Mark Carney: Canada works
Remarks by Mr Mark Carney, Governor of the Bank of Canada and Chairman of the
Financial Stability Board, to the Board of Trade of Metropolitan Montreal/Chambre de
commerce du Montréal métropolitain (CCMM), Montreal, Quebec, 21 May 2013.
* * *
Introduction
It is almost six years since the start of the global financial crisis, and its dynamics still
dominate the economic outlook.
In the United States, households are emerging from a painful period of deleveraging. Their
economic expansion continues at a modest pace, with gradually strengthening private
demand partly offset by accelerated fiscal consolidation. Despite recent progress, the U.S.
economy has not yet achieved escape velocity.
Europe remains in recession, with economic activity constrained by fiscal austerity, low
confidence and tight credit conditions. Deep challenges persist in its financial system.
Without sustained and significant reforms, a decade of stagnation threatens.
Europe can draw lessons from Japan on the dangers of half measures. It is now more than
two decades since the Japanese financial crisis erupted. To end its debilitating legacy, Japan
has just embarked on a bold policy experiment. Its success or failure will have a major
impact on the outlook over the coming years.
Amongst the G-7, Canada is unique. For us, the global financial crisis was an external rather
than internal shock. When Canadian policy-makers responded quickly and forcefully, our
financial system channelled credit to where it was needed and our economy adjusted
smartly.
As painful as our recession was, Canada suffered less. By the start of 2011, all of the output
and all of the jobs lost during the recession had been recovered (Charts 1 and 2). A further
480,000 jobs have been created since, with the vast majority of them full-time and in the
private sector. Nearly all the new jobs are in industries that pay above-average wages.
Relative to our peers, Canada is working.
Why did we fare better? Our outperformance reflects four critical advantages:
•
responsible fiscal policy,
•
sound monetary policy,
•
a resilient financial system, and
• a monetary union that works.
I will discuss these foundations of our prosperity in more detail, but I don't intend to oversell
them. These are the cornerstones of Canada's prosperity, but lasting growth depends on
what is built on this foundation through longer-term investments in infrastructure, human
capital, innovation and new markets.
A monetary union that works
Canada's monetary union has the essential elements of an effective currency union: an
integrated economy, fiscal federalism and labour market flexibility. Allow me to elaborate.
An integrated economy
While the composition of provincial output varies, the Canadian economy is highly integrated.
Consider the case of commodities.
When commodity prices increase, all provinces benefit. All else equal, the Canadian dollar
appreciates. Its adverse impact on our non-commodity exports is partially offset by the fact
that a stronger currency reduces the cost of productivity-enhancing machinery and
equipment and imported inputs to production.1 Various mechanisms distribute benefits
across provinces: fiscal policy; increases in personal wealth through income and ownership
of stock; and movements in internal real exchange rates and interprovincial trade.2
During the recession and its aftermath, the importance of interprovincial trade was clear. For
example, the increased demand from other provinces for Quebec's goods and services
significantly offset lost international exports (Chart 3).
Movements in provincial real exchange rates are another important part of the adjustment
process. Although there is one exchange rate for Canada as a whole (we all use Canadian
dollars), price differentials across the country yield different real provincial exchange rates.
This matters.
Consider the Alberta/Quebec real exchange rate (Chart 4). When higher energy prices
stimulate production and investment in Alberta, extraction, construction and labour costs
there rise. This increases the real Alberta exchange rate, making goods and services from
the other provinces, including Quebec, more competitive. Interprovincial trade is boosted,
spreading benefits from energy price increases throughout the economy.
It is interesting to compare developments in the Canadian and European internal exchange
rates. For example, since the euro was introduced, Spanish competitiveness (as measured
by GDP deflators) has fallen by about 30 per cent relative to Germany. During the same
period, the Alberta exchange rate moved even more dramatically, rising 40 per cent relative
to Quebec (Chart 5). Intra-regional exchange rates in Canada have generally been more
volatile on average than most internal exchange rates in the euro area (See Tables 1 and 2,
Appendix).
