Mr. Stephen S. Poloz (Governor, Bank of Canada):
Thank you very much, Chair. It's a pleasure to be here.
Good morning. Bonjour, tout le monde.
The Bank of Canada's commitment to Canadians is to promote the economic and financial welfare of the country. One way that we do this is to communicate our objectives openly and effectively and stand accountable for our actions. Thank you very much for this opportunity to come before you to share the bank's perspective.
Kindly note that today is day four on the job for me. It has been a busy three days. I trust you'll forgive me if there are any details, though, that I haven't yet become familiar with. But that said, I look forward to hearing your views and taking your questions, and I'll answer them to the best of my ability.
The common denominator that ties together all the bank's work is confidence. Through our actions and our words, what the Bank of Canada delivers is, first, confidence in our currency; secondly, confidence in our role as fiscal agent for the federal government; thirdly, confidence in our banking system; and fourth, confidence in the value of money.
This is familiar ground to all of us here today. I don't propose to delve into the details of the bank's functions. Rather, I will discuss the current context in which we are operating and how that is influencing the bank's work of delivering confidence.
It is now almost six years since the start of the global financial crisis. Given the near-collapse of the global financial system and the dramatic plunge in global demand, it's perhaps no surprise that we haven't yet returned to normal economic conditions.
The global economy continues to struggle. Most advanced economies are still facing credit stresses and record-low interest rates. Many central banks continue to use unconventional means to provide stimulus, and governments are doing everything they can to manage their respective debt situations.
Clearly, the global economy is still in recovery. Global economic activity is expected to grow modestly this year before strengthening over the following two years. But this is not a recovery in the usual sense; it's closer to a post-war reconstruction. It will require sustained and focused efforts to rebuild global economic potential.
Allow me to talk about how, in this context, the Bank of Canada delivers confidence. Let me start with confidence in our currency, which for many Canadians is our most tangible work. Every banknote in the wallets of Canadians is the product of specialized and sophisticated expertise. We have nearly 200 people at the bank, physicists, chemists, engineers, and other experts, who design, test, and distribute banknotes across Canada. We also communicate with retailers, financial institutions, and the public, and we work with law enforcement to fight counterfeiting.
The stakes are high when it comes to counterfeiting, not only in direct losses to Canadians but also the loss of confidence it creates in the use of banknotes.
The challenge of counterfeiting is significant. There was a time in 2004, for example, when counterfeiting in Canada was at an historic peak and very high by international standards. I'm sure many of you will remember seeing the signs posted in stores saying $100 or $50 banknotes were not accepted.
The Bank of Canada introduced enhanced security features and worked closely with law enforcement agencies, the RCMP, and the courts, as well as financial institutions and retailers, to bring those counterfeiting rates down, and we succeeded. Even before the introduction of our new polymer banknotes, counterfeiting rates had been reduced by 90%, but it's important to remember that staying ahead of counterfeiters is a constant challenge and we must always be proactive.
That's why the bank launched a new series of polymer banknotes that are safer, cheaper, and greener. They're safer because of sophisticated security features that make these notes very hard to counterfeit and easier to verify. They're cheaper because they last at least two-and-a-half times longer than paper-based notes. This means that fewer notes will need to be printed, making the series more economical. And they're greener, because over the life of the series fewer notes produced means fewer notes transported, and when they do need to be replaced the notes will be recycled right here in Canada. With these new notes, Canadians can have full confidence in their currency.
The second area of our focus is much less visible to most Canadians. As the fiscal agent of the federal government, the Bank of Canada provides advice and administers the government's debt and its reserves and demonstrates global leadership in these realms.
Innovative work is being done, for example, to reduce the reliance on external credit-rating agencies in the management of the government's assets and liabilities. There's a lot of money at stake. In 2012, the bank managed Government of Canada daily cash balances averaging about $17 billion. We also managed on behalf of the government, official international reserves amounting to about $69 billion.
The third area where the bank delivers confidence is in our financial system. As with any plumbing system, we tend to take notice only when things go wrong. Through the crisis and since, the bank's work has meant that the resilience of Canada's payment clearing and settlement system has been maintained at a very high level, ensuring that Canadians can have confidence that the economy is supported by solid financial market infrastructures.
Financial stability at home is necessary, of course, but not sufficient. The crisis made it abundantly clear that the global financial system needed remodeling and the Bank of Canada has been at the forefront of global reform work. Canada has also made good on our G20 commitments. Among other reforms, we have put in place Basel III capital standards ahead of schedule. We have made significant strides on other market infrastructure reforms, which we can address in detail during our discussion.
These are real accomplishments, and our financial system is stronger as a result. But we must not lose momentum, here in Canada or on the international stage. More work is required to end the phenomenon of institutions that are too big to fail, including recovery and resolution plans for banks. And countries need to address the issue of shadow banking to ensure that systemically important financial institutions operating outside the perimeter of regulation come broadly into line with their regulated counterparts.
