[Recorded by Electronic Apparatus]
Wednesday November 8, 1995
.1531 
[English]
The Chair: I call this meeting to order.
The finance committee is pleased to have with us today the Governor of the Bank of Canada, Mr. Gordon Thiessen, and the deputy governors, Mr. Tim Noel and Mr. Bernard Bonin.
Thank you for being with us. We look forward to your presentation.
Mr. Gordon Thiessen (Governor of the Bank of Canada): Mr. Chairman, along with my colleagues I welcome the opportunity to appear before this committee to discuss our autumn monetary policy report that was released earlier this week.
[Translation]
The purpose of these semi-annual reports is to provide timely, forward-looking information on our conduct of monetary policy. It is a report of the Bank of Canada's Governing Council, made up of the Governor, the Senior Deputy Governor and our four Deputy Governors. This is the group responsible for the conduct of Canadian monetary policy.
[English]
As the report states, the basic task of Canadian monetary policy is to encourage a rate of monetary expansion that is consistent with the bank's inflation control target of 1% to 3% for the period through 1998. The challenge in conducting monetary policy is to deal with the uncertainty that exists because of the long lags between central bank actions and their effects on inflation, and because of the unexpected events that can influence the economy and the trend of inflation. Therefore, monetary policy must be forward-looking and based on projections of an uncertain future. Those projections must be reassessed continually in the light of unexpected events.
[Translation]
The challenge posed by uncertainty has been evident this year. We have had two periods of financial market turbulence, the first following the Mexican currency crisis and leading up to the federal budget, and the second during the referendum campaign. These occasions led to increased risk premiums in our interest rates and to monetary conditions temporarily tighter than we would have preferred.
[English]
After having expanded rapidly during 1994, economic activity in Canada during 1995 slowed more than we had anticipated. This slowdown largely reflected two unanticipated developments: cutbacks on spending of big-ticket items were particularly large and quick to occur in response to the sharp rise in interest rates last winter, and the decline in net exports because of a slowdown in the U.S. economy was surprisingly pronounced. With this period of slow growth in our economy, the gap between actual and potential output widened.
However, as we look forward, the prospects for the latter part of this year and into 1996 look more promising. The U.S. economy, the most important element in Canada's external economic environment, appears to have a solid underlying momentum. Most overseas economies are also expected to continue to expand at a moderate pace. Commodity prices should therefore remain firm, and good external demand should once again bolster the Canadian economy.
.1535
[Translation]
In addition to the effect of renewed export activity on employment and income, the declines in interest rates since last spring should also stimulate demand. Nevertheless, the domestic picture is somewhat mixed since continued restructuring of our economy in both public and private sectors will remain a source of uncertainty that could dampen confidence.
[English]
Overall, however, I feel confident that economic activity and employment will soon show increasing signs of a strengthening trend.
[Translation]
A key reason for my optimism about the future is Canada's good underlying inflation performance. When all the factors are weighed, we are confident that the trend of inflation will remain within the Bank's target range for inflation control.
[English]
It will also be important in the period ahead that governments remain resolved to put their debt positions on a sustainable track. Such measures will reduce risk premiums in our interest rate structure and contribute to a sounder, less vulnerable economy over the medium and longer term.
I'd be pleased to take your questions now.
[Translation]
The Chairman: Thank you, Mr. Thiessen. Mr. Loubier now has the floor.
Mr. Loubier (Saint-Hyacinthe - Bagot): Welcome to the three of you, Mr. Thiessen, Mr. Noel and Mr. Bonin. Welcome to the Finance Committee.
Mr. Thiessen, I would like to put a question to you concerning statements you made the day before yesterday. You said at that time that the Bank of Canada had not completely foreseen the extent of the economic downturn which occurred at the beginning of the year. If you had done so, would you have managed interest rates otherwise during that period?
Mr. Thiessen: That is very hard to say, Mr. Loubier, given that during the winter and spring, there was some degree of lack of confidence in the Canadian currency. We had to support the Canadian dollar over that period. It was really necessary to maintain tighter monetary conditions than at other times.
It is quite certain, I believe, that it would have been possible to maintain more relaxed monetary conditions than those which prevailed over that period.
[English]
Just to make sure I'm clearly saying what I want to say here, there was a period when we had to support the dollar because there was a kind of undermining of confidence. All things being said, had one been able to anticipate the weakness earlier, we certainly would have tried to ease monetary conditions earlier than actually happened.
[Translation]
Mr. Loubier: Therefore, if the Bank of Canada had better foreseen the extent of the downturn over the winter and spring, there would have been some relaxation in the management of interest rates. In other words, they would have been lower than those observed in the winter and spring. Is that the case?
Mr. Thiessen: Possibly at a later point. During the winter, however, we did have problems on the financial markets and it was necessary to support the Canadian dollar.
Perhaps we could have had slightly lower interest rates a bit later on. However, it is always hard to say how one could have acted differently in other circumstances.
.1540
Mr. Loubier: But, Mr. Governor, with interest rates higher than warranted by market conditions, did not the Bank of Canada contribute in a certain way to a rather dismal employment situation as well as to the increase in the unemployment rate, which for Quebec, reached 11.2%?
In other words, in not having foreseen the importance of the downturn, did not the Bank of Canada contribute to a rather dismal labour market situation?
Mr. Thiessen: When markets are unstable, monetary policy cannot manage monetary conditions with greater certainty. The first thing to do is to stabilize markets and then it is possible to concentrate on the economy, the inflation rate, etc.
The Chairman: Do you have any questions, Mr. Brien?
Mr. Brien (Témiscamingue): I have two short questions for now and I will be coming back later. Thank you.
Mr. Loubier: Thank you, Mr. Thiessen.
Mr. Brien: You have mentioned two periods of uncertainty in financial markets. One was the referendum period. During that campaign, the No supporters were saying that a No vote would put an end to uncertainty in financial markets.
Now one week or nine days after the referendum, do you find that the response of October 30th has put an end to uncertainty in financial markets?
Mr. Thiessen: It is always difficult to pinpoint that kind of market uncertainty. I think that there is still some political uncertainty and that there is also uncertainty related to our fiscal problems. Those two together will certainly foster risk premiums on our interest rates.
Mr. Bernard Bonin (Senior Deputy Governor, Bank of Canada): We can see that the spread between short-term rates in Canada and the United States has narrowed sharply following the referendum.
