FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, November 27, 1997

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[English]

[Editor's Note: Technical Difficulty]

Mr. Gordon Thiessen (Governor of the Bank of Canada): ...to us and there are also potential effects on our other trading partners to be taken into account. These developments are probably reflected to some extent in the softening of some global commodity prices that are of importance for Canada.

[Translation]

Taking all these influences into account our judgement is that the impact on Canada does not, at this stage, look likely to be large. But we are sensitive to the fact that some industries and regions will be affected more than others.

Moreover, a good deal of uncertainty remains about likely developments in Asia. Let me reassure you that we are monitoring the situation very closely.

[English]

We're following the events in Asia and their likely impact on Canada very closely. I must say, even with the uncertainty about Asia, the suggestion that one hears these days of a risk of world-wide deflation strikes me as being far too pessimistic. While developments in Asia will lower somewhat the pace of economic expansion in the world, the largest economy in the world, the United States, is in fact pressing the limits of its capacity and is much more at risk of having upward pressure on its inflation rate than the reverse. Certainly, for Canada, it is the United States economy that is by far the most important. Moreover, the outlook for the economies in Europe and Mexico have been improving recently.

I'd now like to turn to Canadian monetary policy. I don't propose to summarize what we say in our report about likely developments over the next six months. I believe our assessment is reasonably clear both in the report and in the summary.

[Translation]

I would like to say a few words about our focus on keeping inflation low and what we are trying to accomplish with this objective. To see the benefits of low and stable inflation, we need only look to the United States these days.

That country is experiencing an improving rate of productivity growth, a stable and prolonged economic expansion and the best employment performance in decades. And that is what low inflation should help to deliver.

[English]

In Canada the economic cycle has been running a few years behind that of the United States because of the restructuring in our private sector and because of the need for fiscal restraint. However, our economy is now beginning to gain momentum and we are starting to see improvements in productivity and employment. For these improvements to continue, the crucial requirement will be to keep our expansion on a non-inflationary and therefore sustainable path.

What we've learned at considerable cost over the past 25 years is that a willingness to live with increased inflation inevitably sets the economy on a course of boom and bust, and what you may think you're gaining in the boom you more than lose in the bust.

[Translation]

I would also like to underline the fact that reductions in unemployment lag well behind the expansion in the economy. That is why a prolonged expansion is also important for achieving sustained reductions in unemployment.

[English]

A prolonged economic expansion is important if we're going to get sustainable, sustained declines in unemployment.

Finally, Mr. Chairman, I just want to provide a word of explanation about our increase in the bank rate yesterday. That action was in response to the recent persistent weakness of the Canadian dollar. With low interest rates, a low value for the Canadian dollar and rapid money supply growth, monetary conditions in Canada have been highly stimulative for some time.

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The economy has gained momentum this year and while it is by no means overheated, it does not need still more stimulus coming from a further weakness in our currency. Perhaps even more important is that this decline in the dollar potentially puts at risk our ability to have medium- and long-term interest rates below those in the United States.

Lower interest rates here are only possible if there is an expectation that the Canadian dollar is going to rise in value. Having low-, medium- and long-term rates is particularly important for our economy because of the role these rates play in the financing of housing, new technology, machinery and equipment, and production capacity more generally.

That's all I'd like to say by way of introduction.

The Chairman (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): Thank you very much, Mr. Thiessen.

We'll now proceed to the question-and-answer session. Mr. Ritz.

Mr. Gerry Ritz (Battlefords—Lloydminster, Ref.): I thank you for your remarks. We've had pretty decent economic growth in this country for the last three or four years, but when you say prolonged economic expansion is desired, what kind of timeframe do you have in mind?

Mr. Gordon Thiessen: I'd like to think very prolonged, over a number of years.

I don't want to suggest we have somehow reached a stage where we don't have to worry about business cycles any more, but I do think the kind of situation we saw in the last 25 years of inflationary booms followed by deep recessions is something we can avoid in the future if we keep our inflation rate low.

If that is true, I think we have the possibility of many years of expansion. You cannot be sure, because events arise in the rest of the world that can have an impact, but if nothing dramatic happens in the rest of the world, I think we can see quite a number of years of expansion.

Mr. Gerry Ritz: So you're saying that effects from outside the country can be as detrimental as anything we do from within.

Mr. Gordon Thiessen: Almost certainly, but of course what really matters for us is what happens in the United States. As long as that American economy continues to expand in a kind of non-inflationary and stable way, that is just extremely good news for Canada.

[Translation]

Mr. Gilles-A. Perron (Saint-Eustache—Sainte-Thérèse, BQ): We've had rather thorough discussions on the inflation rate, in this very room, during the Finance Committee hearings. Most experts said that the Canadian rate should be around 3%. Your position is to maintain it lower than that. Explain to me why we must have an inflation rate approximately equal to that of the United States, or around 3%.

Mr. Gordon Thiessen: The US inflation rate is now between 2% and 2.5%. But there is a mistake in the way they calculate the rate. And when you take that mistake into account the inflation rate in the United States is closer to 1.2%, which is very close to our own rates here, in Canada. At this time there is indeed no difference between our inflation rate in Canada and that of the United States.

But I must say that we are aiming for a rate of between 1% and 3%. I don't believe that most experts feel that 3% would be the best rate of inflation. I don't think so. I think that you need a low and stable inflation rate and that 3% is still fairly high.

[English]

The Chairman: Mr. Nystrom.

Mr. Lorne Nystrom (Qu'Appelle, NDP): I want to welcome Mr. Thiessen to the committee. I'm sorry I was a bit late. I had to stay in the House on Bill C-2, the Canada Pension Plan.

I want to ask you a couple of questions. The bank rate went up yesterday and I gather the dollar is down again today. It went up yesterday and dropped again today. Can you can elaborate on why that happened? Is that a signal that maybe the hike in the short-term rate was not necessary in terms of your overall plan?

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Mr. Gordon Thiessen: I don't believe that it suggests the increase in the bank rate yesterday wasn't necessary, but there is no doubt that the currency has been weak and is relatively weak again today.

But these are rather unsettled circumstances that we are seeing around the world. And in those circumstances, I think it's very difficult indeed for investors, other people in markets, to make a judgment about what all of this implies for Canada, the Canadian dollar, and the level of commodity prices in Canada.

So I think that in these circumstances you're going to have movements in our currency that I believe don't reflect the underlying circumstances. This reflects a lot of uncertainty and some rather unsettled conditions.

I continue to believe that the underlying circumstances for both the Canadian economy and the Canadian dollar are positive ones. But you know, on any given day in any given week, even longer than that, in a world where international markets are unsettled, you can have this kind of pressure we're seeing.

Mr. Lorne Nystrom: Could I ask you a bit more about what the minister described as anticipated inflationary pressures? Our inflation rate is actually very low historically. It's at 1.5%. It was actually down a bit in the last month.

The concern I and a lot of people have is that if one starts to increase interest rates, it starts to dampen off the economy in terms of job creation. Unemployment is officially at 9%. There's lots of hidden unemployment and welfare out there. A lot of aboriginal people aren't even counted in the statistics, and so on.

I'm just wondering if you're not a little bit too sensitive to inflationary pressures and running the risk of slowing down the economy? People who are unemployed are suffering. I'm sure that with your background you're fully aware of that.

I'm wondering why you are so sensitive to inflation being 1.5%. Don't you look at the other side? The other side is part of your mandate as well. Yet at one time, if we had seen 1.5% inflation, we would have been celebrating in the street.

Mr. Gordon Thiessen: First of all, I don't think that there is a kind of trade-off. By settling for a higher inflation rate, you don't get sustained improvements in employment and reductions in unemployment.

But I must tell you that we do not see inflation pressures around the corner. The reason we've been acting is not because we think there is inflation coming around the corner that we need to respond to. Really, the situation we're in is that we have been through a very difficult period. It's a period when the Canadian economy has gone through a major restructuring. That has led to all sorts of lay-offs and uncertainty about the future. We've also gone through a very important, but difficult, period of fiscal restraint.

Those two things have acted as kind of headwinds for our economy. So what monetary policy has been trying to do over the last couple of years is compensate for those with monetary conditions that are extraordinarily stimulative and extraordinarily easy.

