:
Thank you very much, Chair. It's a pleasure to be here. I appreciate the opportunity for Tiff and me to be here to share with you some of the highlights from our recent economic outlook.
The bank, of course, aims to communicate openly and effectively so that Canadians know how we are achieving our mandate to promote the economic and financial welfare of the country. One of the best ways that we do this is by appearing before this committee and answering your questions.
I'll briefly discuss the bank's outlook for inflation, and then move on to our outlook for global and Canadian economic growth. I'll touch on some recent bank research and finish with trends that we are observing.
Inflation in Canada remains low. We expect core inflation to stay well below our 2% target this year, returning to target over the next two years. Total CPI inflation, however, will move closer to the target in the next few quarters due to temporary factors. Let me take a moment to explain.
We expect economic slack and heightened retail competition to keep core inflation below target until early 2016. At the same time, higher consumer energy prices and a lower Canadian dollar will contribute to total CPI inflation moving up.
Total CPI inflation will remain fairly close to target throughout our projection period. This is even as upward pressure from energy prices dissipates, because the impact of retail competition will gradually fade and excess capacity will be absorbed. When this happens, core inflation will gradually make its way up to 2% and catch up with total CPI inflation from below.
[Translation]
Let’s now move to our economic outlook.
Global growth should gather steam in the coming three years as the headwinds that have dampened growth dissipate.
Overall, we see global economic growth picking up to 3.3% in 2014, moving to 3.7% in 2015 and 2016. In Canada, real GDP growth is expected to average about 2.5% in 2014 and 2015 before easing to around 2%.
These numbers are essentially in line with the Bank of Canada’s January outlook, but they don't reflect the actual quality of the outlook, which has changed in meaningful ways, especially for emerging-market economies and Europe.
Growth in Europe is modest, but inflation remains too low, and hopeful signs of recovery might be stalled by the Russia-Ukraine situation.
China and other emerging economies are showing solid growth, although there are some growing concerns about financial vulnerabilities—specifically, increased market volatility in response to political uncertainty.
The economic recovery in the United States, however, is proceeding as expected, despite recent softer results largely due to unusual weather. In fact, private demand could turn out to be stronger than we had thought.
[English]
The issues Canada's economy faces are not unfamiliar to you. Competitiveness challenges continue to weigh down our export sector's ability to benefit from stronger growth abroad.
Given the importance of the export sector to an open economy such as ours and given the growing wedge between Canada's exports and foreign demand, the bank has deepened its analysis of the export sector, specifically non-energy exports.
By breaking down non-energy exports into a large number of subsectors, interesting facts and new trends emerge. To start, we're discovering that there are some subsectors, such as machinery and equipment, building materials, commercial services, and aircraft and parts, that are in line with their fundamentals, or in some cases doing even better than their respective U.S. benchmarks. This suggests that as the U.S. recovery gathers momentum and becomes more broadly based, many of our exports will benefit. The lower Canadian dollar will also contribute to the recovery of these subsectors.
Other subsectors, including auto and truck makers, food and beverage suppliers, and chemicals, will also be helped by a lower Canadian dollar, but this will be to a lesser extent since they are experiencing greater competitiveness challenges. Their recovery will be slower.
The big picture tells us to expect a gradual convergence between the growth rate of Canada's exports and that of the U.S. economy. This more granular research indicates that the wedge between exports and foreign demand will endure, and make no mistake: this wedge is real and it is large.
The good news is that we now know more precisely just where it is, with about half of our non-energy exports. The bad news is that these subsectors are doing worse individually than we thought before. This deeper understanding of our export sector is valuable, but it does not make us any less concerned about the challenges ahead.
Looking forward, we continue to believe that rising global demand for Canadian goods and services, along with the assumed high level of oil prices, will stimulate business investment in Canada and help shift the economy to a more sustainable growth track.
[Translation]
We continue to expect a soft landing for the housing market and Canada's household debt-to-income ratio to stabilize. Nevertheless, the imbalances in the housing sector remain elevated and would pose a significant risk should economic conditions deteriorate.
We are observing, anecdotally at least, an increased awareness of this risk. Consumers are showing responsibility; for example, homebuyers who opt to buy less house than they qualify for so they don't find themselves overextended if interest rates rise.
Banks, as well, are underwriting loans more carefully, ensuring that people can service their debts if rates go up. So, while the risk could be significant, we are comfortable that it is not outsized.