And yet, the challenges of regaining competitiveness are central to the economic travails of
Spain. This is because Spain is experiencing a balance of payments crisis. In the years
following monetary union, Spain ran large intra-euro-area current account deficits, funded in
part by foreign purchases of real estate and inflows to the Spanish banking system. When
these dried up, domestic activity collapsed. There are few institutional mechanisms within the
Economic and Monetary Union (EMU) at present to offset the shock.
In Alberta's case, a rising tide has lifted all boats. That is because the Canadian monetary
union has what Europe does not: a single financial market; a flexible, national labour market;
and significant fiscal transfers. These smooth the adjustments brought about by the large
shifts in relative prices.
Fiscal federalism helps to share risks
Despite the equilibrating movement of real provincial exchange rates, shocks to our economy
can still have a more significant impact on some regions than others. Since monetary policy
works at an aggregate level to support aggregate demand, it cannot easily deal with such
distributional consequences.
Fiscal transfers are thus an important element of a successful monetary union. They are
sizeable in Canada, representing 8 per cent of GDP across all levels of government
(Charts 6 and 7).
Canada's equalization program helps stabilize the impact of asymmetric shocks. For
example, between 2006 and 2011, federal support programs, including equalization
payments and Canadian social and health transfers, grew more rapidly for provinces whose
economies were hardest hit by the crisis (Chart 8).3
The Employment Insurance program also shares risk. Through transfers to 2 per cent of the
working-age population, the program particularly benefits provinces with higher
unemployment rates (Chart 9).
In the medium term, one of the building blocks of European fiscal federalism could be a
panEuropean employment insurance scheme built on a common European labour market. This
would reduce impediments for those looking across the continent for work, while providing a
cross-country automatic stabilizer.
Labour market flexibility
For Canada and Canadians to work, workers must be able to move to different jobs, and
wages must adjust to help maintain full employment.
By international standards, the Canadian labour market is highly flexible, although there is
still room for improvement.4 Our labour mobility as a whole is similar to that in the United
States. By some estimates, the Canadian labour market is almost four times as flexible as
the European labour market.5
An obvious example of this flexibility is the way that Canadians have responded to the higher
wages and employment opportunities in the energy sector. Last year, there was a net inflow
of more than 40,000 people into Alberta from the rest of Canada, a level of mobility that
approaches its previous peak (Chart 10).
As a consequence, labour markets are becoming more similar across the provinces. In
particular, the dispersion of employment rates in Canada has fallen steadily over the past
30 years to levels comparable with those in the United States. Again the contrast with
Europe, where it has risen substantially, is striking (Chart 11).
3
The amount of transfers to Alberta has been adjusted to exclude a one-time cash increase occurring in
2007-08 which resulted from a transitional change toward a per capita cost allocation. The decline in fiscal
support for Newfoundland and Labrador is due to the fact that the province no longer qualifies for equalization
payments (as of 2008/9).
4
Bank of Canada
D. Amirault, D. de Munnik and S. Miller, "Explaining Canada's Regional Migration Patterns,"
Review (Spring 2013): 16-28.
5
Based on the 2006 Census, the migration rate in Canada was 4.6 per cent compared with 4.8 per cent for the
United States. Bayoumi et al. (2006) find that Canadian labour markets respond in a similar manner to their
U.S. counterparts and are more flexible than those in major euro-area countries, while Partridge and Rickman
(2009) find little overall evidence to suggest that provincial labour markets are more sluggish or less flexible
than U.S. state labour markets. A recent report by McKinsey & Company shows that cross-border labour
mobility in the European Union is low (0.18 per cent in 2008). See T. Bayoumi, B. Sutton and A. Swiston,
"Shocking Aspects of Canadian Labor Markets," International Monetary Fund Working Paper 06/83,
March 2006; M. Partridge and D. Rickman, "Canadian Regional Labour Market Evolutions: A Long-Run
Restrictions SVAR Analysis," Applied Economics, Taylor and Francis Journals, vol. 41(15), p. 1855-71, 2009;
and F. Mattern, E. Windhagen, M. Habbel, J. Mu?hoff, H-H. Kotz and W. Rall, The Future of the Euro, An
Economic Perspective on the Eurozone Crisis, McKinsey & Co., January 2012.