Those who operate in financial markets on a short-term horizon, with three-month rates, for example, were right to judge that the situation would be satisfactory for the next three months.
In the case of long term rates however - 5, 10, 30 years - spreads have remained high, beyond the historical average, because people who deal in that market have come to the conclusion that some degree of uncertainty, both political and fiscal, continues to exist. Some among them have even seen there some inflationary possibilities. That is why they are protecting themselves with a premium.
Mr. Brien: Therefore, the No vote has not put an end to uncertainty in financial markets. It is a question of degree.
You have said, Mr. Thiessen, that the real uncertainty factor in financial markets was first and foremost the debt and that if this debt was not there, social concerns related to the political status would not translate in the market into economic concerns.
So what you said in your presentation, essentially, is that the main factor of uncertainty was the extent of the debt at the present time.
Mr. Thiessen: The two go together. If there is political uncertainty as well as problems with the budget situation, this contributes to an increase in risk premiums on our interest rates.
.1545
Mr. Brien: You have said that if Canada did not have a large debt, the fact that there is uncertainty in Quebec would be a concern from a social point of view, but not from a financial point of view for investors.
Mr. Thiessen: It would not be as worrisome as it is at present.
Mr. Brien: I see.
[English]
Mr. Grubel (Capilano - Howe Sound): Thank you very much, Governor, and gentlemen, for being here again. I appreciate this regular report on monetary policy twice a year. I think it's very useful for the public.
A year ago I suggested that the year-to-year consumer price index changes that you report on page one are hiding short-run trends. At the time you were very strong, and the data show indeed that the inflation rate has been almost constant at 2% since 1992. I suggested then that the inflation as reflected in month-to-month and quarter-to-quarter changes at annualized rates was in fact much higher. We can see that now.
I want to ask you straightforwardly what the month-to-month or quarterly annualized rates show now. Are you going to go outside of the target range when they will be coming in in a few months on an annualized rate, because we are very close to the upper range of the target?
Mr. Thiessen: Mr. Grubel, we fully expect that the consumer price index measure of inflation is gradually going to decline, certainly on a year-over-year basis. I forget precisely what we see in terms of month to month or quarter to quarter, but they must be coming down, otherwise the year-over-year rate probably wouldn't come down as we expect it to.
We certainly believe that in the next couple of months and into early 1996 we're going to see the year-over-year rate down closer to 2%, the middle of the range, which is what I think I said the last time.
Mr. Grubel: Yes, but it didn't happen. This levelling off is almost within the margin of error.
I would like to turn to a somewhat more controversial issue. You said the government would have to do its thing in order to make sure the inflation rate does not go up. I believe the Bank of Canada has some responsibility for competition in the financial sector in Canada. Am I correct on that?
Mr. Thiessen: Not directly, but I'm not sure what it is you're referring to.
Mr. Grubel: We know it's been widely publicized that the five oligopolistic banks in Canada have had substantial profits. I don't think this is bad. They have to recover from the past. We see from your statistics that inflation was practically non-existent.
I have a report here that was sent to me. In the face of these huge profits and in the face of practically no inflation, the banks of Canada have raised fees, all within the last three months, on bank machine withdrawals by 35%, on cheque clearing by 20%, on debit card purchases by 22%.
I believe in competition and I believe that we shouldn't be telling banks what to do in detail, but the fact that given banks are able to pass on those kinds of fee increases at a time when there is neither inflation nor a profit squeeze - in fact they have record profits - suggests to me that some of the critics who are saying that policy on financial institutions in Canada is not enough, that we need more competition, that we need credible entry of foreign banks by removing the capital requirements and all those other things.... It would make a significant contribution to keeping competition under control and I think it is certainly something the Bank of Canada and this government should be looking at. Why is this oligopoly protected so that they can do what I think is an irresponsible thing to do?
Mr. Thiessen: I certainly believe that competition is a very important aspect of the financial sector and it is indeed what over time ensures that the prices we pay for services in the financial sector are as low as they can be and the service is as good as it can be.
.1550
I don't feel able to comment particularly on the specific events that you mention. The bank is not the overseer of the chartered banks. We have an Office of the Superintendent of Financial Institutions. I think that's just one of the things that need to be looked at certainly in the period ahead when one is examining financial legislation to make sure there are not barriers to competition. I think that's terribly important.
I must say I've always been impressed by how much competition there is, that in addition to the banks there are of course institutions such as Canada Trust, the credit unions, the caisses populaires, which also provide a substantial amount of competition for the banks.
Mr. Grubel: Governor, I have been saying the same thing. But I am appalled, when there is this price stability, when we're all trying to go through a difficult period and when profits are at record levels, that the banks would have the gall to increase the fees by those rates all across the board.
I would like to hope that the bank will have an input into government policy and urge the government to reconsider the Bank Act and all the other financial institution legislation so that this kind of thing cannot take place.
Thank you very much for your answer.
[Translation]
Mr. Discepola (Vaudreuil): I must respond to the statements by my colleague, Mr. Brien, who lays the burden on the No side. Although the referendum is over, I believe that the debate must continue, given that, during the campaign, the issue of monetary policy, etc. was not really discussed.
What I believe, Mr. Thiessen, is that if the problem of uncertainty continues to exist even though Quebeckers voted No in the last referendum, it is probably because on the same evening, the two leaders, Mr. Parizeau and Mr. Bouchard, clearly indicated that despite the political choice made democratically by the people of Quebec, they were not ready to accept the results and that they were threatening us with a third referendum.
I would like you to answer Mr. Brien's question by telling us how much political uncertainty will cost Canadians and Quebeckers. You have mentioned the risk premium we are paying in Canada because of political uncertainty. Could you tell us how much of a risk premium we have to bear as Canadians and as Quebeckers?
Mr. Thiessen: We cannot calculate that. All we know is that the uncertainty which is prevailing in financial markets is the cause of the current risk premiums. We do not know if these risk premiums stem from political uncertainty or from our fiscal problems. All we can do is note that there is a 170 basis point spread between long-term interest rates in Canada and the United States, a spread which is quite high.
Normally, the spread is roughly 100 basis points, but given the lower inflation rate in the United States, we could expect a spread of less than 100 basis points. However, because markets are nervous due to political uncertainty and our fiscal problems, the spread is roughly one percentage point.