[English]
To sum up, the bank continues to see a gradual strengthening in the fundamental drivers of growth and inflation in Canada, but this view depends largely on the projected upturn in exports and investment. There is a growing consensus that when we do get home, interest rates will still be lower than we were accustomed to in the past. This is because of our shifting demographics and further, after such a long period at such unusually low levels, interest rates won't need to move as much to have the same impact on the economy.
With underlying inflation expected to remain below target for some time, the downside risks to inflation are important, as are the risks associated with household imbalances. The bank judges that the balance of these risks remains within the zone for which the current stance of monetary policy is appropriate, and as you know, we decided on April 16 to maintain the target for the overnight rate at 1.0%. The timing and direction of the next change to policy rates will depend on how new information influences this balance of risks.
Just before Tiff and I respond to your questions, I would like to take one more moment to say a few words about the man sitting next to me.
Tiff's contributions at the bank started long ago as a new recruit with a fresh master's degree in hand. I hired him then. His contributions throughout his career have been significant. At the bank, we'll miss him for his intellect and management skills, but we'll also miss a great friend to many, myself included. We can rest assured that Tiff's contributions to the financial welfare of Canada will continue as the dean of the Rotman School of Management, where he will be busy ensuring that the next generation of economists and business leaders are prepared to take Canada into a prosperous future.
Tiff did such a great job as senior deputy governor that to find his replacement we've had to split his position and look for two people to fill his shoes. I'm pleased to report that we will be in safe hands.
I look forward to introducing you to Carolyn Wilkins, our incoming senior deputy governor. Carolyn will oversee the bank's strategic planning and operations and she will share responsibility for the conduct of monetary policy.
I also look forward to working with our new chief operating officer, Filipe Dinis, who will be responsible for managing all of the bank's administrative functions.
With that, Tiff and I are happy to take your questions.
:
Yes, of course. I would call the member's attention to a background paper which we published on our website last week. It's a four- or five-page piece which summarizes this, so I'll attempt to bring out the highlights for you now.
The methodology is not very complex. It's that in our macro models we use to model the entire economy, exports are modelled as a single category or in resources and non-resources. There are still quite a lot of things that are inside the non-resource bucket.
What we've observed over the last 18 months to two years is a growing wedge between the fundamental drivers of our non-resource exports and how many exports were actually selling. Right now, we're at about $35 billion to $40 billion fewer exports than our models would have predicted at this time.
Looking beneath this into the 31 subsectors, we're able to find a number of sectors, approximately half, which in fact have tracked their drivers quite well. That means the error term that we're concerned about is more restrictive to a smaller group, although it is still about half of our exports.
One of the ones you've mentioned is the passenger cars and light trucks. It has in fact matched reasonably well with growth and demand in the United States, not too surprisingly given the integration of the North American auto market. However, it has not historically been sensitive to exchange rate movements and as well, what we know is that the new investments that have gone into that sector in the last two or three years have primarily been outside of Canada. We reach from that the conclusion that although that sector is doing all right at this stage, we are not expecting it to contribute to a major closure of this gap that we've seen emerging.
The sectors that we believe are going to lead the way are mostly tied to U.S. investment activity, which has been relatively quiet given the stage we're at in the cycle. The U.S. recovery has been primarily driven by consumer demand and a rebound in the housing sector. Companies have not really started in full bore to invest in behind that.
We believe, in fact we stated this belief about six months ago, that as the U.S. recovery broadened into the rest of its sectors including investment and government spending—not surprisingly, state and local governments have been very tight budget-wise for some time—those constraints are easing up and so you're getting almost all cylinders beginning to fire. As that happens, we will see a stronger export recovery in Canada for many of the sectors that have lagged.
:
Yes. The competitiveness equation is something from a company perspective that includes a large number of things, but the economists usually narrow it down to the relative costs of production, and what goes into that mix is any movement in the exchange rate. That would determine the price that you're able to sell, let's say, to an American buyer.
The bigger picture of this story, as we discussed in a speech last week, is that the rise in Canada's terms of trade that has happened in the last five to six years has in fact been an important gift to Canada. It's primarily resource prices that are high, oil in particular. When foreigners are spending more money on the things we're exporting, that's just more money that gets spent in Canada.
