Mr. Thiessen reports on the future performance of the Canadian economy  (Central Bank Articles and Speeches, 25 Mar 98)
Central bank: boc | Type: speech | Date: 1998-03-25

Mr.

Thiessen reports on the future performance of the Canadian economy Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Can Club of Winnipeg, in Winnipeg on 25/3/98.It can take anywhere from one to two years for monetary actions to have thei effect on the economy.

Because of this, the conduct of monetary policy must be based on a what the economy will be like -- not tomorrow, not in a month -- but rather in one to two yThat is why in speeches in Vancouver and Toronto last year I spoke about wher Canadian economy might be heading in the future; what this might imply for our econ performance over the medium term; and what should the contribution of monetary policy Understandably, these important issues can get pushed aside because of the public focus current economic situation and on recent movements in short-term interest rates and in th value of the Canadian dollar.Today, I would like to use this opportunity to revisit these medium-term iss doing so, I will be underlining the crucial role played by productivity improvements in our performance.

The best place to start is with a brief review of the recent record.

## Recent economic performanceAs we approach the end of the decade, we can take satisfaction in the good eco performance of the past two years and in the notable improvements in our economic fundame The Canadian economy has expanded at an average annual rate of 4 per cent since mid-1996 even with the dampening effects of the Asian crisis, it is expected to continue to grow a pace

this year.

This should contribute to further gains in employment and reduce the a unused capacity.Inflation is low, and we are committed to keeping it low.

Last month, togethe the federal government, we announced that we would extend our target of holding inflation range of 1 to 3 per cent to the end of 2001.

Moreover, government deficits have v disappeared, and the ratio of public debt relative to the size of our economy is finally on path -- for the first time in about 25 years.

Low inflation and improved fiscal health rep contributions towards the sounder economic fundamentals I mentioned a moment ago.

They ar doubt the main reason why our interest rates have been below US rates.The other key area where there have been important improvements in recent year in the private business sector.

Since the early 1990s, Canadian businesses have take challenge of structural adjustment, which their US counterparts had started several years response to the gathering momentum of technological change, globalization, and heigh competition.With the benefit of low inflation and low interest rates, Canadian business been investing in new technology and streamlining their operations to enhance productivit success in doing so will be crucial to our future economic performance.

## The importance of productivity growthWhy this emphasis on improving productivity?

Whether viewed from the perspecti of an individual firm or of the economy as a whole, it is almost impossible to overemph importance of rising productivity for overall performance and prosperity.Productivity growth is what allows firms to hand out real wage increases, holding their production costs down and remaining profitable.From a broader perspective, productivity growth is a key element that deter economic welfare and the general well-being of a society.

At any point in time, our perc how well we are doing economically is probably influenced by where we happen to be in the c fluctuations that affect any economy.

But over the longer term, the trend in productivity the economy as a whole is the basis for growing incomes and rising standards of living.Now, I know that for some people any discussion of the need to increase produc can be rather unsettling.

They tend to associate improvements in productivity in an i company with downsizing and layoffs.

And from there it is only a short step to the belief economy-wide productivity gains can only mean a more difficult job market and hi unemployment.But the history of industrial economies shows that growth in productivity has gone hand in hand with improved overall employment conditions.

This is borne out by experience of countries like Japan in the 1980s and, more recently, the United States and Kingdom.

That was also our experience in Canada during the 1950s and 1960s.

## Canada's productivity recordSo how has Canada fared in the productivity department since the 1950s and 19 Not all that well, I'm afraid.

After a relatively strong showing from the end of the Second to the early 1970s, our productivity performance became rather lacklustre.

Productivity estimated to have slowed from an average rate of about 2 per cent in the 1950s and 1960s to 1 per cent in the 1980s and 1990s, although it has picked up recently with the recovery in activity.I should note that economists do not fully understand why productivity grow Canada (and, indeed, in other industrial countries) has slowed so sharply since the mid-1 not propose to try to untangle this puzzle today.

Nonetheless, there are a few points I w make with respect to the Canadian situation.The sharp rise in the world price of oil in the 1970s no doubt dealt a major Canadian industry.

Because of our climate and because of the importance of primary comm production in our economy, we are major users of energy.

Adapting to higher energy costs c took considerable time.˝In my view, two other important factors inhibited productivity improvements th much of the 1970s, 1980s, and early 1990s: large fiscal deficits and high inflation.Government deficits through the 1980s and early 1990s tended to crowd out pri sector investment by appropriating an ever-increasing share of Canadian savings.

It was, possible for businesses and governments to get foreign financing.

But the accumulation o public sector debt and the rapid buildup of foreign indebtedness eventually resulted in premiums being built into our interest rates.

High inflation through the 1970s and 1980s ha effect on interest rates.