.1555
Mr. Discepola: Is it reasonable to assume that this costs us on average 0.5%?
Mr. Thiessen: We do not really know. It is too difficult to say. Our fiscal problems and political uncertainty go hand in hand; it is impossible to separate them.
Mr. Discepola: You say that there is a correlation between the political uncertainty and the level of indebtedness of various governments. You say that these two factors combined exert enormous pressure on monetary policies. Which of these two factors represents the biggest burden?
Mr. Tim Noel (Deputy Governor, Bank of Canada): As the governor said, it is very difficult to separate political risks from financial risks. It is clear that one leads to the other and they are both involved in the overall picture. As Mr. Bonin mentioned earlier, short-term interest rates dropped 140 basis points after the vote; given that the term is three months, people are not concerned when the timeframe is that short.
But in the case of long-term interest rates, the decrease in the spread was only 20 to 30 basis points after the referendum.
Mr. Discepola: The fact remains that the spread for long-term interest rates is roughly 1.7%.
Mr. Noel: Absolutely.
Mr. Discepola: If we could settle this issue once and for all, we could save an enormous amount on our borrowings. If we can reduce the spread by 1%, we will be able to pick up three billion dollars that could be used to maintain social programs.
Here's my last question. You say that monetary policy is necessary. Do you believe that it is possible to have an economic and fiscal policy if there is no control of monetary policy? And how are the two related?
Mr. Thiessen: I am not sure that I fully understand your question. Can you repeat it?
[English]
Mr. Discepola: Okay. How do you relate monetary policy to fiscal policy? Can you possibly have no control of monetary policy yet expect to maintain your economic policies and your fiscal policies intact? Are the two related? If so, can you tell us how?
Mr. Thiessen: I think monetary policy certainly has an obligation to pursue its objectives even though there are other objectives being pursued by fiscal policy. I think there's no question that monetary policy has an obligation to deliver low inflation. You can't say somehow that if other policies aren't appropriate you should be relieved of that responsibility. To that extent - and I'm not sure this is where your question was leading - monetary policy has to be responsible for what it delivers or doesn't deliver. We cannot say sorry, other policies weren't right.
Mr. Discepola: But why has the bank's fixation always been on low-inflation policies, for example, for the past several years?
Mr. Thiessen: Because that's what's going to help this economy to work as best as it possibly can. That's the kind of policy that's going to bring us the lowest interest rates possible, the kind of policy that makes it easier for people in business, for savers, for individuals, to make good economic decisions. That's the kind of thing that contributes to productivity growth, and in the end the only way our standard of living rises over time is with good productivity growth. That's what monetary policy geared to low inflation can help to deliver.
Mr. Discepola: For my last question, then, I would ask why it is that despite the low-inflation policy we've had in Canada, the true effect of real interest rates has been larger.
Mr. Thiessen: Because, as we've been talking about, the problems we've had with our fiscal situation intertwined with, or related to, the political uncertainty we've also had to deal with. The two are very much intertwined.
.1600
The Chair: Mr. Campbell, please.
Mr. Campbell (St. Paul's): Mr. Chairman, I have my questions all lined up, but I must say I'm a little confused, as indeed the governor may be. It throws me off a little bit when I hear my friend from the Reform Party talking about bank profits that way, expressing concerns about the banks. It's refreshing indeed, although some things never change before this committee. We still have people who say and believe that it doesn't matter what we say, what the political reality is in Canada, what is threatened, or what the future may hold, none of it should have any impact on the things you look after.
Clearly foreign holders of Canadian debt and foreign investors don't look only at the fiscal monetary policies of the federal government. They tend to look at Canada as a whole. I wonder if you care to comment on how that debt management picture has changed across the board since your last appearance before this committee.
Mr. Thiessen: Well, Mr. Campbell, it certainly has improved. There is no question about that. There was a series of provincial budgets, as well as the federal budget, which certainly contributed to investors, both Canadian and foreign, taking a far more positive view of the financial situation in this country. I think that has been reflected in some narrowing of interest rate spreads. Certainly the kind of commentary that we hear in financial markets is a much more positive one than the one we were hearing, for example, in January of last year. So yes, I think the situation has improved more generally.
Mr. Campbell: Are there any provinces that haven't yet taken any steps in that direction?
Mr. Thiessen: I really do not like to get into the business of specifying individual governments and what they have and have not done, Mr. Campbell. It's always a very dangerous business for the central bank to comment too specifically on individual budgets, individual fiscal positions. The point I really do want to make over and over again is that the overall fiscal situation matters a lot. Until we really have it under good control, we will continue to be vulnerable to every little piece of bad news that comes along. We will pay dearly for those pieces of bad news in terms of risk premiums in our interest rates. We need to reduce the vulnerability we have in this country to those circumstances.
Mr. Campbell: So if I understand you correctly, we are only as strong as our weakest link. If provinces as part of the overall picture are not cleaning up their act and the federal government is not doing its part, we are all affected in the spreads. And some provinces indeed pay higher premiums for failure to act than others. Is that true?
Mr. Thiessen: I would agree that you would certainly prefer to have all governments on a good, sustainable, fiscal track.
Mr. Campbell: That's not currently the case as far as a foreign investor would see things?
Mr. Thiessen: I think foreign investors still are nervous about the future.
Mr. Campbell: Mr. Chairman, I have one other quick question.
Recently in the House I asked a question of the Secretary of State for International Financial Institutions with respect to derivatives. He commented on steps being taken to bring more stability or more public confidence in that market. To what extent does the increase in derivatives trading make your job more difficult?
Mr. Thiessen: I don't think it normally does. Normally derivatives make a financial market work better. I guess what it really does is allow a lot of people, and particularly financial institutions, to bear the amount of risk they wish to bear and the kind of risk they wish to bear. Derivatives really do allow people to move risk around and carry the kind of risk they feel most comfortable with. That's a very good thing. It makes institutions more sound and reduces the risk to the system as a whole.
It is the case, however, that the nature of derivatives is such that they can at times exaggerate fluctuations in the market. I must confess that overall I think the contribution they make to making markets work better is the more important of the two. That being said, it is absolutely important that authorities monitor those situations closely and make sure that those people who are issuing and using derivative instruments are doing so appropriately. That requires that a substantial amount of information be provided on their operations.
.1605
Mr. Noel: There is a way in which derivatives help the central bank do a better job, in the sense that they provide more signals as to how the market feels about the future course of interest rates or the exchange rate. In that sense, it is helpful to us.