So our concern has been not that we see inflation around the corner, but as we see that restructuring process starting to diminish in importance and as we see governments coming to the end of the need to make fiscal cuts, that kind of super degree of stimulus doesn't seem to us to be needed as you look into the future.

And of course we must look into the future. We must look one to two years into the future when we're making our judgments.

So as for the notion that we think the economy is currently growing too fast and we see inflation around the corner, no, we're perfectly happy to see the economy grow at 4%, and if we do our job really well, you won't see inflation.

Mr. Lorne Nystrom: There's some concern out there that John Crow certainly went overboard a few years ago. Even the highly respected former Liberal cabinet minister, Paul Hellyer, said this a number of times.

I think there's a bit of a fear out there that you might be the clone of John Crow by putting too much emphasis on anticipated inflation. I just wanted to point out to you that there are a lot of people who are really concerned that the bank's going to cool off the Canadian economy too soon.

The recovery in the United States is better than our recovery. Their unemployment rate is much better than ours. I guess when the Americans sneeze, we catch the cold. I'm just wondering how much flexibility you do have anyway.

• 1550

I come back to my question that perhaps you put your foot on the brake a little bit too quickly sometimes at the Bank of Canada. How much flexibility do we have as a country in terms of having an impact through monetary policy and what happens in the economy?

I'm not so happy about what you think of your predecessor's work. Obviously, I wouldn't anticipate you to launch into a big critique, but there are people who are concerned about your following in the footsteps.

Mr. Gordon Thiessen: I think our circumstances now are very different from those in the late 1980s into early 1990. Indeed, with our inflationary glow and with increasing expectations in Canada that it's going to remain low, we in fact have more room to manoeuvre in monetary policy than we've had for probably 25 years, and I think that does give us an opportunity to test the potential of this economy to produce.

As I've been saying to the people I've been talking to recently, I believe the American experience is very interesting here, whereby with an inflation rate that is declining and is down close to where ours is now, they have in fact managed an economy on a prolonged period of expansion, an economy where both inflation and unemployment declined at the same time, an economy where they have managed to find out that they have more room to expand than people thought earlier. You only manage to do that if people aren't worried that you're about to embark on another bout of inflation.

I think we have the prospect now of pursuing something comparable to that, but the way we do it is not by taking major risks with inflation but by keeping this economy expanding, and that means expanding at a sustainable, non-inflationary rate. That's what we're trying to do, and I think that holds out the best promise for unemployment we've had in this economy for very many years.

Mr. Charles Freedman (Deputy Governor of the Bank of Canada): If I may add a word, obviously monetary conditions have tightened somewhat in the last little while, but remember that the level is still very, very stimulative. We are on the short side, 170 basis points below the U.S., and we're below American rates out to 30 years, something that's basically unprecedented.

So it's not as if, to quote an analogy the governor has used before, we're “slamming on the brakes”, we're just taking the foot off the accelerator. But it's still very, very stimulative out there.

Mr. Lorne Nystrom: I'm aware of that. But just as you're anticipating the possibility of a bout of inflation and major risks coming down the pike in terms of inflation if things aren't done properly, a lot of the public out there is very concerned, too, that you may go overboard and cool off the recovery in the economy and put more people out of work. That certainly happened under John Crow's administration, and that's really a concern that people do have.

I want to ask you why you're concerned now, when the inflation rate is so low. I heard what you said a few minutes ago about the fiscal changes in the last few years and so on, but my goodness, we are at a very low inflation rate and it's pretty hard for people to understand out there.

I think you're originally from Saskatchewan, and I think you understand that a lot of ordinary people out there are very happy with the general recovery right across the country, and the danger of having it slow down.

The other question I would ask, too, is when do you start becoming really concerned about the dollar? You're worried about the dollar now, and the dollar is soft; it's a bit over 70¢—I checked a few hours ago. When it goes below 70¢, does that become an even greater concern?

I know some things you can't comment on very directly because they're rather sensitive, but if you could elaborate a bit on those two points I'd really appreciate it.

Mr. Gordon Thiessen: I must say, with respect to the dollar, I don't like to see a weak currency. I don't think a weak currency is in the long-run interests of—

Mr. Lorne Nystrom: Could you describe what a weak currency is? Some people in our part of the world, where you come from and I come from, like the dollar fairly low because it stimulates exports from the province, and exports from any other province, on a per capita basis. So what do you mean by a weak dollar? At one time 70¢ would have been an extremely weak dollar.

Mr. Gordon Thiessen: It's true. I mean, what constitutes a weak currency depends upon your history of inflation.

We have a very long history of high inflation, which is why we have a dollar as low as it is. If we had not had an inflation rate higher than the Americans, essentially for 20 years, we'd have a stronger currency, at least in the levels, than we have now.

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A weak currency is essentially one whereby it continues to provide a major degree of stimulus for the export sector, a situation in which, when you compare prices and costs of exports in Canada versus the United States, they are much lower here. There's nothing wrong with that for a temporary period of time while you're economy is recovering.

What you absolutely expect to see when your economy is weak are low interest rates and a low dollar. That's part of the process of getting back to full capacity. What you don't want to see is that persisting over some very long period, because that's the kind of thing that's going to involve pumping too much stimulus into the economy, thus getting you down that road of boom and bust. We've been to that before, and we want to avoid it this time.

If we manage to do this, then the people who have some concern right now are going to have their concerns alleviated. We managed to keep this economy going, and especially going at these kinds of rates of growth, which are taking up unused capacity. I think that bodes very well for the economy. It's going to bode well for incomes; it's going to bode well for employment.

The crucial thing is that we don't hit the ceiling of capacity with a bang that results in inflation breaking out again. That's what the Americans have avoided this time around, that's how they've managed to prolong their expansion, and that's what we want to do.

[Translation]

The Chairman: Mr. Harvey.

Mr. André Harvey (Chicoutimi, PC): Mr. Thiessen, first let me tell you how pleased I am to be able to participate with my colleagues in the work of the Standing Committee on Finance. For me it is a first. My colleague, Mr. Jones, sends his regrets.

Mr. Thiessen, of course, we could discuss at great length all the economic and monetary parameters, interest rates and inflation levels. But we already have a good idea of your views on those topics.

However, while we are discussing these important theoretical concepts you know that poverty is increasing tremendously in the country and that increases in productivity still don't translate into net job creation. Obviously, new technologies do have an impact on the issue.

Are you worried by this situation? Relatively good parameters do not necessarily bring an increase in well-being for the people. Unemployment is still high. There isn't a region in the country these days that doesn't have a symposium on poverty and so on.

I don't mean to be partisan, but we go all over the world, we have teams on every continent and, it is an important fact, thanks to free-trade we have maintained our exports. Exports have in fact increased by 140%.

Yet we know perfectly well that if we applied that same free- trade principle inside our borders, in our own country, we could get an 8% to 10% increase in trade and create between 200,000 and 300,000 jobs.

Is it possible for you, through monetary policy, to create an incentive for this type of agreement? How do you feel about our rate of unemployment in spite of relatively positive parameters? Personally, I am worried.

Mr. Gordon Thiessen: I think that in the long term, productivity and job creation go hand in hand. In the short term, we always say that increases in productivity translate into job losses, but that is not true in the long term.

It is very interesting to look at the 1960s. During that period, productivity increases were high, but the rate of job creation was also very high. It's very interesting.

When productivity increases, employers are more prepared to hire workers. It's interesting. There is no real trade-off between productivity and unemployment.

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In my view an increase in productivity would be the best thing that could happen to us. It would increase our standard of living in Canada and increase employment. Even if there can be consequences or difficulties at the time, in the long term the best thing for the economy is to have the highest possible increase in productivity.

And that is what is happening now in the United States. They also have the lowest unemployment rate since the 1960s, but increases in productivity have been very high.

Mr. Bernard Bonin (Senior Deputy Governor, Bank of Canada): I might add that the whole point of our economic policy is to increase the well-being of the population, not to add to its problems or difficulties. In that sense I think that decision-makers are indeed concerned with poverty and unemployment.

