David Dodge: Update on economic and monetary developments in Canada
Opening statement by David Dodge, Governor of the Bank of Canada, before the House of Commons
Standing Committee on Finance, Ottawa, 1 May 2001.
* * *
I am pleased to appear before this Committee for the first time since my appointment as Governor of
the Bank, on the occasion of the release today of our spring Monetary Policy Report. Mr. Knight and I
hope to be able to return on the day of, or shortly after, the publication of our Report every May and
November.
The Report provides our latest assessment of the outlook for economic growth and inflation in
Canada. Before I give you a flavour of that assessment, I would like to say a word about the objective
of Canadian monetary policy and how we go about achieving it.
The Bank of Canada has a commitment to contribute to the economic well-being of Canadians. Thus,
we must conduct monetary policy so that it fosters sustained economic growth by creating conditions
that favour rising output, employment, and incomes, and a more stable macroeconomic environment.
The unique contribution that the Bank can make to sound economic performance is to preserve
confidence in the future value of money. Canadians should be able to go about their business fully
expecting that their central bank will keep future inflation low, stable, and predictable. In this way, they
will be able to make sounder economic decisions. And this will lead to better overall economic
performance.
The Bank pursues low inflation within a monetary policy framework based on an inflation-control target
and supported by a flexible exchange rate. The current target is to hold the trend of inflation inside a
range of 1 to 3 per cent, with emphasis on the midpoint of 2 per cent.
Inflation-control targets help to anchor policy and to anchor people's inflation expectations. And they
provide the Bank with an effective mechanism for assessing demand pressures. In this way, we can
take action to prevent overheating when the economy is strong and is pushing against capacity limits,
and to support growth when the economy is weak.
At the same time, a flexible exchange rate allows our economy to adjust to disturbances, such as
changes in foreign demand for our products or changes in the relative prices of our exports compared
with our imports. And it helps us to adjust with less overall fluctuation in output and employment than if
the exchange rate did not move.
With this brief overview of Canada's inflation-control strategy, let me now turn to the economic
situation. When my predecessor appeared before you in May 2000, our economy was growing
vigorously, bolstered by strong domestic and U.S. demand. Indeed, with signs of emerging capacity
pressures, and with the need to sustain non-inflationary economic growth in Canada, the Bank raised
interest rates the day after our appearance before this Committee.
These higher interest rates led to some cooling off in domestic demand in Canada. What we, and
most other analysts, did not anticipate was the abrupt slowing in U.S. economic growth. This is the
factor that has contributed to a greater-than-expected moderation in economic activity in Canada.
Since February, the Bank has been saying that we expect growth in the first half of this year to be very
modest. And we have indicated that, by the middle of 2001, the Canadian economy will probably be
operating somewhat below potential. Overall, the information received to date is broadly in line with
the Bank's expectations. The monthly numbers have been volatile: some have been weaker and some
have been stronger than anticipated. But they are generally consistent with our view that the
weakness in the first half will be mainly associated with inventory adjustments in markets facing soft
demand-in particular, motor vehicles-and with adjustments in other industries-notably electronics
and telecommunications equipment.
The Bank continues to believe that, after very modest growth in the first half of 2001, economic activity
in Canada will pick up in the second half and strengthen further in 2002. Let me explain what we are
basing this on. Despite lower production in the three high-profile sectors I just mentioned, aggregate
economic activity continues to grow, buttressed by underlying strength in other areas, including the
energy sector, retail sales, housing, non-residential construction, and most service industries.
Supported by recent tax cuts that boost disposable income, final domestic demand should continue to
expand. And we expect a recovery in foreign demand in the latter part of the year, encouraged by the
substantial reductions in U.S. interest rates. Nonetheless, there are uncertainties about the exact
timing and strength of the pickup in U.S. growth.
Here in Canada, we have lowered interest rates significantly to support growth in total demand in line
with our objective of keeping inflation close to 2 per cent over the medium term. Since January, the
Bank of Canada has cut rates by a total of 100 basis points, bringing the overnight rate-the rate that
corresponds to the U.S. federal funds rate-down to 43⁄4 per cent.
With this monetary easing and with the strengthening in the pace of economic activity in the second
half of the year, we now project annual average growth of between 2 and 3 per cent in 2001. For next
year, we see output expanding at a rate slightly above the Bank's estimate of potential output growth
of 3 per cent.
Consistent with the Bank's expected path of output growth, core CPI inflation will likely average
somewhat below 2 per cent over the remainder of 2001, then move back up to 2 per cent by the end
of 2002. Total CPI inflation is expected to be volatile over the next few months, before moving down to
about 2 per cent by the end of the year if world energy prices remain close to current levels.
I would now like to say a word about recent developments in financial markets. These developments
have essentially reflected the increased concerns and uncertainty surrounding world economic
prospects. In the circumstances, global investors have, once again, sought the safety and liquidity of
U.S. financial assets. And this has led to an appreciation of the U.S. dollar against all major currencies
despite the marked economic slowdown in that country. Although the Canadian dollar has remained
firm against other major currencies, the decline in its value against the U.S. dollar until just recently
has been the subject of much public commentary in Canada. Since the exchange rate is a key price in
our economy, the Bank recognizes that movements in its value can be a source of concern for
Canadians. I want to assure you that the Bank monitors market developments very closely. And we
carefully assess the implications of currency movements for aggregate demand and inflation in
Canada.
In closing, let me reiterate that the Bank remains generally positive about Canada's economic
prospects in the period ahead. We continue to expect a pickup in growth in the second half of this year
and further strengthening in 2002. The main risk to this outlook is the timing and strength of the
projected pickup in U.S. growth. Given this uncertainty, we will continue to monitor developments
closely and we will respond appropriately.