Mr. Campbell: Thank you.
Mr. Silye (Calgary Centre): Mr. Thiessen, I'd like to talk about the debt. In my notes it says that the Bank of Canada also acts as fiscal agent for the federal government, handling the national debt and operating the foreign exchange account. What is the size of the debt right now?
Mr. Thiessen: I guess it depends on exactly -
Mr. Silye: What was it the last time you checked?
Mr. Thiessen: Are you talking about the federal debt?
Mr. Silye: Yes, the federal debt.
Mr. Thiessen: There are various ways of looking at it. You can look at the federal debt, the total public debt, or the debt of Canada vis-à-vis the rest of the world.
Mr. Silye: Could you give me the federal debt, please?
Mr. Thiessen: It should be a number that I know off the top of my head -
Mr. Silye: Five hundred billion something.
Mr. Thiessen: I think $550 billion is the right number.
Mr. Silye: How much of that federal debt - I won't use the word ``national'' - is foreign held?
Mr. Thiessen: About 40%.
Mr. Silye: Is that the same percentage on the combined provincial debt?
Mr. Thiessen: No, in the provincial area it would be higher than that.
Mr. Silye: What would be the combined provincial debts of the ten provinces?
Mr. Thiessen: It's another couple of hundred billion. I'm sorry that I don't have those numbers. I should have them, but I don't.
Mr. Silye: Round numbers are okay.
The Chair: I think you can assume that the total provincial and federal debt is roughly $800 billion. It's greater than our gross national product.
Mr. Thiessen: It's greater than 100% of our gross national product, that's right.
Mr. Silye: Are you saying that the provincial debt is about $200 billion or higher?
Mr. Thiessen: It's somewhere in that vicinity. I'm sorry that I don't have the number, but -
Mr. Silye: And foreigners have lent us how much of that money?
Mr. Thiessen: I think it's somewhere in the order of 50% or more, but I'm less certain of that number. I can certainly check it for you.
Mr. Silye: Okay. It seems to me that the debt and the size of the debt must be a major concern when you sit down and think about monetary policy, regulating credits and what's in the best interest of our economy.
Mr. Thiessen: It certainly influences financial markets, and those are the markets that we use to implement monetary policy, yes.
Mr. Silye: So the speed with which we stop adding to that debt and present a plan to foreign lenders that shows us being fiscally responsible and that we will stop adding to this debt in a short period of time - would that be a positive sign to foreign lenders?
Mr. Thiessen: Yes.
Mr. Silye: The finance minister and his department, with whom you have to work very closely, have this target of 3% of GDP by the end of his mandate, which is another two years from now. Do you feel that -
Mr. Discepola: That's 1996-97. Don't forget that we have a five-year mandate.
Mr. Silye: My point is that this finance minister has set his target at reducing the deficit to 3% of GDP. So on the one hand he's trying to reduce the amount he's adding to the problem, but he is still adding to the problem.
Would it not be better from a fiscal economic point of view to present Canadians and foreign lenders with a program that shows how we can get to a zero deficit, stop adding to the problem, over a three- or four-year period?
.1610
Mr. Thiessen: I don't know. I think you're getting into areas that are really in the end political decisions.
Mr. Silye: Mr. Thiessen, you handled a political situation on behalf of the Bloc here, on behalf of the Liberal member, that the political uncertainty of Quebec separation affects interest rates and there is a risk premium that we pay. So what's the risk premium we pay if we don't get to a balanced budget?
Mr. Thiessen: Once again, the crucial thing here is to have a credible plan that convinces investors they don't need to worry about their investment into the future. That's what matters most of all. I don't think I or anybody else can say precisely what the best way of doing it is.
Mr. Silye: There's an interesting section here prepared by the Library of Parliament about managing government debt, and I'd like to ask a few questions related to that. I think it's very pertinent to this briefing.
The Minister of Finance proposed the introduction of a new retail debt program in order to reduce the reliance on foreign investors. Combined with this target of 3% of GDP, which is adding to the problem at lesser amounts than the previous government, he's also trying to figure out a way to instil confidence in our own domestic markets and get to handle more of our debt ourselves in our own country.
They're looking apparently at consulting widely with the financial community to find out if there's any new set of instruments that can be used over and above say Canada savings bonds. Have you been involved in these negotiations, and if you have, can you shed any light on this?
Mr. Thiessen: Yes, we certainly have been involved with them. We act as agent for the government in a lot of these areas, so we have been a source of advice.
Certainly the idea is that there is a retail market that has not been as well tapped into or perhaps quite as well served as it might have been. So the idea is to look to see whether there are new instruments, new arrangements that would make various government debt instruments more accessible to the individual.
Mr. Silye: Could you give us an example of one type of new instrument?
Mr. Thiessen: I don't know that we're all that far advanced. One of the first things that was done this year was to make Canada savings bonds eligible for RRSPs. I think what you need to do is to look at the current arrangements for Canada savings bonds. Are there other kinds of instruments that might be useful or not? I think you really want to consult with the people who are out there providing those services all the time and find out what there is that can usefully be done.
Mr. Silye: From what I read, the introduction of the deductibility of a Canada savings bond directly into an RRSP is.... I thought it would work a lot better than it has and I'm personally not happy or satisfied with the results. Are you personally satisfied with this new issue of Canada savings bonds?
Mr. Thiessen: I think it's very early to say. Last year we put in a new form of Canada savings bond that had a three-year term. We continued that this year. We added the RRSP, but of course the campaign was held during October, a time when there was volatility in financial markets and quite a lot of uncertainty. I don't think you really want to judge this campaign too harshly, given the time period during which it was conducted.
Mr. Silye: You know, Mr. Thiessen, RPMs are measured in a car and there's always a red area as you sometimes accelerate and you stay in one gear too long. With this analogy, where does it start to show red on your RPMs in terms of overall national debt? My good colleague Herb is always telling me about debt-to-GDP ratios. As a Canadian taxpayer, where is it as a country that we really have to start worrying? Are we in the red zone now? Do we still have more RPMs left to get to the red zone? Can we still increase our national debt?
Mr. Thiessen: It's sadly one of those questions for which I wish there was a nice, clean, simple answer. Certainly economics isn't capable of providing us with a nice clean answer. What we know is that you learn from experience. What we know is that in the last few years we have become very vulnerable to shocks of one kind of another - the bad news that I was mentioning a while ago. That puts us in a vulnerable situation.