But, although that may seem obvious, monetary policy deals with currency. Our goal is to maintain as much as possible our currency's buying power. Monetary policy does not generate revenues and it does not generate wealth. What you can do is try to create conditions that are favourable to an increase in income and in wealth. And the best way to do that, as the Governor explained very well, is to have a prolonged period of economic expansion in Canada and to encourage an increase in productivity.

Mr. André Harvey: Thank you very much.

The Chairman: Thank you.

[English]

We are going to go to the Liberal side now. We'll start with Mr. Pillitteri, followed by Mr. Assad.

Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you, Mr. Chairman, and it's good to see you again, Governor. It seems to me that the past four years we've seen you a couple of times a year and it's quite good to see you reporting to this committee.

I have a two-part question. One is that as a government I think we have been trying to attract investment from outside and create an environment so that foreign investment could come into Canada, and therefore they would want some returns for their investment. But I have a little bit of problem understanding your remark here, where you talk about the interest rates and the rapid growth of the money supply. We've also been doing the CPP, and also there's to be a lot of capital there coming into the Canadian market, some $40 billion to $50 billion originally, and then also some pension funds putting on more pressure to have more money investment outside of Canada.

I just can't really grasp the two. On the one hand, we're trying to create an environment for capital to come into Canada, and of course any business person will want to make money at it. Then on the other hand, we're trying to create an opportunity for these pension funds and RRSP funds...having a limit at 20%, some individuals wanting to increase it to more than 20%. I can't see the two. Then wouldn't we have what you call an oversupply of money in Canada, therefore further weakening our Canadian dollar?

Mr. Gordon Thiessen: I don't think the problem is likely to be a further weakening of the Canadian dollar, and there is a difference here between the shorter term and the longer term.

Right now the Canadian economy has been going through a major restructuring. There are lots of things we've needed to do—invest in new equipment, invest in plants, and get ourselves really competitive in the international economy. But when you look over a longer period ahead, I believe that Canada is increasingly going to be a net saver. If this economy is as successful as I hope it's going to be in the period ahead, I think increasingly we are going to become, as rich economies probably do, a net savings economy.

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So at some point it's going to be terribly important—and this is not for tomorrow—for Canadian investors to be able to invest in the rest of the world. Indeed, the growing economies of the less-developed part of the world will really be looking to the wealthy economies as places where they can get investment, but I don't think that's for tomorrow. I think there is a difference between the short run and the long run.

But we're talking about investments, and that's a little different from the money supply that we're talking about. The rapid money growth that I'm referring to is the money that Canadians hold in currency, demand deposits, checkable deposits of various sorts—the money they use for transactions. That's what's been growing very rapidly. It had been growing at the rate of 16%. More recently it's more like 12%. That's a little different from the investments that one makes through pension funds, mutual funds and so on.

Mr. Gary Pillitteri: I have just one more question.

Mr. Charles Freedman: May I just add one word to that? In a very open economy, in the kind of world capital markets that we see, what you're going to see is diversification. Canadians will want to have some of their assets held outside the country so as to diversify against risks that will pertain just to Canada, and foreigners, of course, will want to hold a lot of Canadian assets as well. What you will see is people having portfolios, no matter where they are in the world, that contain a lot of domestic assets and also a lot of foreign assets. Just as we have trade going in both directions, you'll have investments going in both directions as people diversify their portfolios both in Canada and abroad.

Mr. Gary Pillitteri: In your opinion, then, we should not have any worries about the amount of capital generated by our own CPP pension plan or by any Canadian pension plans. We should be allowing more of the opening of the door to investors outside of Canada if the Canadian economy is able to absorb all of these funds.

Mr. Gordon Thiessen: As my colleague has just said, if you have this highly diversified world economy and world savers, you're going to have some foreigners wanting to put money in Canada and some Canadians wanting to put money elsewhere. But what I was talking about, in fact, was a situation where Canadians in effect saved more than we needed. Therefore, the net surplus would go abroad. Again, let me say that I don't see this for tomorrow or the day after. This is somewhere in the future. I'm not suggesting that we ought to rush out and change these rules very quickly.

The Chairman: Thank you, Mr. Pillitteri.

Mr. Assad.

Mr. Mark Assad (Gatineau, Lib.): Governor Thiessen, I don't remember if it was the last time you were here or the time before, but you mentioned later that you were sorry you brought up the question of deflation.

In light of the events in Southeast Asia, or in Asia in particular, the international press seems to think that there is a menace of deflation, that it could take root, and that it will be have repercussions here.

The Bank of Canada has restructured a lot of things, but when we consider that you've abandoned the reserves...and that was a great boon to the chartered banks in the past, in 1990 or 1991, there's no doubt about it. Should the Bank of Canada not be rethinking its policy of using interest rates to control inflation when basically we could be facing true deflation? That will have a terrible effect on the employment scene in this country. Do you think, Governor Thiessen, that we should be considering an alternative plan in case this problem in Asia materializes and there is a problem of quite devastating deflation?

Mr. Gordon Thiessen: As I tried to point out in my opening remarks, I think those suggestions of deflation are very overstated. I think they're overly pessimistic. They are presuming that the worst of everything happens, but I don't think there are grounds to believe the worst of everything happens. They also presume that when the worst of everything happens, there's no sensible policy response to it. Now, those are an awful lot of bad things that need to happen before all of this is going to come true, so I don't believe the risk they are suggesting is at all high.

• 1610

As I was suggesting, the largest economy in the world, the United States, is pressing the limits of its capacity to produce. If anything, it runs a risk of inflation rising rather than falling. So given the situation in the United States, given the fact that European economies are picking up, and given that the U.K. is pushing the limits of its ability to produce, I don't think this is a deflationary kind of world. However, were there to be more deflationary pressures than I am suggesting, then it is indeed the role of monetary policy in central banks to respond to that. That is why I believe our inflation control targets are so important.

We believe it is equally our job to prevent the inflation rate from falling much below 1% as to prevent it from rising much above 3%. Were there to be a major worldwide deflationary shock, and were that to lead to downward pressure on our inflation rate, then the job of the Bank of Canada would be to ease monetary conditions to prevent that from happening. And if you found that inflation in Canada was falling below the Bank of Canada's target and we were doing nothing about it, then I think you would have strong grounds for believing we were operating in an incompetent way.

Mr. Mark Assad: Would you permit me just—

The Chairman: I'm afraid we'll have to move on.

Mr. Iftody.

Mr. David Iftody (Provencher, Lib.): Thank you, Mr. Chairman.

Thank you very much for your presentation, Mr. Thiessen. I actually wanted to pick up on a number of comments that were made by the member from the New Democratic Party.

I, too, have been following the movement of the dollar, and I checked it before I came in. That was one of the reasons I was late; I was waiting for the recent numbers on it. It seems to me that the change we made—raising the rate by 25 basis points—almost had little or no effect. It gained 67 points, and if I'm correct, the dollar is now close to historic lows, close to 70¢.

I represent the riding of Provencher in Manitoba, and I know you've been to our area there.

Mr. Gordon Thiessen: Yes.

Mr. David Iftody: Having a low dollar certainly helps our exports. For the farmers there this is good news. It's very, very helpful. But I can tell you that at the same time, many of them are very nervous about a 70¢ dollar and the sense of uncertainty that it casts upon the market, at the same time sending a signal to both foreign investors and our own people here in Canada as well.

My own view is that a 75¢ dollar would probably be a healthy one. I think our exports would still certainly be very competitive right up to an 80¢ dollar under current conditions, as a matter of fact. But in my view, we are getting sort of dangerously low here. I'm afraid that should we, for example, break 70¢ and go to 69¢, we'll send a psychological signal not only to Canadians but also to foreign investors. That's notwithstanding the remarks that you made, and that I fully agree with: the fundamentals are there. We just don't have the believers to grab onto that, and I'm not sure why that's happening. The question is how long we can hold on. How far are you willing to go on that currency before we perhaps get into trouble?

Now, with the recent events in Vancouver over the last couple of days, for example, we've had a run on the currency. We've had a number of presidents from Asian countries saying that our fundamentals are strong, but the problem is some bad guys out there, currency traders, those famous 28-year-olds in red suspenders, wreaking havoc on our country. But the eighteen countries in APEC have agreed just recently to a large safety net package to support that currency, and we've had the President of Mexico leading off the discussions apparently about how well it worked to stabilize his country. What about some of those same variables or notions of underlying support from the Bank of Canada for the Canadian currency?