Bank of Canada research suggests that the main reason behind these improvements has
been the increased sensitivity of provincial population growth to labour market opportunities
- Canadians are going where the jobs are.6
Finally, wages are flexible in Canada. Results from the Bank of Canada's wage setting
survey indicate that, while firms are typically reluctant to reduce base wages, incentive pay
offers a possible source of downward flexibility in total compensation.7 About 90 per cent of
Canadian private sector firms currently use short-term incentive pay plans.8 Such risk sharing
is an effective way to maintain employment and profitability during uncertain and volatile
times.
A resilient financial system
An important lesson from Europe's experience is the critical role that a sound financial
system plays in the monetary policy transmission mechanism. It helps to ensure that
changes in central bank policy are transmitted effectively to all regions to support growth and
employment. When a sizeable share of a country's banking sector has (or is perceived to
have) deficient capital and liquidity positions, credit doesn't flow to where it is needed.
Recent experience in Europe has shown the particular problems a monetary union faces
when banks become less willing to lend across borders within the union. This fragmentation
has reinforced the links between sovereign and bank solvency. As European leaders now
recognise, without major reforms to create a banking union, EMU is fundamentally
weakened.
In Canada, the existence of largely centralized prudential regulation and deposit insurance
pools risk across the country. When combined with a large number of national banking
institutions, this greatly reduces the risk that localized economic and financial disruptions
impair provincial solvency.
Since the strength of the Canadian banking system has been well documented, I will
concentrate on Canada's sound regulatory framework. Its key elements are:
First, supervision is focused and proactive. Consolidated prudential supervision is not
burdened by other objectives such as the promotion of home ownership or community
reinvestment. The staged intervention approach of the Office of the Superintendent of
Financial Institutions (OSFI) means it works with institutions to correct problems at an early
stage, while they are still manageable.
Second, efforts to promote financial stability are coordinated. Federal authorities consistently
share information, coordinate actions, and pool advice to the federal government on financial
sector policy. Most notable in this regard has been a series of actions to slow the rate of
increase in household debt. The Bank of Canada also works with provincial authorities to
implement a number of global initiatives.
Third, Canada has clear and credible recovery and resolution mechanisms, including
lenderof-last-resort policies, a deposit insurance scheme with risk-weighted premiums, and
bridgebanking powers that enable the rapid closure of failing institutions and the swift re-opening of
their viable operations. In its most recent budget, the federal government announced it will
consult stakeholders on how best to implement a bail-in regime to recapitalize failing
Canadian banks that are systemically important to our domestic economy through the very
rapid conversion of certain bank liabilities into regulatory capital.
bank capital regulation is
Fourth, prudent. Prior to the crisis, Canadian capital requirements
were higher than international norms thanks to OSFI's insistence that common equity form a
large share of required capital. Since the crisis, Canadian banks have become considerably
stronger. Their common equity capital has increased by 80 per cent, or $77 billion, and they
already meet the new Basel III capital requirements six full years ahead of schedule.
Finally, the entire financial framework is regularly reviewed and updated, in accord with the
statutory requirement to renew the federal legislative and regulatory framework for the
financial system every five years. This has proven invaluable given the pace of change in the
financial system. In addition, Canada's regulatory system is subject to regular, rigorous
external examinations.
A massive and disciplined policy response
Allow me to review. The structure of the Canadian economy, the risk sharing across the
federation, labour market flexibility and financial stability together meant that Canada could
adjust quickly to the shock of the global financial crisis.
It also meant that when Canadian policy-makers responded, they were able to do so swiftly
and massively.
During the crisis, the Bank of Canada aggressively cut our policy rate until it reached
onequarter of one per cent, the lowest it can effectively go. The Bank then provided
extraordinary guidance on the likely path of interest rates necessary to achieve the inflation
target in order to maximise the monetary stimulus from its policy rate.
Canada's inflation-targeting regime was a critical anchor during those turbulent times. It gave
the Bank a simple, unwavering goal to guide its policy actions. It provided financial markets
and Canadians with a clear means to understand why the Bank did what it did. And that
understanding kept inflation expectations well anchored around the 2 per cent target
throughout the period, maximising the stimulative impact of our policies.
Although fiscal policy is always less nimble than monetary policy, it also responded
aggressively. Government expenditures rose by almost 3 percentage points of GDP within a
year, with government contributing about one-third of GDP growth in 2010 (Chart 12).
