I appreciate that answer; however, I think we are dealing with the question of public confidence in you as the Governor of the Bank of Canada. The public is wondering how you, as Deputy Minister of Health, could have been sitting on top of a volcano and not feel some heat, not know that your assistant deputy minister was absconding with all kinds of public money and engaging in corrupt, fraudulent activities.

    The Chair: Ms. Wasylycia-Leis, that question is out of order to the Governor of the Bank of Canada on the order of the day, very definitely, and I think you know that.

    Your time is up, actually, and I will move to the next questioner, who is Mr. Wilfert, and I think Mr. Normand is wishing to share that time

    Mr. Bryon Wilfert: Thank you, Madam Chairman.

    I realize the NDP's strong suit is not monetary policy, so I'm not too surprised. However, I would suggest, Madam Chairman, that the rise of the Canadian dollar is probably also because of the work of the Minister of Finance and probably because of the coming of the next Prime Minister, which is probably why the markets have such confidence in what's going on here.

    However, I'd like to talk about the real issues dealing with consumer debt, and the fact, Governor, that consumer debt presently is at very high levels, probably record levels, and obviously mortgage debt is up, and consumer credit is up.

    First of all, I'd like to ask you, what are the bank's thoughts in terms of the rise in consumer debt and consumer insolvency at this point? This issue is obviously of concern, and of concern out there in Canada generally.

    Mr. David Dodge: Let's be quite clear, first of all, that the real issue with debt is the ability to service debt. And indeed, the percentage of household income that is going to the servicing of debt, whether that be mortgage debt or consumer debt, is at the moment actually quite low. It's well below the average of the last number of years.

    So the real issue and why one would be concerned about the rise in the stock of that debt is really for two reasons. First, a lot of it's against housing. About 80% of it's against housing.

»  (1725)  

    Mr. Bryon Wilfert: That's where I was going, yes.

    Mr. David Dodge: And if there were a real concern that indeed the price of housing was likely to collapse, that we were into some sort of housing bubble....

    Now, we actually have done a lot of analysis on this, and certainly in Canada there is absolutely no indication that indeed this is the case. House-price-to-income ratios are not by any means abnormally high. Secondly, in a number of cities we're only now getting back to the real price of housing, to what it was in the 1980s. So the Canadian situation on housing is quite different from what you find in much of the United States, and certainly very different from that in the U.K. and Australia. While they may not--and we certainly don't think they should--continue to go up at the rate they have for the last two years, we think there is good reason to believe that house prices, in level terms, have not reached levels where we are concerned about a bubble.

    On the consumer side and to a certain extent, of course, on the mortgage side as well, the other concern is this. If there were to be a very large jump in interest rates, then this would dramatically increase the monthly servicing costs of the debt that is out there. In fact, it would take an extraordinarily large jump in interest rates to do that.

    So within the normal bounds of what one might contemplate, again we don't see a problem down the road in consumers' ability to carry the amount of debt. So the summary is that after really quite extensive analysis, we are not issuing warning signs.

    Mr. Bryon Wilfert: I'm glad to hear that, because I know the servicing costs on the growing debt are down, but concerns that.... This economy has been quite resilient, given the fact that we've had all of the issues that you raised in your opening remarks, but if in fact further shocks occurred to the system and they had an impact on unemployment issues, obviously, or if interest rates suddenly started to spike, then I think we would be in a very precarious situation, or certainly a difficult situation.

    Certainly I wanted to get your thoughts on the amount of consumer debt, and you have certainly addressed some of those issues, which I appreciate.

    Madam Chairman, I realize I'm sharing my time with my friend here, so I'll turn it over to Mr. Normand, if I might.

    The Chair: Yes, go ahead, sir. You have just under four and a half minutes.

[Translation]

    Hon. Gilbert Normand (Bellechasse—Etchemins—Montmagny—L'Islet, Lib.): I have two short questions to ask you.

    First, your confidence seems to be based on the recovery of the US economy. However, this year, the United States will have a deficit of $380 billion. This is equivalent to a deficit of $40 billion in Canada. The US trade deficit has considerably increased with many countries. For example, Washington presently has a trade deficit of $100 billion with China. China is robbing them of part of their international markets, mainly in Asia.

    The United States intended to use Iraqi oil to finance their war in Iraq but they are unable to do so. Moreover, their debt is much larger than they thought it would be. Don't you think that the US recovery could be short-lived? This is my first question.

    Second, the Canadian dollar went from 63¢ or 64¢ in April to 76¢. Surely, many foreign exchange dealers made a lot of money. Can you identify those who benefited from the rise of the Canadian dollar?

    Mr. David Dodge: I will answer the first question, and then I will let my colleague answer the second.

    No doubt there's a structural deficit in the US and the federal government will have to deal with this issue, maybe not this year but in the future. When the government is ready to take steps to reduce this structural deficit, there will have to be enough demand at that time to maintain the US economy. This demand may come from other countries if the growth rate outside North America is very strong. This demand can also come from the business sector, from companies that invest more or from households, although there is less flexibility in the household sector. It may not be too difficult to deal with this situation. As we did in Canada, Americans will have to face their fiscal situation in the future.