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To summarize, I agree that the fundamentals are there, but they don't seem to be signalling that in the markets, notwithstanding yesterday's 25 basis point increase. Would we allow the dollar to go below 70¢? Is that healthy? Would that send off a crisis in the country? How far are we prepared to go on some of these things? I'm uncomfortable with that, and if we take the lead from the IMF recently with respect to the Asian economies, they are indeed prepared to provide that kind of support in order to send a signal to those investors that we are confident in those Asian economies. Perhaps, Mr. Thiessen, we need to do that same kind of measure here in Canada in order to send a stronger signal to foreign investors that Canada is indeed healthy and strong and open for business.

Mr. Gordon Thiessen: I'm afraid you're getting into territory that is rather delicate for me. Commenting on current levels of the currency and what we might do or what we might not do is just not a comfortable place for me, and I hope you understand—

Mr. David Iftody: I do understand.

Mr. Gordon Thiessen: —that I'm a bit hesitant to say very strongly one way or another what we might do. I just think that is the wrong thing for a central bank to do.

I agree with the general notion that an exchange rate that is sliding at a time when the underlying fundamentals are good is not a kind of circumstance that one likes to see, and it is not ideal over the long run. That's why I must say that unless something very dramatic happens in the rest of the world to somehow weaken the position of Canada in a major way, I don't believe the underlying situation of the Canadian dollar is this weak.

I don't think there's any question that a weak currency for too long can in fact undermine your export industries. I think it is really interesting to look back at 1986, when the dollar got down to 69¢. In fact, a number of export companies admit freely to me today that it was an unfortunate occurrence. In many cases, they came to rely on the low currency rather than on their productivity and their competitiveness. Again, I think it's very interesting to use the American experience. Currently, they have a relatively strong currency against the rest of the world, and it's remarkable to see how well the U.S. export industry is doing.

Another example is the yen. When the yen was relatively strong in the 1980s, the Japanese export industry did remarkably well as well. Isn't that interesting? It's as though the incentive that comes from a strong currency brings out the best in your export industry.

Mr. David Iftody: Thank you, Mr. Chair.

The Chairman: Thank you, Mr. Iftody.

Before I move on to the next question, I'd like to ask a question in reference to your continuous reference to the American example—that they're able to “push the limits”. What's stopping us from pushing the limits?

Mr. Gordon Thiessen: I'm hoping that's exactly what we're going to be doing within the next year or two. If we do our job well, apart from the possibility that some nasty things are going to happen internationally, that is exactly the Bank of Canada's strategy—to see whether we cannot push the limits of the ability of this economy to expand, and to see what kind of unemployment rate we can get down to.

The crucial thing I'm suggesting is that we have to ensure that this expansion continues. The way we do that is by ensuring that we don't get an outbreak of inflation. This means trying to set monetary policy in a way that supports the economy on in ongoing way but doesn't lead to this boom and bust scenario. If we are successful in doing that, Mr. Chairman, I think we do have the opportunity to do some of the probing our American neighbours have managed to do.

The Chairman: One of the issues that is of concern to me is, of course, the issue related to productivity. More than anything else, the low dollar may give a sort of unfair sense of productivity to some of our firms, as you've correctly stated. It's been suggested that Canadian firms are in fact depending on the low dollar to make them competitive. Can you comment on that?

• 1620

Mr. Gordon Thiessen: I don't have any evidence of that yet, but I must say it is something that is on my mind as well. Just as I was citing the experience of 1986, I think it would be most unfortunate were that to happen again. I believe this is a time, this period of low interest rates and low exchange rates, for Canadian businesses to get themselves geared up to being highly competitive and productive in an increasingly globalized economy.

I think the low dollar gives people a chance to break into markets, to get themselves set up, but if it comes to the point where they absolutely have to have the low dollar in order to survive, then we will not have achieved much. I must say that is on my mind, but I haven't come across any hard evidence yet of that being so. I try to speak to lots of Canadian businesses, and the point you've just made I make to them as well. They assure me that they're all geared up to be able to compete with a higher currency. I most certainly hope that is true.

The Chairman: Thank you, Governor. Mr. Keyes.

Mr. Stan Keyes (Hamilton West, Lib.): Thank you, Governor Thiessen, for your concise presentation to the committee. I want to touch on a couple of spots that were mentioned previously. One has to do with fundamentals and one of the touchstones that you and your people use to determine the outcomes and fundamentals.

I worry a little bit when I hear you say in an answer to the question by the chairman that you're prepared to look at pushing the limits. My question has much to do with what you said when you spoke of doing what you do or are not going to do; I worry that it's based on the mechanisms you currently have in place to determine that.

I was fascinated by an article by the chairman of the U.S. Federal Reserve Board, Alan Greenspan—and you can correct me if I have this a little out of kilter. The touchstones they're using, or the methodology they use, is that as long as production keeps ahead of demand and as long as there is a workforce available to “fill the orders”, there is no danger of the overheated economy, therefore no need to increase the bank rate.

I was fascinated because I considered it to be a new, different or more modern way of examining the monetary activity of a country. I'm a little concerned when I hear you say we may look at pushing the limits, only because I wonder if, given the new global economy and given the new technology, etc., we are using the old touchstones, the old benchmarks, the old performances, the old way of gauging monetary activity in a country to make the decisions to respond to current and foreseeable monetary conditions as compared to our American neighbours, who are now implementing new and different approaches, new looks at the way...because of the new economy, new almost aggressive patterns on determining monetary conditions.

I fear we haven't done that. and therefore if we try to get the results the U.S. is getting, or push any limits that the U.S. is pushing.... They're doing it in a very different, more modern, newer way of gauging economic activity as compared to the way we do things. Do you think we are moving to change those touchstones or that methodology as compared to the U.S.?

Mr. Gordon Thiessen: There is in fact no difference between us and the Americans as to the way we run monetary policy. We run it identically. The difference between us in recent years is that they have been rather ahead of us in the process of gearing up to deal with the new economy, new technology and globalization. So they're ahead of us by a few years. But the way the Federal Reserve runs monetary policy is no different from the way we run monetary policy.

• 1625

What both of us are very conscious of now is that there have been a lot of structural changes going on in the world, so your sense of exactly where the capacity limits of your economy are, are subject to a range of error probably greater than before, which means that you should be rather more agnostic than you were before about precisely where those limits are.

What the Americans have done is exactly what I am proposing that we will do, that you gradually test those limits because you're not precisely sure of where they are. You're not precisely sure of what the structural changes in your economy are providing you by way of productivity growth and the ability to have unemployment rates that are much lower than before. But the way they've gone about finding that out is exactly the way we have gone about or are going to go about finding out.

If the notion you have in mind is the famous new paradigm, I can assure you that Alan Greenspan does not accept the notion that there is some remarkably new paradigm about the way the economy works. What there may be, however, is a higher rate of growth of productivity, therefore a higher potential growth rate in the economy, and therefore more rapidly rising standards of living than we have seen since the 1960s.

The Chairman: Thank you very much, Mr. Keyes.

Mr. Calder.

Mr. Murray Calder (Dufferin—Peel—Wellington—Grey, Lib.): Thank you very much, Mr. Chairman.

Governor, this is the first time for me here. My background is in agriculture, but let me tell you, the bank has always been a big interest to me as a farmer.

I want to deal with demographics here. Mr. Pillitteri touched on it a wee bit as to the amount of saving we see going on in this country at the present time. In fact, probably next year we're going to see around $300 billion in mutuals, for instance.

The reasoning for that is, I'm 46 years old and I'm no longer a spender; I'm a saver, because I'm starting to think about my mortgage, my kids' education and my retirement. This population is starting to turn 50 at the rate of 500,000 a year, on average, so this is only going to keep accelerating.

You made a statement here on page 3 about inflation. I think one of the reasons inflation is under control right now is just because of that. I'm no longer spending; I'm starting to save. Therefore, I'm not inflating the economy and I'm not causing shortages. However, if that's true, there is a population spike, my children, who were born in 1983 to 1985, so we're probably going to see inflationary pressure again in around the year 2005 to the year 2010.