The effectiveness of fiscal policy was underpinned by Canada's strong fiscal position.
From the mid-1990s onwards, successive governments ran more than a decade of
surpluses, cutting the government debt-to-GDP ratio from almost 70 per cent in 1995 to
22 per cent in 2008. As a result, Canada's net debt relative to GDP went from being the
second-highest ratio among the G-7 countries in 1995 to the lowest (Chart 13).
This fiscal flexibility provided leeway for governments to respond while maintaining our credit
standing at the highest levels.
Having clear policy frameworks has disciplined the post-crisis response. Fiscal consolidation
has begun, with the combined deficits of all levels of government falling from 4.8 per cent in
2009 to an expected 2.8 per cent this year.9
Disciplined by its inflation target and reflecting the relative strength of the economy, the Bank
of Canada was the only G-7 central bank not to engage in quantitative easing, and we have
been the only one to move away from emergency settings of interest rates. In addition,
mindful of the risks to financial stability arising from rapid increases in household debt, the
Bank has maintained a tightening bias on interest rates over the past year, in part to
complement efforts of the federal government and OSFI to achieve a constructive evolution
of household debt.
Conclusion
In the immediate aftermath of the crisis, the broad economic strategy in Canada has been to
grow domestic demand and to encourage Canadian businesses to retool and reorient to the
new global economy.
Stimulative monetary and fiscal policies proved highly effective in supporting robust growth in
domestic demand, particularly household expenditures, which grew to record levels.
As effective as it has been, the limits of this growth model have been clear for some time. We
cannot grow indefinitely by relying on Canadian households increasing their borrowing
relative to income (Chart 14). Nor can residential investment remain near a record share of
GDP, particularly given signs of overbuilding and overvaluation in segments of the real estate
market.
Domestic demand, which pulled Canada out of the recession, is now slowing. Consumer
spending is expected to grow at a moderate pace over the next few years. The Bank expects
residential investment to decline further from historically high levels. The contribution of direct
government expenditures should be modest for some time, consistent with the ongoing need
to consolidate budgetary positions.
Thus, the challenge for Canada is to rotate the sources of growth toward net exports and
business investment.
Exports are currently more than $130 billion less than they would have been had this been a
"typical" postwar recovery (Chart 15).
In the short term, the Bank forecasts some rebalancing and a pickup in real GDP growth.
However, relative to previous cycles, investment is expected to remain below average and
the contribution of net exports to be very weak (Chart 16).
Is that really the best we can do?
Yes, there are immense uncertainties in the world economy, but we need to focus on what
we can control. We cannot save the euro or fix America's fiscal challenges.
Should we just wait out a decade-long deleveraging process in the rest of the G-7? Or should
we control our destiny by building on our strengths in the new global environment?
To find and compete in new markets will require a concerted, multi-year effort by workers,
firms and governments. These efforts should be guided by three principles.
Openness is better than protectionism. Trade brings innovation, growth and jobs. That is
why Canada is pursuing a series of bilateral trade discussions with economies such as the
European Union and India, and will participate in the multilateral negotiations of the
TransPacific Partnership involving a number of Asian countries. Emerging-market economies do
not just account for one-half of all of global import growth, they also are essential to securing
Canada's positions in global supply chains.
Economic flexibility is essential. Markets change, industries rise and fall, exciting new
products emerge and then become commoditized. In a rapidly shifting world, only sustained
education, ingenuity and investment can maintain competitiveness. This means we must
continuously invest in our workforce. With technology and trade transforming the workplace,
the need to improve skills across the spectrum of work has never been greater.
Sound macroeconomic policy is the cornerstone of prosperity. Fiscal profligacy erodes
economic sovereignty; price stability is paramount.
The advantages I have discussed today are self-reinforcing. Our monetary union - with its
resilient, national financial system at its core - gives monetary and fiscal policy traction. A
strong fiscal position means that Canadian governments have had the flexibility to respond
as needed. Our principles-based macroeconomic policy frameworks help ensure that
extraordinary actions do not give rise to extraordinary fears. And the discipline they instil
means that stimulus will be withdrawn appropriately as threats diminish.
All of this has meant that, unlike the rest of the G-7, Canada does not need to repair.
To keep Canada working, we need to build.


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