Finally, confidence is clearly important for the conduct of monetary policy. Monetary policy in Canada is supported by a governance structure that instills confidence and ensures that Canadians, through their government, have a say in setting the monetary policy framework. Importantly, the structure also ensures the independence of the central bank to make the right policy decisions to achieve our inflation target.
Canada's monetary policy framework is a good one. After a tremendous amount of research, Canada adopted an inflation-targeting regime in 1991. Since 1995 the target has been 2%. We recognized at a very early stage that a commitment to hold inflation absolutely steady at 2% was unrealistic. Shocks to the economy must be taken into account, so the framework was designed to keep total CPI inflation at the 2% midpoint of a target range of 1% to 3% over the medium term.
It bears mentioning that this target is symmetrical: we care just as much about inflation falling below the target as we do about its rising above it. The bank raises or lowers its policy interest rate as appropriate in order to achieve the target, typically within a horizon of six to eight quarters. That's about the time it normally takes for policy actions to work their way through the economy and have their full effect on inflation.
Over the past couple of decades the average rate of inflation has been very close to target. Even during the global economic and financial crisis, our commitment did not waiver. The inflation target is sacrosanct to us and has become a credible anchor for the inflation expectations of Canadians.
A key component of the Bank of Canada's inflation-targeting framework is a flexible exchange rate. While the exchange rate is influenced by such variables as commodity prices, relative inflation rates, and relative interest rates, its value is determined in currency markets.
The credibility earned by the bank over the past 20 years allows us to take advantage of the flexibility inherent in this framework with respect to the amount of time it takes to return inflation to target. The recent turmoil tested the limits of our flexible inflation-targeting framework. Nonetheless, the inflation expectations of Canadians remain well anchored, proving that our framework is secure and working. But it also informs us that we need to validate those expectations to maintain our credibility.
This brings me to a discussion of the domestic context. The severity of the global economic and financial crisis meant that the recession it triggered in Canada was different from any other post-war recession. Canada experienced a particularly deep contraction of investment and exports, as business confidence plummeted along with global demand.
In the immediate aftermath of the crisis, stimulative monetary and fiscal policies proved highly effective in supporting robust growth in domestic demand, particularly household expenditures, which grew to record levels. Yet, as effective as it has been, with domestic demand now slowing, the limits of this growth model are clear.
What's less clear is the rebuilding process that underlies the necessary rotation of growth toward net exports and business investment. While the Canadian economy as a whole has recovered from the recession, thanks to domestic demand, the depth and duration of the global recession delivered a direct, sharp blow to Canadian businesses.
In many cases, temporary plant shutdowns were not sufficient to match the fall in demand. Some firms permanently downsized their operations. Others simply closed their doors. Large job losses resulted. In effect, the recession caused a significant structural change in the Canadian economy. The level of our country's productive capacity—in other words, its potential—dropped, as the bank noted in April 2009. Standard macroeconomic models don't really capture these dynamics.
Just as the financial crisis triggered an atypical recession, the recovery cycle is also unusual. The rotation of demand will require more than just the ramping up of production. The sequence we can anticipate is the following: foreign demand will recover; our exports will strengthen further; business confidence will improve; companies will invest to increase capacity; and existing companies will expand and new ones will be created.
In short, what we need to see is the reconstruction of Canada's economic potential and a return to self-sustaining, self-generating growth.
The sequence may already be under way. We are now seeing signs of recovery in some important external markets, notably the United States and Japan, and there's continued growth in emerging market economies. The bank expects that the gathering momentum in foreign demand should help lift the confidence of Canada's exporters. This is critical for Canadian firms to boost their investment to expand their productive capacity.
To conclude, the bank has a role to play in nurturing that process to the extent possible within the confines of our inflation-targeting framework. There is no conflict between nurturing this and our need to get inflation up to the 2% target.
In monetary policy, actions are critically important, but words, too, matter a great deal. We can bolster confidence by explaining the forces at work in our economy, our projections for what's ahead, and our monetary policy response. And we help nurture confidence by listening to businesses, to labour groups, and to industry associations in order to expand our understanding of what's happening in the real economy.
We must always remember that beneath our economic and financial statistics and analysis are real people making real decisions that can lead to bad outcomes as well as good ones. Those decisions are very hard to make at any time, but when uncertainty is high and confidence has not been fully restored, they can be even more difficult. A lack of confidence can mean that such decisions are simply postponed and opportunities are lost.
To help engender confidence, an active engagement with Canadians must be a cornerstone of the policy of the Bank of Canada, not least of which is a continuing dialogue with this committee.
With that, I thank you for listening and I would be pleased to take your questions.
Mr. Stephen S. Poloz:
Thank you. It's a pleasure to be here.
Thanks as well for the opportunity to elaborate. I think this is a very important part of the story.