One of the consequences of this is that it tends to carry with it a higher currency. I liken that to walking your dog on one of those stretchy leashes. The terms of trade are the owner, and the dog is the exchange rate, and it zigzags around it, but they eventually leave the park together. The footprints look like an economist's chart, which means.... So you get the idea. They tend to be related over the long term.
The fact that our terms of trade today are about 25% higher than they were on average in the 1990s is a very significant development. It means approximately 7% more income in aggregate for Canada as a whole. This is pretty significant. One of the consequences of that, and one of the ways that gets spread around, is that the Canadian dollar goes up with it.
If you're a manufacturer in that mix, you have two things happening. The U.S. had this massive downturn, so you lost perhaps 40% or 50% of your export orders, on top of which the Canadian dollar drifted up over the course of that recession, because the price of oil was still rising. Those two things made it very challenging for that sector. As the U.S. cycle comes back, that's half the problem. The other half remains for our companies that over a long term have not been able to overcome those conditions with stronger productivity growth or other cost-saving measures.
That's why we say that about half of our export sector is labouring under that deterioration in competitiveness, and it for sure will take longer for them to gradually rebuild that, possibly through finding new customers in other growing markets, in Asia and so on.
:
It's not just the bank that has been mis-forecasting these things. The economy has underperformed in these two respects in every economic model that I know of. When we ask ourselves why that is happening, it is of course our biggest research question. We look into things such as we discussed before, the animal spirits phenomenon, which is how much uncertainty needs to go away before a company will make its investment.
Given what we've been through over these past five years.... Many companies have disappeared; some 9,000 manufacturing firms have disappeared. The ones that survived may have downsized through the course of that period. We're asking when a company like that will be ready to re-expand to meet the new demands coming, let's say, from the United States or some foreign market.
The answer is they need to be more sure today, having been through all of that, than they needed to be five or ten years ago in a similar situation. This is that confidence thing, which is very hard to put your finger on, yet you know intuitively that it's true. You can talk to real people, and they'll tell you that it's true.
Our models don't capture things like that; it's as simple as that. On the export side, there are things now that, as I said, we are able to look at more deeply. We understand which sectors—we understand that they've had long-term problems maintaining their competitiveness—have lost market share in the U.S.
We can point to those and say that now we understand where it is, do we really understand what it is that is going to turn it around? That is what our model suggests will happen, but in the real world, it's real people making real decisions, so historical behaviour has not been a great guide to what we're seeing. And that is an excuse for how models work.
:
Thank you very much, Mr. Chair.
I would like to talk about the models used by the Bank of Canada. There have been many references to animal spirits in difficult and uncertain times.
[English]
Back in Montreal I think you actually referred to these animal spirits in that sense, when you talked about.... I will find it eventually, but you referred to the difficulty and the models the bank is using are basically raising more questions than answers, because those times are difficult to predict and forecast. This is basically the same analogy.
You also mentioned, as a metaphor, that the dog is sometimes going in many directions while you're trying to lead it. On the other hand, after a while, you know your dog and you start to see a pattern and you can actually see in which direction it goes.
In terms of modelling, after what we've seen in the last three, four, five years, and the experience we had in previous recessions or previous chaotic times, isn't it possible eventually to adapt our models to that reality, to those animal spirits eventually? I do not say perfectly, because there is still a large part that is unknown, but eventually we'll need to include them to have a better idea of what to expect during such difficult times.
:
Thank you very much, Mr. Chair.
I apologize to our guests. We're trying to cram in a little committee business before we get to you. I will speak as briefly as I can.
We've looked at this report in terms of the approach we are taking to the study of the recent Conservative omnibus bill. It will come as no surprise to my Conservative colleagues that, under this Conservative motion, the challenge the committee has is to divide the bill, in name only, so that committees around Parliament will then do a nominal study of various aspects, because the bill is so complex. However, none of those committees will be allowed to make amendments to the bill based on the witness testimony they hear. As you know, Mr. Chair, doing that is the job of parliamentarians, and we don't have the power to allow other committees to do that.
Under this process, they will then kick it back to this committee and, if history is any teacher, the committee will then take a rapid-fire approach to voting on amendments to a complicated bill when almost none of the voting committee members around this table will have seen the witnesses and heard the testimony. This is a bad way to do policy. This is a bad way for the government to conduct itself, and this has led to problems in the past. One would think that the best teacher is experience. The government has been through this before with these monstrous bills, and has taken this approach as a half measure due to the complexity and the massive non-financial elements of this particular piece of legislation.