.1615
One can certainly conclude that where we are right now in terms of debt ratios is that they are too high and we would really like that debt-to-GDP ratio to decline, and that means smaller deficits and a growing economy.
Mrs. Stewart (Brant): There's a specific event I'd like to question you about that occurred in October. I'm interested in it because I received so much mail from my own constituents, and then in the week before the referendum vote from Quebeckers themselves. It's the report that the Province of Quebec used a considerable amount of its cash to prop up the dollar. There were reports that it was maybe somewhere around the area of $500 million.
I was going to ask you if you knew or could estimate how much the province used at that particular juncture. I'm sorry I don't remember the date of the newspaper reporting. What is the medium-term effect on the province, and is there any impact on the country as a result of this initiative? Is it usual that a province would make such a dramatic entry into the marketplace?
Mr. Thiessen: I'm going to disappoint you here, because I really don't think it's appropriate for the central bank to comment on other participants in the financial markets. It's just not our place. I would, however, say that the foreign exchange market is a very large one. Our estimate is that the average flow through it on a daily basis is $30 billion. This means that typically no one participant can have a huge impact on it. But there are times when an individual participant, given the market, can have a temporary effect.
I don't think there's any one single participant who can have the effect the central bank can have. When we go in there and intervene we not only have the tool of exchange market intervention, we also have the possibility of changing our interest rates. So when we're in there the market tends to pay rather more attention than when anybody else is in there.
The Chair: Could I follow up with a supplementary on that? What did the Bank of Canada itself have to do in terms of foreign exchange intervention just before the referendum?
Mr. Thiessen: Chairman, I'm going to be a very disappointing witness. The exchange reserves are only published once a month, and I fear the Currency Act does not allow us to comment on them other than that. So the exchange reserves during the month of October declined by $400 million due to intervention, and that was the point at which the currency went up and down and up again. That's basically all I can tell you about our foreign exchange intervention. We act as the agent for the Minister of Finance, and the law does not permit me to comment on specific actions.
The Chair: Even if we went in camera?
Mr. Thiessen: I'm afraid not, sir.
[Translation]
Mr. Loubier: It's a good thing we're here, Mr. Chairman. It is a good thing the sovereigntists are here, because you would have a lot of trouble justifying your lack of action in controlling public finances. If there was no political uncertainty on the table, you would be in a bind!
A lot of things are attributed to the sovereigntists. Poor federalists! They're part of the political equation, but they have not provided the solutions!
In short, I wanted to clarify that determining exchange rates and interest rates depends on several factors. Moreover, remember when Mr. Mulroney tore up the Charlottetown Accord in Sherbrooke, and said: "That is what we're going to do to Canada if we reject the Charlottetown Accord." The next day, interest rates went up, because the Canadian dollar started to fall.
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Paul Martin, the Minister of Finance, campaigned during the referendum saying that sovereignty would cause more than a million jobs to be lost. It is things like that that do the most damage. It is ridiculous comments like that made by important people on the financial scene that are most often the cause for fluctuations in interest rates and in the value of the Canadian dollar.
I want to remind you of one thing. You said earlier, Mr. Governor, that you could not ease monetary policy last winter because the Canadian dollar was weak on financial markets. That reminds me that last January, just before the Minister of Finance brought down his budget, the Canadian dollar was at 70.2 cents. That was when Moody's said that the federal government's financial situation was being monitored and that its credit rating could even be downgraded. There was no referendum last January, and the Canadian dollar had already hit the lowest point. The same thing happened after the Martin budget. Two weeks after the budget was brought down, the Bank of Canada rate hit 8.6%, if I remember correctly. And yesterday, the bank rate was at 6.18%.
When you look at the current situation and talk about political uncertainty, you can see that the debt and its prospects in the medium-term are what have persisted since last January. There's a lot more than that involved in the change in interest rates and the spread.
You talked about the spread between interest rates in the US and Canada. Don't try to tell us that financial markets have taken note that there may be another referendum at some point over the next few years and that's the situation. The fundamental problem is the federal debt. It seems to me that that's what remains today. There are no more referendums, there's nothing at present, and you are saying that there is still uncertainty. I think that the uncertain future of federal public finances is more at play here than anything else. The current debt is 570 billion dollars. In three and a half years, at this rate, it will reach roughly 800 billion dollars. That's what financial markets are worried about. So stop saying we are responsible, and above all, stop acting like someone who lost last week. I've never seen anything like it!
The Chairman: Excuse me. Do you have a question for the Governor?
Mr. Loubier: Yes, I have a question that is perhaps not linked to the preamble. Is it not true, Mr. Governor...
The Chairman: I had the impression that was the question.
Mr. Loubier: Is it true, Mr. Governor, that one week prior to the referendum, the Bank of Canada rate increased 100 basis points? If, one week later, the rate dropped by between 140 and 150 basis points, there's not much difference with respect to the fluctuations of the week before. Saying that it was an unprecedented drop is not really true.
The Chairman: Thank you. Mr. Thiessen.
Mr. Loubier: It's funny, but when members of the government party ask questions, the chairman is extremely patient. When it's the Bloc Quebecois's turn, he all of a sudden gets impatient.
The Chairman: Thank you.
Mr. Loubier: Mr. Chairman, please preside over this meeting objectively, because it's starting to annoy us. Thank you, Mr. Chairman.
The Chairman: Thank you. Mr. Thiessen, you have the floor.
[English]
Mr. Thiessen: I'm not sure, Mr. Chairman, whether I've discerned the question.
[Translation]
The Chairman: Thank you. Next please.
Mr. Loubier: Mr. Chairman, please play fair. I asked the Governor a question. He did not understand it. I will repeat it.
One week before the referendum, the bank rate increased by roughly 100 points.
Mr. Thiessen: Exactly.
Mr. Loubier: This week's drop is said to be unprecedented. Compared to the way it fluctuated the week before, it didn't drop all that much. It dropped roughly 40 or 50 points. Is that correct?
Mr. Thiessen: Yes.
The Chairman: Thank you.