You've said here that we don't want to cause price instability, and it almost looks as if you target between 1% and 3%, your target is sitting at about 2%, and that wouldn't cause price instability. Given the fact that there is this spike and there probably is going to be inflationary pressure on our economy starting at around the year 2005, what type of mechanisms other than what you have right now...? Do you feel that they're in place? Will they be able to do that? Will the 2% inflationary figure, moving along, keep us away from recessions?

Mr. Gordon Thiessen: The issues you talk about are indeed very long-term issues rather than short-term issues. Much of what monetary policy normally deals with when worrying about inflation are issues over two or three years rather than these rather long issues.

Right now, for example, the actual savings rate in Canada is relatively low. It is partly, once again, because we're recovering from a period of very weak economic activity, and that is one of the reasons we have interest rates as low as we have right now. It's to encourage people to go back and buy those things they've put off over the last two, three or four years.

Right now, the savings rate is low. But I agree with you; as you look a bit further into the future, you see that savings rate rise. Certainly as a population ages, you expect to see that savings rate go up.

• 1630

That's why, for example, the Japanese savings rate is so high. The big bulge in its population is a bit older than it is here or in the United States. When you have this aging population and a high savings rate, you will have particularly low interest rates.

By comparison, however, if you move through that and get to the stage where you have a mainly consuming generation, you will tend to have somewhat higher interest rates than others. All of that doesn't prevent you from continuing to achieve very low inflation rates.

Mr. Charles Freedman: Let me add just one more word to that. I think demographics are important, but you can overestimate their importance. If you think back to the 1950s, it was a time when the economy was growing very rapidly and the population was growing very rapidly. This was the first sharp move of the population we've talked about.

Between the Korean War and the Vietnam War, say 1953 to 1965, we had a rate of inflation not much different from the current rate. We had a situation that was very different demographically from now, yet we were able to have a very low rate of inflation.

Mr. Murray Calder: It's interesting, because I agree with you on the rate of savings we have within this country. As a legislator I try to look at things from a proactive point of view, because I see the numbers coming at us and I don't want to be reactive to what I think is going to happen in the future.

If the rate of savings remains low and that level of the population ages at the rate I've already stated, we could possibly, by the year 2015 for instance, be looking at a lot lower standard of living than what we have right now. I wonder if you can think of something we as legislators could put in place now that would possibly counteract that eventuality or possible problem in the future.

Mr. Gordon Thiessen: I think the current low savings rate is a temporary phenomenon. It is part of the process whereby the economy recovers. I believe, as I was suggesting earlier, that when you look into the future, we're going to have a much higher savings rate.

I don't know whether there needs to be any special extra incentives to save, but I don't feel I've looked at that issue closely enough to be absolutely definite about that. Naturally we will get a higher savings rate as this economy recovers, employment grows, the unemployment rate comes down, and incomes start to rise.

I agree with you that as that baby boom bulge in our population gets older, we will find most of them will wish to save more. I really absolutely believe that's going to happen. I don't see anything there that should impede it.

I also accept the point you're making that over the long term how much a society saves has a great deal to do with its rising standard of living over time. Savings is what allows you to invest in new capital, more productivity and so on.

You can borrow savings from abroad but it means you also have to pay those savers for it. If you really, as a society, want to increase your standard of living over time, you should save and invest your money in productivity growth. That's how you get a rising standard of living. That was the great miracle of the 1950s and 1960s in Canada.

The Chairman: Thank you, Mr. Calder. Mr. Ritz.

Mr. Gerry Ritz: Thank you, Mr. Chairman.

I have just one short question, Mr. Thiessen. I think the low savings we're seeing right now are tied to the less disposable income people have to put into savings accounts. Does the Bank of Canada consider tax cuts to be inflationary?

Mr. Gordon Thiessen: I think tax cuts essentially are a longer-term issue. The really important thing about the level of taxes is again an issue of longer-term productivity. Those are things that as governor of the central bank I always feel very uncomfortable talking about.

The issues of the level of taxation and the level of services a government decides to provide both have implications. In the end—I'm going to duck the question here, if you don't mind—those are questions that legislators have to decide in conjunction with the people of Canada. I think it is a matter of political choice there—what you want.

• 1635

Mr. Gerry Ritz: Is one not tied to the other? Doesn't one leads into the other, and it's a circle?

Mr. Gordon Thiessen: Tax cuts can frequently give you a higher growth and productivity, but it's also true than an appropriate level of public services can also contribute to both productivity and also to the kinds of things society wants to achieve. I must say as a central banker I feel those are areas that I shouldn't stray into.

The Chairman: Thank you, Mr. Ritz.

Mr. Iftody.

Mr. David Iftody: Returning again to the markets and the changes in the dollar, and movement, and inflation, interest rates and the relationship between them, I understand that on December 5 a report on unemployment rates will be released, again giving us some sort of an indicator.

In western Canada—and I don't need to tell this to the gentlemen at the table here—the employment is down. I think even in my riding with the growth we've had, it's below 5%. In Manitoba I think it's 1% below the natural state, as they call it—an unusual sort of term.

If the new numbers come out in a week or a couple of weeks that show there has been a reduction—I'm not sure on the actual numbers what the last...it was 9 something—could one conclude a statistically significant drop? Would that cause you to rethink and have another look at the interest rate policy? What kind of signal would that send to you?

Last month, I guess, we had a rise in the rate, and perhaps there are some changes around in this quarter, but what are you anticipating in that report? If it goes up or goes down, what does that signal to you as the Governor of the Bank of Canada? What can we expect in terms of interest rates—or again, your thoughts about the weight of the dollar?

Mr. Gordon Thiessen: Well, I certainly hope that it's going to show an increase in employment. I think the last two months' pause in the growth of employment really is inconsistent with everything else we know is going on in this economy. I certainly expect to see an increase in employment.

But, you know, when we set monetary policy, we're looking a year to two years into the future. We're not looking at the current state of employment or unemployment, except insofar as it tells us something about the future. If we get a good growth in employment it will simply confirm our view that we're going to have a good strong economy next year. I cannot imagine that it's going to be very weak, unless there is something very funny going on with these numbers, because everything else that we know about in the economy really looks quite strong at this stage.

Mr. David Iftody: If you do see that kind of strength emerging, and you haven't been particularly concerned about some of the fluctuations.... I fully appreciate what you're saying—that you can't chase after every leaf that's falling from the tree; you have to look at the thing in the long term. I think that's a very prudent approach.

But in terms of the long-term prospects and your instruments that are attempting to gauge that and look at that—and we've used a number of analogies in the brake and the gas pedal and so on—for the average working Canadian out there who is looking at mortgages and renewing and so on.... We've enjoyed historically low rates. I think it's been remarkably helpful, particularly for younger couples and younger Canadians wanting to get into the housing market or other kinds of purchases of that nature.

Given the strength, Mr. Thiessen, and looking down 18 to 24 months, what would signal to you that you have to pull even further off the accelerator...that you don't want any unexpected surprises 24 or 36 months from now? Could you help us as a committee in terms of some guideposts and flags that we can look for? At what point would you start to pull back, and interest rates again go up?

Mr. Gordon Thiessen: Well, I think it would certainly require signs that the economy was expanding much more rapidly—that there really was a kind of build-up of activity. Probably more likely it would be because the rest of the world was becoming incredibly expansionary, and that this was spilling over into Canada. I must say I don't see that at the moment.

• 1640

I would also like to suggest to you that if we do our job really well, if we keep this inflation rate low, then the kind of interest rates that matter most won't go up. The very short-term interest rates may go up, but the mortgage rates, the bond rates—the kind of rates that really matter to investment in the future, whether it's housing or businesses—those shouldn't go up. Indeed, they might even go down.

Mr. David Iftody: Those are my questions. Thank you, Mr. Chairman.

The Chairman: Thank you, Mr. Iftody. Mr. Assad, followed by Mr. Ianno.

Mr. Mark Assad: Governor, you were giving the figures a while ago. We had in the last weeks here some distinguished people—columnists, and people from different think tanks, if you want. Mr. Fortin was here, and he was saying that inflation greases the wheels of the economy. Everybody seemed to agree that the inflation rate in the States hovered somewhere around 2.5% to 2.8%. They thought our inflation rate of 1.5% was actually exaggerated—that there were faults with the CPI, they felt, and that actually our inflation rate was probably 1%. They felt that because there's so much slack—we have a lot of production capacity we could meet—even if we went up to 3%, it would certainly have a bearing on the unemployment, and it wouldn't be dangerous, because as you're saying, the dangers of inflation, if there are any, would probably be two years down the road.