I referred to it as a post-war reconstruction to capture the notion I have in mind, that the trauma that we've been through was not like a typical cycle in our economics textbooks at all. It was much deeper. It was caused by a financial crisis as opposed to a simple slowdown. It was longer. It therefore interacted with companies' banks. If you have a nine-month recession, of course your bank will let you ride the recession, but if it's a five-year recession, you're going to have to address the debt with the bank and so on. You have a very much more complex kind of story on the way down.
Part of that story was that companies simply exited. So some of the reduction in output and employment that we've seen is in that sense permanent, because the companies aren't there now.
So when we see the recovery process, then, it's not just a matter of expanding your output back to normal. For many companies it is, but for the companies that are no longer there or that have downsized significantly, it's a matter of their re-expanding, which requires a significant new investment, or being created out of thin air, which of course is an even more risky proposition.
It's for that reason that confidence plays a much stronger role in this move back up than it would in a normal cycle. It's also why our models don't really give us the insight we need in order to understand that process.
At the bank, we'll be investing more energy into this, understanding this, as we climb out. In the past, talks have likened it to a post-bubble crater that we are in, which will take a long time to get out of. We in Canada have been lucky, but the world will be in the crater for a longer period.
I trust that gives you more insight into what I'm trying to say there. It's a process that we need to understand. Clearly we need to nurture it, because it will require that gradual buildup in confidence and the actual self-sustaining Schumpeterian process, if I can use that term with the member, of natural growth, of new companies, new products, etc.
Those decisions are hard to make in an uncertain environment. The confidence, therefore, plays a much bigger role than normal.
Mr. Stephen S. Poloz:
Thank you for your other comments.
Yes, most of what we've talked about this morning has been about the economic cycle, what the crisis did to us, and what the recovery's looked like so far and what we hope it will look like as it further progresses.
On the other side of this is a global imperative that we modernize the global financial architecture. It's just like an old building: it did well and then along comes an earthquake that was totally unexpected—off the Richter scale if you like—and proved to be almost too big to handle.
The financial sector most importantly is a global marketplace, so all of this needs to be fully coordinated at the global level; hence, the activities of the Bank for International Settlements, and the FSB, which Governor Carney heads up at this point. So that gives us the opportunity to all talk about what are the needs, to agree on principles, and then everybody does the same thing, so that we get a level playing field. It's a very important ingredient.
Since then, there's been a massive strengthening in capitalization. Most countries and certainly most banks—all of our banks—are way ahead of schedule in this. So a significant increase in capitalization, an increase in liquidity requirements that go beyond this.... If you ask me if the banking system today in Canada or globally is stronger than it was back in 2007, absolutely it is. It's more resilient today than it ever has been. Still there is work to be done, and it's a very active area.
In particular, we haven't yet found a full-fledged remedy globally for the too-big-to-fail problem, which is very important. If you have an institution that is likely to fail, it is infectious, and it infects your entire system. It therefore leads authorities to do a bailout to protect the system. We saw that a few times during this crisis.
The idea then is to create an infrastructure that allows us not to have that—what we call bail-in—or resolution plans, or both. If you have a full plan of how a particular institution would be resolved if it ran into those kinds of problems, then you just tell everybody it's happening, and then it doesn't infect the rest of the system. That's a very simplistic way to summarize it. It's a very complex issue because financial systems vary a lot around the world. Again, we're looking for the level playing field where everybody can do the same thing. So it will be ongoing, but I'm very encouraged by that progress.
Mr. Stephen S. Poloz:
Thank you. There are actually lots of questions in there, so I'll do my utmost to touch on them.
First of all, let's begin with the premise that we are very lucky that we have these resources. Whenever we get to develop them and sell them to the rest of the world, up until now it has been like money in the bank. It's one of these things that may take time; however, we know it's money in the bank. So we're working on it.
I remember the days when for natural gas, we didn't have any liquefaction terminals, nor the ability to move it around. So it was a closed pipeline, North American market. It was completely divorced from global fundamentals. Now it's a little less divorced, because we can liquefy and export and so on. This shows you, again, exactly what can happen in the oil space, where if you have a constraint, you won't have an equivalence of the price here and the price out in the world.
All I can suggest is that as these infrastructures are developed in various ways, we have every reason to think that over time we become part of a truly global market. But the constraints, hopefully, will go away through time.
As to the implications for regionalization, if you like—or perhaps regional imbalances of economic activity is maybe the way to put it—I'm very heartened by the way we have adjusted to developments over the last five years.
If we cast ourselves back 20 or 30 years, it seems to me we would not have adjusted as well. It seems as though in Canada, our ability to adapt to these kinds of shocks has improved. People are more mobile. People react to these pressures, and off they go. That's great to see. It means that over time, hopefully over the next 20 years, those kinds of imbalances, regional ones, would be fewer than they had been in the past, because of those adjustments.
Bear in mind that when there is one like that, it's usually because somebody has decided that something we have is worth a lot more than it used to be. So we all benefit from that, because that's just more money coming in. And it's something worth adjusting to.