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Mr. Bonin: I would say that this is just a sign of what we call market volatility. When you see interest rates fluctuating in this way, it is clear that the markets are volatile. I would just like to remind you, Mr. Loubier, that while the bank rate was fluctuating, the rate on which we act, the call loan rate, that is the rate for loans made on a day-to-day basis, did not change throughout the entire preceding period in order to stabilize and calm the markets as much as possible.
The Chairman: Thank you. Ms Brushett.
[English]
Mrs. Brushett (Cumberland - Colchester): Thank you, Mr. Chair.
Thank you for being here. You've talked about credibility and the great influence this has in the market place here, on investment in Canada, and also about how we're closely tied to the political system. Do you believe the independence of the Bank of Canada from the political system would have greater credibility in the market place? Would it give you more freedom and ability to generate stability?
Mr. Thiessen: The Bank of Canada already has a very substantial amount of autonomy to operate, and I think that does give us a lot of credibility to operate. It does allow us, I think, to pursue our price stability objective to improve the performance of the economy and then be held responsible for it.
So the answer is yes, we already have a large margin of independence. It is very important, and it assists our credibility.
Mrs. Brushett: May I just take this another step further, then? You say as well that we've been dealing with inflation for a decade, it seems. That's been the governing theme, to keep inflation low. Yet interest rates have had that great spread. Again, we tend to blame political instability. If we have this threat of continuous referendums, does it imply that we have no control over stability for the next few years?
Mr. Thiessen: I'm not sure about that. I hesitate to be drawn in on any questions that have a large political element. That, I'm afraid, makes me rather cautious in the way I respond, but can I just say again, there is no question that more certainty about the future helps financial markets. When financial markets feel more certain about the future, risk premiums and our interest rates are lower, which allows the economy to operate more effectively. It reduces a burden that now exists in our economy because we are paying those high interest rates.
Mrs. Brushett: Thank you.
The Chair: Mr. Grubel.
Mr. Grubel: Thank you, Mr. Chairman, for giving me a second chance.
You undoubtedly saw chapter 9 of the Auditor General's latest report, in which he suggested that national dialogue ought to be taking place on the question of what is a sustainable or optimum level of debt. I wonder whether you could comment with your views on this. Furthermore, I'd like to know whether you have anybody in the research department working on that subject, and if you do, whether we can have a copy. Also, I'd like to know whether you have any ideas on where we as a finance committee might turn to get some ideas on how to approach this question.
Mr. Thiessen: I am certainly aware of the concerns of the Auditor General. No, there's nothing very specific going on in the research department of the Bank of Canada to help answer that question. There may be more work that can be done. I would not wish to hold out to you that I am perfectly aware of all the economic analysis that's been done in this area.
My impression still is that the economics profession doesn't have much to offer when it comes to defining, in an objective fashion, what is the optimal level of debt. I fear that it still remains that you find out when you run into it, and when you are subject to the kinds of risk premiums we've been subject to, I think it tells you you've gone too far.
The Chair: Mr. St. Denis, please.
Mr. St. Denis (Algoma): To the governor and his colleagues, thank you for being here. I would like to ask a couple of questions that relate to the big picture, if I may.
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We had before us yesterday a round table involving people in the charities, the fund-raising sector. We talked about issues relating to how the charity sector can properly function in light of government cutbacks and so on. It occurred to me during that discussion that one of the objectives they have is to try to mobilize wealth in the hands of Canadians to be put to use for the public good.
From your point of view, are there measures of how the wealth of our country as it is held by individuals, corporations, government, etc., is being utilized? Are there measures of how it is moving around to contribute to the growth of our economy? To use a simple analogy, it seems to me that if you put money under a rock, nothing happens to it. If it's invested at a high rate, at a risky rate, however, we have a chance of making some money.
Are there measures of how well we do as a country with our wealth in terms of turning it into new wealth and into growth? Are we a country of people who put the money under rocks, or are we a country of people who take chances with their money? What has the trend been as a nation in that regard?
Mr. Thiessen: There's certainly no money to speak of under the rock. Virtually all of it is invested in some way or another. Whether that money comes from savings that go into a bank account or a credit union account, or whether it goes into a pension fund or insurance fund, all of those moneys are invested. Whether they're invested in the government bonds or invested in loans to business or purchases of equities, all of that money is invested. None of it is lying idle in any way whatsoever.
We are also a major user of foreign savings, and we have been through most of our history. Not only do we need all the savings we generate in Canada, we also have typically borrowed a huge amount of savings from abroad, and we continue to do that. So it's hard for me to say that somehow or other you can see some fundamental flaws in all of that when you look at it.
I know you can argue that perhaps Canadian savers are a little risk-averse and that it would be nice if they were prepared to put their money a little more at risk. Perhaps that's so, but that kind of risk-seeking behaviour typically occurs as you get wealthier. I think you see it mainly in very affluent countries like the United States - more so than you do in lots of other places. So no, I can't say to you that I can see a problem here that needs fixing, that we'd be a lot better off if we could just kind of move those moneys somewhere else.
I guess in the end what really matters is what happens to our productivity growth and how good that has been. And it hasn't been all that good. So I guess there is a measure there that says we could do better than we have in the past. I am, however, rather encouraged by the recent performance of the business sector in Canada. I see a great deal of investment in productivity enhancement and in restructuring to become more competitive, and also an ability to raise money in the equity market to finance these. I must say this suggests to me that we're on the right track for the future.
Mr. St. Denis: Thank you. Mr. Thiessen, I have a second question relating to the big picture but unrelated to the first one. I appreciate your response. Productivity may be the measure I was asking about.
While there has been volatility in other areas, we have seen the inflation rate in Canada remain quite stable over the past several years. Have there been other periods in our recent history - the last twenty or thirty years - that are similar on the inflation side for a similar length of time and from which conclusions can be drawn that are relevant to the current situation, notwithstanding that the circumstances of the world and the country are different? I'm wondering if you have found guidance in other periods of time such as that.
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Mr. Thiessen: Yes. The period I find most interesting to look at is the period of the 1960s, which was a period of rapid growth and productivity, and therefore growth in standards of living, and which was also a period of very low inflation. It was a period when the Canadian economy worked remarkably well. You can see that in productivity growth, you can see it in what was happening to incomes and standards of living. So when people ask me how I know that low inflation is really beneficial, I think that's a very interesting period to look to.