Mr. Gordon Thiessen: Well, I would certainly disagree with that. I don't think inflation does grease the wheels of the economy. I think the only way it can possibly do that is by fooling people, and I just don't think you can fool people for very long.

People who believe that inflation greases the wheels of the economy look at the period in the very late 1960s and the early 1970s when it appeared to do so for a period. But you have to understand that was after a very long period of very low inflation rates. Most Canadians, indeed most people around the world, certainly in the U.S. as well, were persuaded that inflation rates were going to stay low. And so when governments and central banks took risks and allowed inflation rates to rise, for a moment people said, no, that's not going to stay; that's not going to happen.

Effectively what that did was reduce the real level of wages, and encouraged for a time a sense of expansion in the economy, but it very quickly backfired. By the time we got into the mid-1970s, any sense that people didn't understand that inflation rates undermined their wages and salaries essentially disappeared.

After 20 years of relatively high inflation, I think the chances of fooling people are absolutely zero. I also have to tell you I have a lot of trouble with a policy that is based on fooling people.

I believe that if you push the inflation rate up to 3% or above, let us say, it is not going to help the unemployment rate. People are not going to say, gee, the inflation rate is 3.5%; I don't mind the fact that my wages aren't reflecting that. That's not going to happen. And if it doesn't happen, and if you don't effectively cut wages that way, you're not going to reduce the unemployment rate. It is as simple as that.

The Chairman: Mr. Assad, you final question.

Mr. Mark Assad: Thank you. We had the Conseil du patronat come to visit. The first concern they had was that they said the government should be responsible for maintaining the interest rates as low as possible. They seemed to think that we have that total responsibility—obviously we have a good part of it—but they felt that the inflation rate was not a danger right now, and that there could be a certain flexibility, not to worry about it. The overnight interest rate increased. They felt it sent the wrong signal to Canadian people, that they'll hold back.

• 1645

Mr. Gordon Thiessen: I don't believe so. You have to think about the level of interest rates, not just the change.

As I was saying before, we have been through a period in which interest rates are at extraordinarily low levels and the Canadian dollar is at extraordinarily low levels. Both of these have been designed to help the Canadian economy recover from some of the restraint that has been on it because of the need for improving budgetary positions and the need to restructure the economy. As those restraints disappear, this economy is going to continue to grow rapidly without the need for the Bank of Canada to pump money into the Canadian economy at the rate at which we've been doing it over the last year or two.

So I do not agree. I believe that the current levels of interest rates remain extremely stimulative and that deciding to opt for a higher inflation rate, something outside our 1% to 3% range, is not going to do any good for the economy. What we would find if we were to do that is that we would not have the lowest 30-year bond yields in our history, as we have today. We would have higher interest rates and mortgage rates and less investment in housing, machinery and equipment, and new technology.

The Chairman: Thank you, Governor.

Mr. Ianno.

Mr. Tony Ianno (Trinity—Spadina, Lib.): Thank you, Mr. Chairman.

Thank you very much, Mr. Thiessen, for presenting a good case.

I have a couple of questions that are slightly different. I'm going to go with the optimism because I think Canada has good fundamentals. And I think that as things stabilize around the world in terms of Asia and the Pacific and other places, people are starting to read that Canada is a stable economy and things are starting to work in a positive manner.

Having said that, I'm concerned about the boom and bust that you referred to. Dealing with the banking industry, especially with small business in downtown Toronto and especially with real estate picking up, I'm starting to see a lot of competition for a lot of properties.

What kinds of lessons have we learned in the past that will help us to ensure that the kind of inflation you don't want to see doesn't occur to the point where it affects everyone negatively in the long term?

Mr. Gordon Thiessen: You've certainly hit on something. One of the first signs people are getting nervous about the likelihood of future inflation is that they start to speculate in the real estate market, because whether you are a large investor or a homeowner, the best way you can protect yourself from inflation is to invest as much as you can in real estate. That's what we saw in the late 1970s and again in the late 1980s, so that is indeed something to be worried about.

However, you have to differentiate that kind of general development from the expansion of a city, because cities expand and there's a shortage of land and office space and you're going to see prices rise. It's not always easy to make this judgment, but you do have to differentiate the normal process of expansion in a city that is expanding from the more general situation where people become worried about being left behind and feel that they must have the “most house” they can possibly lay their hands on. It's a fine judgment, but you have to make it.

Mr. Tony Ianno: I'm sure that the Bank of Canada will be looking at that, especially with the banking industry, to ensure that the aggressiveness now in play will somehow be somewhat curtailed so that properties that are not in the expansion part of the city but are within the city.... We don't want it so that people can't find properties, whether they are large buildings, apartment buildings or commercial buildings. They're starting to have many bidders, and that's healthy, but that's where the beginning occurs. In your business, perception is reality, so I just hope the Bank of Canada is dealing with this in a very sotto voce* approach.

• 1650

My second question is along the same lines, but is slightly different. With the good fundamentals and the appreciation that comes in terms of people starting to see where Canada is standing on the economic side, I think the dollar will rise. I gather the interest rates will then be decreased. Again, if you're talking about two years in your projections—you're dealing with things today, but for two years down the line—with the dollar increasing, my concern is with the export economy. I don't know the actual number—whether it's 60% of our economy, or whatever the actual number is—but my concern is that as the dollar rises, once you've taken the pedal off the accelerator, how do you deal with a dollar that starts to rise in appreciation without hurting many of the people employed in that industry?

Mr. Gordon Thiessen: When we look at developments in the economy, and when we look at what kind of effect monetary policy is having on the economy, we always look at both the impact of interest rates and the impact of the dollar. In an open economy like Canada's, the dollar is so important. You can't set targets for it, because that is just too difficult. What we do is look at the combined effect of interest rates and the dollar.

If the dollar has risen substantially and is starting to act as a restraining effect on the export industry, that means the economy as a whole is not going to be as strong, and that is something we would immediately take into account. When we decide what level of interest rates is appropriate, we take that effect into account. You must do that.

But as I was saying earlier, if there are exporters who basically have geared themselves up to only be competitive with an extremely weak dollar, I think those people might have difficulty. I would hope they would immediately set about making sure they are competitive even when the dollar goes up somewhat.

Mr. Tony Ianno: Thank you, Mr. Chairman.

The Chairman: Thank you very much, Mr. Ianno. Mr. Calder is next.

Mr. Murray Calder: Thank you very much, Mr. Chairman. I'd like to follow along a wee bit on what Mr. Ianno was saying.

Our situation here in Canada is totally different from that of our trading partner the United States. We pay higher wages here, there's a better benefit package attached to those wages, and the overall cost to a company per employee is considerably higher. So I think the low Canadian dollar is one of the reasons we have been competitive. If there was a rise in the Canadian dollar up to 75¢ or 80¢, do you think that for our companies at present time, the productivity per worker is enough to warrant and offset that rise, given the situation I've already given?

Mr. Gordon Thiessen: I can't be sure of that in advance. I'm sure the productivity is sufficient that some rise in the dollar would certainly be possible. Of all the people I've spoken to, virtually all of them will say they can easily operate and be competitive at higher exchange rates than this. Some people say 75¢, some say 80¢, and some people say they're competitive even at substantially higher values of the dollar than that. My point is that this is something we are always examining. We are always looking at this to make sure we understand what kind of effect the dollar is having on the economy.

You can't just say that you happen to know in advance that 75¢ or 80¢ would be the right number. It really depends on a whole lot of other things that are going on around the world. If you have an absolutely booming world economy and commodity prices—the prices for grains and metals and lumber—are all going up, then we're going to be competitive at a higher dollar. If those things aren't happening, it's going to be a lower dollar that makes us competitive. Those are the things that the bank always has to examine and make a judgment about.

• 1655

Mr. Murray Calder: Mr. Chairman, I have one more question.

Governor, I'll tell you right at the outset of this question that it's just going to take you to the edge of what you probably want to answer.