Conservatives, I remember fondly, used to rail against this technique when in opposition and have since put the technique on steroids and made it common practice. It shouldn't be. It is an uncommon thing to act this way.
We have a massive tax treaty buried within this bill, the so-called FATCA, which may expose as many as one million Canadians. There are measures on temporary foreign workers. There are measures on reducing hospital fees.
There are measures within this legislation that deserve the respect we as parliamentarians can give them by doing our job. That's why people elect us and send us here.
With that, Mr. Chair, we argue that if a compromise can't be found on the way this legislation has been drawn up, the link between the work of committees and MPs will be broken. Committees were created in the first place to study legislation, hear witnesses, and affect legislation through amendments that we think are viable. The past has also taught us that on these omnibus bills—and I can't recall a single amendment from the opposition having been adopted by the government through hundreds and hundreds of pages of omnibus legislation—the government has refused virtually every single amendment based on expert witnesses. There is all of that as well as the experience that the government, in this omnibus bill, has had to fix measures from the last omnibus bill, which had in it measures to fix mistakes from the previous omnibus bill, so obviously the model has its shortcomings.
I'd implore the government to reconsider this approach. It doesn't work for them, and it doesn't work for the opposition, and it certainly doesn't work for the Canadian public we are meant to serve.
With that, in recognition of our guests being here, Mr. Chair, I, for my part at least, don't want to prolong this conversation. I don't know if other colleagues will have things to say, but this motion, as presented by my Conservative colleagues, does much of nothing other than provide confusion in a parliamentary process that's vital over a piece of legislation that is some 300 pages in length and that affects many aspects of Canadian law.
I suspect the next omnibus bill will have to fix mistakes that are in this one. What a way to run a country. It's no good, and I wish the Conservatives would hearken back to the position they held when they were in opposition and they had so much distaste for this type of technique.
I'll leave it at that, Mr. Chair.
No apology is required. You know that I am very familiar with committee business. It's still music to my ears, and it's a very good introduction actually.
Thank you again for the invitation.
I am here with my colleagues: Mostafa Askari, who is the assistant PBO; Peter Weltman, who is the assistant PBO as well; and with the authors of this fabulous report, Scott, Randall, and Helen.
We are pleased to be here to present the PBO's economic and fiscal outlook, which we released yesterday. Since our last appearance before your committee, the PBO team has published 15 reports, and we continue to be very attentive to Parliament's needs that fall under our mandate.
Regarding the economic outlook, global economic activity picked up in the second half of 2013 and is expected to continue to improve in 2014 and 2015 as more modest fiscal tightening is complemented by still highly accommodative monetary policy in advanced economies. That said, downside risks remain with risk related to low inflation in advanced economies coming to the fore more recently.
In the United States, growth in the second half of 2013 was much stronger than expected in October 2013. Despite the stronger than expected growth, PBO has left its outlook for U.S. growth in 2014 unchanged at 2.7%, in large part due to weather-related weakness in the first quarter of the year. Growth over the remainder of the projection is broadly unchanged from the October 2013 economic and fiscal outlook update.
Based on the Bank of Canada's commodity price index, the PBO outlook for commodity prices is modestly stronger than the October 2013 update projection. That said, PBO's outlook for the price index remains higher over the projection than futures prices would suggest, but below the no-change projection assumed by the Bank of Canada in its April 2014 monetary policy report. These developments have led PBO to revise upwards the outlook for the Canadian economy relative to its October 2013 economic fiscal outlook.
Currently, PBO projects Canadian real GDP to grow by 2.1% this year, 2.7% next year, and 2.5% in 2016.
As the economy reaches its potential level of economic activity, PBO projects real GDP growth to be below 2% annually in 2017 and 2018. PBO's outlook incorporates both stimulative and restraint measures introduced beginning in budget 2012. PBO projects that the level of real GDP will be 0.5% lower in 2016 than would have been the case in the absence of these measures.
Further, this economic impact translates into about 46,000 fewer jobs being created by 2016. Just to be clear, it doesn't mean a decline of 46,000 jobs, but in the absence of these restraints, employment would have been higher by 46,000 jobs.
PBO's outlook for nominal GDP, the broadest measure of the government's tax base, is, on average, $17 billion lower than the projection based on average private sector forecasts. PBO judges that the balance of risk to the private sector outlook for nominal GDP is tilted to the downside, likely reflecting larger impacts from government spending reduction, as well as differences in views on commodity prices and their impacts on real GDP growth and GDP inflation.