For these reasons, interest rates were high, even after adjustin This discouraged some of the investment that would have contributed to gains in productivitMoreover, because high inflation increases uncertainty about the future, bus and individuals seek protection from its ravages or try to profit from it.

Either way, sca resources were diverted from productive investments towards hedging and speculative investmI do not mean to suggest that the factors I have mentioned here explain all productivity problems.

But they no doubt worked against the investment that was needed to adjust to both the oil price shocks of the 1970s and the global forces of the past two dec make headway in terms of productivity growth.Let me now turn to the question of what we can expect in terms of productivity future.

## Future productivity trends and Canada's economic potentialIncreases in productivity do not just happen.

We need to work hard to achieve In a world of rapid technological change and intense international competition, t opportunities and incentives for productivity gains -- provided we do what is necessar advantage of the possibilities.Productivity comes from the interaction of business investment in new ca equipment, a skilled labour force, and the adoption of new technology.

It takes entreprene innovation to pull it all together.

Typically, this interaction works best when businesses stable, low-inflation economic environment and when markets are competitive.

Producers ar under pressure to perform in terms of price, quality, and service.With low inflation, a balanced fiscal position, and low interest rates, the policy environment is better now than it has been for over 25 years.

This should pro underpinnings for solid economic growth and increased savings and investment in the future.With this support from improving economic policy conditions, business investm has indeed been buoyant, particularly since mid-1996, and notably in high-technology equ such as computers.

As well, more and more businesses, led by high-tech enterprises, are re have introduced new production technologies.

Progress has also been made in learning new˝removing labour market rigidities, and improving the adaptability, flexibility, and effic labour force.

But more undoubtedly needs to be done in this area.It is likely that these trends will continue in the future, and will spread to have been lagging behind.

With ongoing technological change, deregulation, trade liberaliza intensified global competition, the pressures and incentives are certainly there f productivity gains.Thus, the trends are positive, and the direction of our economy is clear.

Wha clear is just how much our economic performance will improve.

We cannot attach precise est to future growth in productivity.

Neither can we judge the end results of the major structu that have taken place in the private sector of the Canadian economy.

Because of this, we ne a somewhat agnostic view about the production potential of the Canadian economy and abou lowest unemployment rate that can be sustained over time.

## Monetary policy response -- making the most of the economy's production potentialWhat are the implications of all this for the conduct of monetary policy?When

we at the Bank look one to two years into the future to set a cours monetary policy, we must take into account changes in the trends that affect the potent economy to produce over time.

At the same time, we must recognize that our ability to pre potential is restricted by the many uncertainties involved.In these circumstances, the best way for monetary policy to help the economy r its potential is to focus on encouraging a sustained economic expansion over time.

How d this?

By keeping inflation low.

As we move towards full capacity over the next year or so, important to set monetary conditions at levels that forestall a resurgence of inflation an boom and bust cycles that go with it.A responsible, credible monetary policy will allow us to explore the limits economy's capacity to produce, to create jobs, and to support rising standards of living.

US experience amply demonstrates the advantages and benefits of such a policy.I believe that the recent extension of the inflation-control targets and the credibility of those targets give monetary policy more scope to test the limits of ou potential than at any time since the 1960s.Now that I have discussed the rationale behind the Bank of Canada's medium-t strategy, let me explain our recent actions to raise the Bank Rate.As I said earlier, the underlying momentum of the Canadian economy remain positive.

Despite the problems in Asia, Canada's external environment is still favourable strength in our major non-Asian trading partners, particularly the United States.

In ad˝dampening effects on domestic demand from the fiscal consolidation efforts of the past four diminishing.

And monetary conditions continue to support the economic expansion.

Given circumstances, the persistent decline in the external value of the Canadian dollar through and January implied a further easing in monetary conditions that looked to us to be e Moreover, the speed of the decline in the currency risked undermining investor confid Canadian dollar assets.

That is why we took action.

## Concluding thoughtsLet me conclude by summarizing my main points today.For much of the period since the 1960s, we have not had conditions in place would allow the Canadian economy to fully realize its potential.

With low inflation and fiscal position, we now have the foundation that should permit us to move towards full cap to explore what our economy can deliver in terms of sustained growth in output and employme better standards of living.Canada's private sector has been responding to the universal challenges of technological change, globalization, and heightened competition by undertaking major restr initiatives to become more efficient, productive, and competitive.

Although we do not know just how much more productive we are going to be as a result of these initiatives, the reason for optimism.The best contribution the Bank of Canada can make to this process is by continu provide a stable, low-inflation environment.

With an eye to the medium term, this will requ a course for monetary policy that will ensure that the Canadian economy reaches full smoothly and then continues to grow over time at a non-inflationary and therefore sustaina The longer economic growth is sustained, the more benefits we will see in terms of i incomes and employment.˝