Mr. Gordon Thiessen: I'm on my guard.

Mr. Murray Calder: Okay. We've had really low interest rates now for about the last 24 months.

Mr. Gordon Thiessen: Yes.

Mr. Murray Calder: Having those low interest rates, we didn't really see a real change in unemployment or economic activity for at least 18 months, and now we're starting to get some of the benefit.

Given that I'm right in that assumption, if we did go for a tax cut as a stimulus for the economy, would the same be true of that as a stimulus for the economy? Would we have to wait 18 months to see any benefit from it?

Mr. Gordon Thiessen: Well, I think you're getting me down a road on which I feel pretty uncomfortable, all right.

The Chairman: I could rule that out of order if you want.

Some hon. members: Oh, oh!

Mr. Gordon Thiessen: Virtually all these things—whether interest rates, expenditures, or tax cuts—do have their effect over an extended period of time.

The Chairman: Mr. Assad.

Mr. Mark Assad: Governor, by roughly how much did the monetary mass, or the money supply, increase in the last year?

Mr. Gordon Thiessen: The narrowly defined money supply has increased by something over 12% over the last year.

Mr. Mark Assad: Would that be roughly in the $20 billion range?

Mr. Gordon Thiessen: It would be $73 billion.

Mr. Charles Freedman: That is the narrow measure of money.

Mr. Gordon Thiessen: Yes.

Mr. Mark Assad: You'll have to explain that.

Mr. Gordon Thiessen: It is the measure I was referring to before: currency; demand deposits; and checkable deposits people have at banks, trust companies, credit unions and caisses populaires. That measure of money that people use for transactions is some $70-odd billion, and it has been growing by something over 13%.

Mr. Mark Assad: Of that amount?

Mr. Gordon Thiessen: Of that amount, yes.

Mr. Mark Assad: Tell me, Governor, let's assume that you brought back reserves like we've had in the past, like most countries have except Switzerland, ourselves and Great Britain, would it not be of advantage to the Government of Canada and the people if we had reserves?

Mr. Gordon Thiessen: No, reserves are essentially a tax on the financial institutions that have to hold them. They are a tax, because central banks traditionally don't pay interest on those reserves, so it's essentially a non-interest-earning investment.

In the past we found that the existence of those reserves simply diverted activity away from the institutions that had to hold them to the institutions that didn't have to hold them, and that didn't seem to really make a lot of sense. I mean, you essentially want the business to go to those institutions that provide the best service at the lowest price, not those that pay a kind of special tax, which is what the reserve requirement was.

So we don't believe we needed to run monetary policy, and it was simply a special tax on some deposit-taking institutions.

Mr. Mark Assad: Well, Governor, if we've followed roughly the same monetary policy as the United States, why don't they get rid of their reserves?

Mr. Gordon Thiessen: They don't use reserves as a means for running policy. They still essentially have a tax on those financial institutions. I think you'll find that there is a strong sense, however, that maybe it's not a very good tax and they should get rid of it.

Mr. Charles Freedman: It has also declined substantially over the last few years.

Mr. Mark Assad: In other words.... You would obviously refute what the group of the Canadian economists association published a few years ago, that in the past the policies of the Bank of Canada had created a situation where there were unnecessary debts accumulated on our backs.

Mr. Gordon Thiessen: Oh, I don't know about our banks. If what you're saying is that if we'd followed a different policy there would be less accumulation of debt in general in the private sector of this economy, I would agree with you. Essentially, by not responding earlier than we did to a relatively high rate of inflation over the 25 years from the early 1970s to the early 1990s, we encouraged an accumulation of debt in the private sector, because that is exactly what inflation does. It encourages you to maximize the amount of debt you can possibly manage. That is not a good thing for an economy. That is what high inflation does for you. If we had been successful in following a lower inflation policy we would have had less accumulation of debt and we would have had more moderate declines in the economy than we did in the early 1980s and the early 1990s. Those nasty recessions were very much a function of accumulations of private sector debt encouraged by inflation.

• 1700

The Chairman: Thank you, Mr. Assad, for your questions.

[Translation]

Mr. Harvey.

Mr. André Harvey: I have just one question, Mr. Thiessen, before we conclude, even if it isn't exactly in your domain. Still, you're concerned by the $600 billion debt since $45 billion are spent every year to service it and pay it down. Should we have budget surpluses in the months to come or in a year or two, would you be in favour of applying them entirely to the debt or would you try to find a balance between gradually paying back the debt and lightening the tax burden for Canadians, as my colleague suggested earlier?

We might also consider investing in areas that our citizens feel are extremely important. For some, it is our social infrastructure, for others it is our material infrastructure. What is your view of such a balance? As a monetarist would you be in favour of paying back the debt quickly or of striking a certain degree of balance?

Mr. Gordon Thiessen: Again, I think that those are political decisions. It is for the Government, for Parliamentarians to decide what to do with those surpluses.

I can say, however, that the level of debt relative to GDP, the debt-to-GDP ratio, is still very high in Canada. A 100% ratio at the federal level, at the provincial level, etc. is extremely high. In those circumstances our fiscal situation remains very fragile. The ratio must be lower. But how can we achieve that? How can we achieve it quickly? These are political questions. They are decisions for the government and for Parliament to make.

Mr. André Harvey: Thank you very much.

The Chairman: Thank you, Mr. Harvey.

[English]

Governor, I would like to follow up on that comment about the debt-to-GDP ratio and perhaps pose the question in such a way that you may in fact answer it.

Mr. Gordon Thiessen: It was that blatant, was it?

The Chairman: No. As you know, this is the 56th committee meeting this committee has participated in since October 2, and we spent a lot of time listening to Canadians from coast to coast. There's no question in our mind that a priority was certainly the debt-to-GDP ratio. There is, I believe, a greater awareness on the part of Canadians as to the importance this has on the economy. Since we have you here today, can you please outline the benefits of reducing the debt-to-GDP ratio.

Mr. Gordon Thiessen: Certainly. As I was suggesting, if you have a very high debt-to-GDP ratio it puts you in a financial situation that is fragile, it is brittle. It doesn't put you in a good position to deal with shocks that occur in the rest of the world, nasty surprises that may arise from time to time, because what happens in those circumstances is that investors and savers around the world get nervous and worried. They then look to see which country looks to be the most secure in those circumstances. High-debt countries frequently will find themselves suddenly facing sharp increases in interest rates. All of a sudden, you start to pay risk premiums in your interest rates, because if you have such a high debt level, investors and savers, both Canadians and foreigners, start to worry about how you're going to manage in the future. I think that puts you in a very vulnerable situation.

• 1705

Therefore, I cannot say to you, Mr. Chairman, exactly how fast you should reduce that ratio. But I think it's very clear that if we don't want to leave ourselves vulnerable to those kinds of nasty events that do happen from time to time, we should aim at a lower debt-to-GDP ratio.

The Chairman: Governor, I think the debt-to-GDP ratio for Americans is approximately 45%. Is that more or less the ballpark figure?

Mr. Gordon Thiessen: I think that's right, but I must say that I don't have the number in my head. But my colleagues undoubtedly will have that.

A voice: It's 49%.

The Chairman: When you consider the interdependency of the two economies, do you think it would be wise for this government to perhaps be within that range?

Mr. Gordon Thiessen: That's a good question. I'm not sure I've got the answer for it.

Economic analysis, all by itself, doesn't give you a good answer to exactly how low the ratio should be. But lacking that kind of analysis, I think there's a strong argument for saying that you're going to be compared to your neighbours and trading partners, so bear that in mind.

The Chairman: But, Governor, you seem to like the way they've been dealing with inflation and interest rates, so why is it that you can't commit yourself to the debt-to-GDP ratio? That's a political question, I gather.

Mr. Gordon Thiessen: I can't bring to bear economic analysis that says, yes, absolutely, that's the right ratio. But as I say, I think that's more a political judgment. “Political” may not be quite the right word.

Certainly I think it's very likely that markets will make a judgment about our situation and compare it with that of Europe, Japan, and the United States. If we are a long way out of phase with them, if we have a very different debt-to-GDP ratio compared to theirs, we will certainly stand out.

So failing any other analysis, I guess what I was trying to do was agree with you, without being too definite, that putting yourself in a situation where you compared favourably to the other big industrial countries was probably the right way to go.