However, based on its projection of nominal GDP, PBO judges that the downside risk to the private sector outlook for nominal GDP is broadly in line with the government's $20 billion annual adjustment for risk.
I will continue in French.
[Translation]
I will now talk about the fiscal outlook.
Prospects for budgetary surpluses are higher over the outlook than in PBO's October 2013 update, due to a combination of an improved economic outlook and measures in the Update of Economic and Fiscal Projections 2014 and budget 2014, in particular further planned restraint in direct program expenses.
PBO estimates that the deficit will be $11.6 billion (0.6% of GDP) in 2013-14 and will return to a surplus in 2015-16 ($7.8 billion), maintaining a surplus of $8.6 billion (0.4% of GDP on average) over the remainder of the outlook.
PBO estimates that the likelihood of achieving a budgetary balance or better is approximately 50% in 2014-15, 70% in 2015-16, 60% in 2017-18 and 65% in 2018-19.
While PBO projects budget surpluses over the medium term, these are primarily attributable to the economy growing faster than trend, rather than revenues being structurally higher than expenses. Therefore, there is limited room to implement new policies that reduce tax revenues or increase spending without re-introducing structural deficits. That said, PBO has identified several risks to the fiscal outlook.
First, the PBO projection of the commodity price index assumes that, after two years, real commodity prices will remain broadly unchanged. In contrast, the projection using energy and non-energy futures prices suggests that the commodity price index will decline over the projection. Were this to occur, the level of nominal GDP would be $26 billion below PBO's baseline projection in 2018.
Second, the discretion granted to the Governor in Council for setting employment insurance rates introduces considerable uncertainty in the outlook for revenues. Were the government to set rates to balance revenues with forecast expenditures, it could decrease the revenue outlook and the budget surplus by $2.2 billion in 2015-16 and $2.8 billion in 2016-17.
Third, PBO currently takes Finance Canada's projection for direct program expenses as given, as the government has refused to release the data required to assess if the current restraint is sustainable and to allow PBO to do its own projection of direct program expenses.
Such a prolonged period of suppressed direct program expenses growth has never occurred in the history of the modern public accounts. Historically, a year of reductions is typically followed by a year of increases in direct program expenses of around 6.4%. As a result, direct program expenses may face significant pressures following the 2014-15 cuts, as the most significant year-over-year reduction in direct program expenses is set for 2014-15. Were the typical rebound from a period of direct program expenses reductions to occur in 2014-15 or 2015-16, it would eliminate the projected surplus in 2015-16.
I and my colleagues will be happy to respond to questions you may have regarding our economic and fiscal outlook or any other relevant matter.
Thank you, Mr. Chair.
:
Welcome to our witnesses.
It's an interesting discussion. As you know, the Parliamentary Budget Officer's role is a complex and difficult one that is made more difficult, I suspect, because of requests that come to you from MPs and from political parties and for various other reasons. Those reasons can be political reasons. They can be anything, but they have an economic base.
I think it deserves to be mentioned that CRA is responsible under the Income Tax Act and under the Excise Tax Act. CRA members and officials are held criminally responsible for breaking confidentiality. That's not something to be taken lightly. It's certainly not something that is easy to deal with when you're dealing with personal information.
The other thing is the civic question on the tax gap that most G-20 countries don't follow up on, because you can't get good information on it, mainly because of confidentiality and the difficulty of handling it. I'm not asking for an answer on it, but I'm simply looking at your role and the difficulty of that role when you're trying to respond to questions with a limited budget. Even though you have a well-qualified team and a limited team, it's not an easy role.
I want to pick up on a comment that Mr. Askari made on the exports since 2000, because according to your information, really the exports since 2000 have not made a contribution to the Canadian economy. I'd like to explore that a little bit deeper. I don't think that's exactly what you meant, because I suspect if we took away the exports.... I mean, we are an export-driven economy and very much of that is commodity driven. If we took those exports out of the Canadian economy, I think we'd leave quite a gap there. Using rough numbers, 60% or 65% of our economy is export based. Of that, 72% or 73% is based on trading with the United States. I can't fathom that since 2000 it has really not made a contribution to the economy.
I'm going to give you a chance to explore that a little deeper.