The other interesting thing to do is to look at other countries that have maintained relatively low inflation rates and see how well their economies have functioned. I guess the best examples there are Germany, Switzerland, and Japan, which by and large have functioned rather well. It doesn't mean you avoid all the problems, because certainly all of them have problems - and currently the Japanese have some serious problems. But when you look at the last 20 years and you ask which countries have worked well, what periods have worked well, it seems that you can see this relationship between low inflation and good productivity growth. That is not to say it's the only thing that matters, but it obviously helps.
You will see that Alan Greenspan in the United States is making quite a lot of this these days. I know he and some of his people have been looking to see if they can't put some hard numbers to that relationship.
[Translation]
Mr. Brien: I have two brief questions.
Earlier, you said that you may have incorrectly assessed the extent of the economic downturn, particularly this spring, because there had been too much volatility during the winter. I would like to know what direct influence the minister of Finance had on your assessment and on the management of your activities at that time.
Mr. Thiessen: The activities of the Bank of Canada?
Mr. Brien: Yes.
Mr. Thiessen: As required by law, we discuss the Canadian economic situation, and our economic, fiscal and monetary policies with the minister almost every week. However, the Bank of Canada and its board are responsible for monetary policy.
Mr. Brien: That's what I thought. In recent weeks, we've heard the minister of Finance say several times that he was responsible for monetary policy and that the federal government was responsible for managing it. However, in response to Ms Brushett's question earlier, you said that the Bank of Canada was very independent as to the management of monetary policy.
So one of you is not telling the truth. I am more inclined to believe you. So is the Minister of Finance being accurate when he tells people that the federal government and he himself control monetary policy?
Mr. Thiessen: It's important to point out that the minister is responsible for monetary policy as well, because he can direct us to change it.
[English]
So he always has the possibility, finally, ultimately, that if he doesn't like the policy, he can change it. So he has to take a kind of general and ultimate responsibility. But in terms of the day-to-day, week-to-week, month-to-month operations of monetary policy, the bank is responsible and the governing council of the bank takes responsibility for policy.
[Translation]
Mr. Brien: But only once was there a major difference of opinion between the minister and the Governor of the Bank, and the governor resigned in that case.
Mr. Bonin: That was before the minister had the power to issue directives. In 1967, the Bank of Canada Act was amended to include this power and to set out the relationship that exists between the minister and the governor. You are referring to an incident that happened in the 60s, involving Mr. Coyne.
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[English]
The Chair: Merci, Mr. Brien. Mr. Pilliterri, please.
Mr. Pillitteri (Niagara Falls): Thank you, Mr. Chairman, and thank you, Governor, for being here today.
Of course this is very serious and should not be a forum where anyone scores political points. I think we should be more rational in the questions we ask and not make any innuendos.
A minute ago the honourable member said the Minister of Finance referred to the fact that two million people would have lost their jobs. In fact, the remark he made was that one million jobs would have been at risk, not two million. So before we condemn others in numbers, I think we should check our own numbers.
I recall last year we had representatives from the Department of Finance here and we asked them how much of our debt was foreign held. At the time they said it was about 26% of the national debt, but if you took the rest of Canada into account it would be closer to 40% Is there much fluctuation in the debt held by Canadians or being bought by outside interests?
Mr. Thiessen: It does vary a little. In fact we just put out some tables in our last quarterly bulletin that show a substantially smaller reliance on foreigners in the recent period, so it does fluctuate a bit. But in terms of proportions of debt, you have to have some really large movements to vary those percentages very much. The flows can seem to change quite a lot, but because the stock of debt is large, it would take quite a lot to move it. So the 40% we mentioned doesn't change that quickly.
Mr. Pillitteri: Would that be in regard to the total national debt, or just the federal government?
Mr. Thiessen: That was the number we had for the federal government. Isn't that right, Tim?
Mr. Noel: I thought maybe it was for the total of all governments. I'm not sure of the numbers. We can check them for you.
Mr. Pillitteri: I would appreciate it.
The Chair: I think approximately $300 billion is held outside Canada, of the total $800 billion of combined provincial and federal debt. That's the working hypothesis we've been using,Mr. Pillitteri.
Mrs. Stewart: Governor Thiessen, there are people, and maybe some around this table, who think we should be far more aggressive in our pursuit of a zero deficit. You were saying what seems to be important to the foreign markets is a clear and stable plan.
If we were more aggressive, would the markets consider as well the impacts of that aggressiveness, the impact of a downturn in economic growth in consumer confidence as people virtually lose their jobs? We're seeing some of the impact, even with the more balanced and controlled strategy we're undertaking as a government.
If there isn't a very aggressive strategy or single-minded focus on moving to zero, I'm wondering whether that in itself creates an uncertainty or confusion in the marketplace.
Mr. Thiessen: I think that's difficult to say. It's certainly true, however, that if you get on a credible strategy for reducing your deficit and therefore bringing your debt to gross domestic product onto a declining track rather than a rising track, you are likely to get a benefit in terms of those risk premiums we've been talking about.
There is a benefit on the other side. Remember that when the risk premiums go down for the government they also go down for all borrowers in Canada.
Mrs. Stewart: The important word there is ``credible'', and in the determination of what is credible some aspects are identified in terms of the impact on economic growth in the short term and the medium term and the impact on individual consumers or citizens in their day-to-day lives. Are those things part of this definition of credibility?
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Mr. Thiessen: It's certainly true that if the markets thought a program brought forth by the government would have such economic impact that it would lose public support, it wouldn't be a very credible program, obviously. I certainly think the financial markets look for programs that are credible, and the more public support they carry, the more credible they are.
I think one of the very interesting things that has happened over this past year is the evident public support for measures to put budgets on more sustainable tracks. There's no question that when you talk to people in markets who are responsible for investing accumulated savings in this country and elsewhere, that's certainly on their minds.
Mrs. Stewart: But is it also credible and real to expect that if significant cuts are made to government programs, to things that relate to the continued maintenance of a deficit, that rate of economic growth can be impacted significantly? Despite whether there's public approval to get down to zero really quickly, don't we know, can't that really have an impact on economic growth and its sustainability?
Mr. Thiessen: When you have these large risk premiums in your interest rates, it's not clear that you don't benefit more by getting your deficit down, that the benefit to the economy of lower interest rates is very substantial.