The Chairman: For the benefit of Canadians, when you look at long-term debt and short-term debt, how do we stand as a country?

Mr. Gordon Thiessen: Are you speaking of government debt here, Mr. Chairman?

The Chairman: Yes.

Mr. Gordon Thiessen: Typically, I think we have a larger proportion of short-term debt than a lot of other countries do.

We also issue very long-term debt of 30 years. Essentially, the Americans are the only other government that tends to issue debt that long. Most Europeans don't issue debt much longer than 10 years. But we have, typically over the last number of years, probably issued more treasury bills and short-term debt than a lot of them have.

I know that the government, over the past few years, has gradually tried to lengthen the term of our debt. That provides you with some protection against the inevitable swings that may occur in international interest rates. So if all your debt is very short term and it's coming due every three months or six months, then of course you're far more vulnerable to a brief spike in interest rates in terms of your debt service costs than if you have more of your debt in the long term.

I think most governments have tended to want to stay at the long-term end of the spectrum in terms of the maturity of their debt. But I have to tell you that I'm not absolutely certain about that ratio. But that is my impression. We have had a somewhat higher proportion of short-term public debt than would be true of the other G-7 countries, for example.

The Chairman: As we travelled the country, we also heard about a sort of repatriation of our debt. Canadians would feel much better if we were the holders of our own debt. How important is that to our situation or to the Bank of Canada?

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Mr. Gordon Thiessen: I don't think it is very important, Mr. Chairman. Much of the debt that foreigners hold that the Government of Canada issued is debt that the government issued in Canada in Canadian dollars. If you're going to have an open capital market and people think your bonds are attractive, they're going to buy them. Short of putting a wall around Canada, that's going to happen.

I guess you can argue that if we were to gradually reduce the deficit in our balance of payments, as a country we would stop being such a large borrower from the rest of the world, and as I was suggesting earlier, that's something I expect to see in the future. I expect to see us become a net saver, and against the rest of the world, that means we will be running at some point in the future a surplus in our balance of payments and we will be a net investor in the rest of the world. Therefore, what will happen in those circumstances is that our net foreign indebtedness position will gradually dwindle away.

So I must say in regard to the notion that we would go out and somehow ask those foreigners that hold the Canadian-dollar debt of the Government of Canada to please allow us to pay it off, I can't see that.

The Government of Canada does have some foreign currency debt, but all of that has been issued to finance Canada's foreign currency reserves. So the foreign currency reserves we hold have as their counterpart all of the foreign currency debt issued by the Government of Canada, but that is the only reason the Government of Canada has issued any foreign currency debt.

The Chairman: Mr. Iftody, a final question.

Mr. David Iftody: In terms of the effect on the Canadian economy of the ratio of GDP to debt, I had this discussion with Josh Mendelsohn, who was here from CIBC. We were having a debate and a discussion about the vulnerability of Canada, and how to fix interest rates, and the price of the dollar, if we're at current levels of 73% or 75% of debt-to-GDP ratio, which is extremely vulnerable.

It emerged in the discussion and I asked the question: if that is a fixed, hard economic fact, and I've heard you repeat this in Steinbach and everywhere else, then why was it, Governor, that in the mid-1970s when our debt-to-GDP ratio was around 22% or 23%, we had the horrific experience of interest rates that went to 22% or 23% at a time, in fact, from an outside observer's point of view, or these red-suspendered money speculators...? Why would there be this attack, this pressure and the upward movement on interest rates at a time when...? Gosh, if we were at 23% of our ratio right now, we would think we were halfway to heaven.

So there is an inconsistency in the discussion that we've heard in the last two or three months in consulting with economic experts. This seems to be a mantra, but there is certainly historical evidence in the not-too-distant past that suggests there are indeed variations to this.

We talked about the confidence. You used again the terms that if we have our economic house in order in terms of those levels, then we can be reasonably assured that speculators will treat us with respect, because they're going to look at the economy and say, well, Canada is a safe and reasonable place to invest, so we're not going to pull our dollars out of there. But I began my discussion and opened my comments by saying notwithstanding all the good work that has been done in the Canadian economy by the Canadian people and the government and others in the last three years, we're not seeing, at least today, that kind of confidence.

So there's the first question, why the variation in the mid-1970s when we were at 20%, which would suggest that it could happen again if we got down to those levels; and what's lacking in the message of confidence from Canada to these foreign investors about buying Canadian dollars?

Mr. Gordon Thiessen: What happened in the 1970s—and the high interest rates you refer to, we got to 1980-81—was after a period in which our inflation rate gradually rose and, I guess, reached a peak of about 12% or 15% inflation rate. If you have a low debt-to-GDP ratio—a government that's doing absolutely the right thing—and you let your inflation rate get away on you, you're going to have high interest rates. Absolutely.

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The problem that we ran into in the 1990s was that our inflation rate had come down to 2%, but we still had a federal and provincial fiscal situation that wasn't under complete control and a debt-to-GDP ratio that was rising inexorably. In those circumstances, we were not able to get the benefits of low inflation. We ended up with interest rates that had large risk premiums in them for the fact that governments might renege on their debt or they might force the Bank of Canada to inflate or whatever by changing its legislation. Those were the concerns. So you could have inflation without a high debt-to-GDP ratio, although I must tell you that by 1980 it was rising fast.

Mr. David Iftody: But, Governor, this was not only Canada's experience. I've looked at a number of documents about this. The U.S. and all the other G-7 countries, including Canada, went through the same “horrific”—to use your words—interest rate rises and the havoc they wreaked on our respective economies. What was the independent variable that was wreaking this havoc among the G-7 countries at a time when the GDP was so low?

I'm sort of looking for these dark arrows in the night. We have to put up some defences to prevent this from happening again, because what we're doing here right now is perhaps going to be washed away by some of these outside influences. Can you name them or discuss them at all?

Mr. Gordon Thiessen: It was basically inflation. And the reason we made those terrible mistakes on inflation...and you're right when you say it wasn't just Canada, it was around the world, certainly in the U.S. It was essentially the problems that we got into with the sharp rise in oil prices and an initial feeling that you had to somehow accommodate those. And in the end, in the process of trying to accommodate them, we allowed the inflation rate to get up. Then we just kept providing them monetary accommodation—the growth in money supply—that just kept those inflation rates up.

As we were saying earlier, as people came to realize that the inflation rate was going to stay high, it then became very difficult to get it down. The only way you get it down once people are absolutely persuaded that you don't have the courage to bring down the inflation rate and that in fact their only risk is that it's going to continue to go up, you get very high interest rates indeed. To break that psychology, as happened particularly in the United States in the early 1980s, get interest rates very high.

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

The Chairman: Thank you very much, Mr. Iftody.

I have a final question, Governor, which is more of a housekeeping item than anything else. The Bank of Canada and the Government of Canada need to set new inflation targets. I was just wondering if you felt that this committee should be playing a role in the discussion or examination and the establishment of targets.

Mr. Gordon Thiessen: I think it most certainly could. In December 1993, the Minister of Finance and I agreed that this issue should be revisited by the end of 1998, and that's something we most certainly have to do. I must say that I would defer to the minister and what he thought was appropriate in these matters rather than suggest to you myself what you should or should not do.

The Chairman: What about the relationship the Bank of Canada has with the finance committee? Do you have any comments on that?

Mr. Gordon Thiessen: I must say, Mr. Chairman, that we really do appreciate the willingness of your committee to invite us to appear before you when we put out our semi-annual monetary policy report. I must say it's something that I feel very strongly about. We've been trying over the last few years to make the monetary policy we're following, along with why we're trying to do it, more “transparent”, to use a buzzword.

I believe we have a duty of accountability to Parliament and to the Canadian people. That is why I think it's terribly important for us to say what we're doing, and that is why I appreciate your invitation for us to appear before this committee. It is part of our accounting for what we do before Parliament.

The Chairman: Thank you very much, Governor.

Mr. Bonin, Mr. Freedman and Governor Thiessen, on behalf of the committee, I would certainly like to express to you our warmest and sincerest thanks for your presentation. It's important material for this committee to review as we attempt to chart a better course for our country.

The meeting is adjourned.