    Paul, would you please answer the second question?

»  (1730)  

    Mr. Paul Jenkins: It is very difficult to analyze sectoral effects of the appreciation of the Canadian dollar. It will no doubt affect producers whose products include a substantial percentage of imports. It is therefore important to analyze the composition of each product in order to answer your question.

    Overall, profits are high in the economy. For example, their level as a percentage of GDP is almost at a record high. Generally, the level of profits of Canadian companies has recently been very high.

    Hon. Gilbert Normand: Can you determine whether the decline of the US economy has encouraged Canadian companies to seek new markets in other countries? I know that in my riding, we have seen a lot of people from Italy, Germany and France in the last few months. That was not the case before because companies didn't feel they had to open up more markets. Many businesses have now started to look for other markets in Europe and even Asia.

    Can you detect any changes in the trade balance? Did our trade with United States decrease while our trade with other countries increased?

    Mr. Paul Jenkins: It is difficult to analyze data on the movement of exchange rates because this situation is very recent. It is clear however that price movements due to exchange rates represent very large amounts of money. I would imagine that in the future, Canadian businesses with initiative will find other markets. Presently, as I mentioned, Asia, and particularly China, represents a very strong market with huge future potential.

[English]

    The Chair: Thank you very much.

    That has completed our round. We're about eight minutes from the bell. With your consensus, I have two people who want to ask one question each, and we have time for that.

    So, Mr. Jaffer, I am going to give you the floor, and then Mr. Loubier, for very short questions and very short answers. Then we'll wrap up our meeting.

    Mr. Rahim Jaffer (Edmonton—Strathcona, Canadian Alliance): Thank you. I have a very quick question.

    You mentioned that the spreads are not the main factor driving the greenback down or the loonie up, that there are sometimes more fundamental issues, such as the overvalued dollar. This implies to me that the loonie's rise may be sustained even when spreads narrow.

    Do you believe the loonie will be sustained in the mid-70¢ range over the next little while?

    Mr. David Dodge: We don't know. We just don't know how all these factors that are driving currencies at the moment will work out.

    What I would say and what is critical is that the whole of the international trading system has to make the adjustments, and as you know, at the moment, we in North America--particularly the U.S., but it's true for us as well--have really quite a large deficit on current account vis-à-vis non-Japan Asia. It will be very important going forward that non-Japan Asia makes adjustments or at least allows the adjustments to take place to deal in part with this.

    There are many ways those adjustments can take place. One is through exchange rates. Another is that they could run very significantly higher rates of inflation than we do in North America. A third would be to open up their capital markets in a much freer way.

    There are a number of ways to have the adjustment, but what cannot happen--and the world will be in difficulty--is if in fact there aren't adjustments to allow re-equilibration of that system. It will simply have to come.

    Of course, the most dangerous of all possible adjustments would be that the rest of the world gets driven to trade restrictions. That's certainly not something we would like to see.

»  (1735)  

    The Chair: Thank you.

[Translation]

    Monsieur Loubier.

    Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ): Thank you very much, Madame Chair, for giving me the opportunity to ask a question.

    Welcome, Mr. Dodge. I am very pleased to meet you again. I have two questions to ask you.

    In the past, we didn't necessarily talk about the level of the Canadian dollar but rather about its volatility. This is what hurts industry most. Is there anything you can do to ensure that the Canadian dollar will be less volatile in the future? Are you working on a policy that will help reduce the harm done to the industrial sector?

    Second, I want to ask you a question that everyone would like to ask without having an opportunity to do so. You were deputy minister of Finance for many years. This is when we met for the first time. You were then very close to the Finance Minister, Mr. Martin. Many business people in particular asked me the same question. Can you guarantee that in the future, when Mr. Martin is Prime Minister, the monetary policy of the Bank of Canada will be totally independent from political influence, which is essential if it is to be effective?

    Mr. David Dodge: I will start with the first question.

    It is true that financial markets, including the bond market, the exchange market and even the securities market, have been very volatile in the past two or three years. I believe this is an aspect of markets that we will have to learn to live with from now on, because of the removal of obstacles that prevented transactions at a fair price from being made on the market. So we will have to live with that. As I said earlier, companies have hedge mechanisms to minimize the impact of this volatility.

    Your second question was about our independence. I have a seven-year mandate as governor of the Bank of Canada and I intend to stay for seven years. According to Canadian legislation, the Bank of Canada is responsible for monetary policy. The six members of the board make decisions on Canada's monetary policy. We will proudly and forcefully defend our independence.

»  (1740)  

    Mr. Yvan Loubier: Thank you.

[English]

    The Chair: On behalf of all the committee members, we very much appreciate your attendance to go over the Monetary Policy Report. Thank you for your testimony and for answering our questions here today.

    We are adjourned until tomorrow morning.