Mr. Grubel: May I just remind Mrs. Stewart of the fact that the GDP is $750 billion? If the economy grows at 4%, the GDP would go up by $30 billion. The deficit is $30 billion. In one year economic growth would be sufficient to cover the reduction in spending, except that there are also spending increases to the interest and accumulating debt. As far as the size of the economy is concerned, what is needed to go to zero quickly is tiny, as long as we have economic growth.
I would like to ask the governor just one question on the subject of retail debt. Why was it decided to do that in house? It seems to me this is a classic example of an economic activity that could have been contracted out to the private sector. We all know that the private sector is more efficient. You set the standards and the requirements. You could have asked for bids for the right to handle the contract. Why did we burden the budget with yet another activity like that, invite another unionized group that will have difficulty keeping expenditures under control, when the private sector was ready to take it?
Mr. Thiessen: I'm not sure whether the private sector was ready to take it, but remember the whole idea of setting up this special group to manage retail debt was so one would be in a very good position to contract parts of it out. So there has been no decision about exactly how much will be done in house as opposed to how much is going to be contracted out.
The crucial thing is to have a group of people in place who would manage the strategy. After that we'll see how much gets done in house as opposed to what gets done in the private sector.
Mr. Grubel: Did the bank hire a president to head this organization?
Mr. Thiessen: The government is in the process of hiring a president to run this organization.
Mr. Grubel: What will his employment contract be and for what length of time?
Mr. Thiessen: Goodness, I don't know. That will have to be negotiated, I guess, between the Ministry of Finance and the person who takes it.
Mr. Grubel: Has the government approached those in the private sector and asked whether they were interested in doing it?
Mr. Thiessen: There have been a lot of discussions among the government, the bank, and the private sector about the way to run this kind of an operation.
Mr. Grubel: Is there a particularly great risk? Is it expected not to be profitable? Do you expect the deficit will accumulate in the process of retailing the government debt?
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Mr. Thiessen: No, this is really a big operation. For the Bank of Canada to keep track of all those Canada savings bonds and make all those payments is a larger operation than any that exists in the private sector.
Mr. Grubel: Yes, but word has it the reason it's so clumsy is because the bank hasn't discovered modern computers yet.
Mr. Thiessen: Oh, I don't think that's fair.
Mr. Grubel: I don't know the details of this, but I wouldn't be surprised if, as in many other government agencies, the speed with which technical change is introduced is not the same as in the private sector. So I really don't find that to be a particularly satisfactory answer.
I would love to have seen an official open approach to the very competent private sector in Canada - all the banks, all the investment dealers - that says the plan from now on is to not just sell bonds to big organizations in big denominations, but to have a system whereby private individuals could put that into their portfolios. Was any organization prepared to do that? Why did it have to be done in house?
Mr. Thiessen: I said the final decisions about how this is all going to be managed haven't been taken. All we've done so far is set up a special operating agency to manage it in the future. But that doesn't prevent the contracting out of all or part of it, whatever turns out to be the most effective.
Mr. Campbell: When the governor appears before us and we get into these discussions of debt and deficit, I'm always reminded of that story of the U.S. senator who said a billion here, a billion there. Sooner or later we're talking real bucks.
Following up on Mr. Grubel's last comment, it would be helpful, as plans are made for this program and in looking to the future at what may be contracted out, to know whether he's aware of other countries that have turned over the management of such a program to the private sector. I am not aware of any.
Mr. Noel: I'm not aware of anywhere that it has happened, but it doesn't mean there are some portions of the delivery of the service that can't be done by the private sector. In fact that's what the governor was saying in answer to Mr. Grubel's question.
Mr. Campbell: That's what I understood him to say. But I was concerned Mr. Grubel was talking about turning the management of it over to the private sector, holus bolus, as opposed to contracting out certain segments of it, which I heard the governor say is entirely in the realm of possibility.
Mr. Grubel: We know the banks have historically done this. There are an awful lot of things the government used to do that are now done by the private sector. In my judgment, the sale and redemption of these, the detailed operation of keeping books on who owns what, and all of that can be computerized and handled by the private sector. A lot of it is already being handled by the private sector.
Mr. Campbell: But you're not aware of any other country that currently does that.
Mr. Grubel: I don't know of any other government. We're also innovating here in the sense that for the first time we're going to have an instrument that in effect will compete with Canada savings banks as a retail instrument. It's not as clear to me at all on this distinction between the liquidity and the minimum size and what the rationale is for going into this business.
Mr. Campbell: I'm reacting to the suggestion that maybe we were doing something when everybody else was doing something differently. We're in virgin territory here and anything is possible. No other government currently contracts out the management of this kind of an operation. As far as we know, sitting around this table today, we might be the first.
Mr. Thiessen: I'm not aware of it.
Mr. Campbell: Mr. Grubel and Mr. Silye were very much concerned, as we all are, about the sustainability of debt. I think it was Mr. Grubel - it might have been Mr. Silye - who asked about what sort of guidance or benchmarks there will be.
I haven't heard much about this lately, but in the 1980s we used to talk at the IMF about debt service ratios. Now we're talking about deficit-to-GDP ratios and we're talking about comparing the overall debt to the size of the GDP. Are people still using that measure of debt service ratios? Is there any guidance there for those who are particularly concerned about the issue of sustainability of debt?
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Mr. Thiessen: Yes, the IMF, certainly for some small, heavily indebted countries, does calculations about debt service costs to export revenue, that type of thing. But for large countries, when you're worried about the future and your ability to carry a debt burden into the future, I think the best measure, and the one that most people tend to use, is the ratio of debt to gross domestic product. I think that's the one that by and large probably captures best the issue.
As I was saying earlier to Mr. Grubel, there is no really solid economic analysis that says to you it should be this ratio or that ratio. We do know there are some countries that have substantially higher ratios of public debt to GDP than we do. We do know, however, that in our current circumstances we are vulnerable.
Mr. Campbell: Thank you.
[Translation]
The Chairman: In answer to the questions asked by the Bloc Québécois, you said that interest rates in Canada were too high for two reasons: the size of our national debt and the political uncertainty in our country.
Thus, despite what the Bloc Québécois says, we are paying dearly for the political uncertainty it is subjecting us to at this time.
[English]
I would like to thank you very much, on behalf of all members here, for your presentation to us. You're always welcome before our committee.
Before we adjourn, I'd like to say that I neglected yesterday to thank our two clerks, Pierre Rodrigue and Martine Bresson, for the wonderful job they did organizing that round table.
We adjourn until tomorrow. Thank you very much.