David Dodge: The Canadian economy - current and future challenges
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Greater Moncton Chamber of
Commerce and the Conseil économique du Nouveau-Brunswick, Moncton, New Brunswick,
24 October 2001.
* * *
It's a pleasure to be talking to you today, although I wish these were happier times.
All of us at the Bank of Canada share a deep sorrow at the loss of so many lives in the 11 September
terrorist attacks in the United States. Among those who died were innocent citizens of many
nationalities, including Canadians. To their families, friends, and colleagues we extend our heartfelt
sympathy. As we strive to come to terms with this tragedy and its implications for all of us, we are
tremendously encouraged by the co-operation, solidarity, and determination that are abundantly
evident both at home and in the international community. Through this time of anxiety and uncertainty,
we at the Bank of Canada will continue to fulfill our responsibility to support the economic well-being of
Canadians and to promote the stability of the domestic and international financial systems.
As we all struggle to fathom the dimensions of this tragedy and to get a measure of its immediate
economic effects, it is important that we look through the short term to the longer-term trends and the
potential of our economy. If we are to solidify our economic performance in the years ahead, we
cannot lose sight of the challenges we must meet as a nation. Those longer-term challenges are my
main topic for today.
Of course, in the current circumstances, there are also important near-term challenges for monetary
policy. So I will conclude with a brief discussion of the current economic situation and the steps that
the Bank is taking to support domestic demand in Canada.
Longer-term challenges to good economic performance-progress so far
Let me start with the longer-term challenges.
The past decade was a watershed for the Canadian economy. Low inflation was firmly established,
fiscal health was restored, and Canadian businesses undertook major restructuring. In short, we made
remarkable progress in improving our economic performance.
Let me quickly review that progress, starting with the achievement of a credible low-inflation record.
. . . establishing a record of low and stable inflation
Since the early 1990s, the focus of Canadian monetary policy on low, stable, and predictable inflation
has helped to anchor inflation expectations and to reduce the ups and downs in economic activity.
Canadians have been able to make spending, saving, and investment decisions with greater certainty,
knowing that their central bank will hold the line on future inflation and that the economy will be more
stable.
. . . restoring fiscal health
But low inflation, although essential to good economic performance, is not sufficient by itself. It has to
go hand in hand with prudent fiscal management.
Since the early 1990s, Canada has also taken action to put its fiscal house in order. And this is paying
dividends. Wiping out deficits at all levels of government has helped to bring about low interest rates
and relatively more stable financial markets.
. . . undertaking business restructuring and embracing open markets
Low interest rates and greater confidence about the future have, in turn, encouraged Canadian firms
to undertake important restructuring initiatives to meet the challenges of sweeping worldwide
technological change and intensely competitive global markets.
Over the past decade, these restructuring efforts have taken place against a backdrop of sustained
efforts to open up our economy even further. Indeed, building on the trade agreements that we forged
in the late 1980s and early 1990s, such as the North American Free Trade Agreement (NAFTA), we
have significantly increased our involvement with the world economy.
Altogether, it is clear that, over the past decade, we in Canada have done a lot to strengthen our
economic foundations. Because of this, we are now better positioned than we have been in a long
time to weather economic turbulence and to take on new challenges.
But, in a rapidly changing, increasingly competitive world, "they who stand still, fall behind." If we are
to seize the opportunities out there in the global economy, we have to continue to move forward and
make further progress.
Longer-term challenges to good economic performance-the way ahead
Before I focus on the new things we need to do to facilitate progress in the future, let me stress how
important it is that we maintain the strong base on which everything else rests-sound
macroeconomic policies.
. . . sound macroeconomic policies
Fostering a climate of low, stable, and predictable inflation is the best contribution monetary policy can
make to good economic performance over the medium term. The Bank of Canada is carrying forward
its commitment to preserve confidence in the future value of money-that you can bank on!
On the fiscal side, it is critical that our public finances remain healthy and that all levels of government
continue to reduce their net indebtedness over time. A declining public debt relative to the size of our
economy will make us less vulnerable to external shocks. But I hasten to add that I do not mean to
suggest that we should not let the "automatic stabilizers" work when faced with an economic shock.
(These stabilizers are the built-in features of revenues and expenditures that work to offset economic
fluctuations. For example, in an economic downturn, tax revenues automatically go down and some
expenditures, such as employment insurance payments, automatically go up.) Let us remember,
however, that it is because of the progress we have made over the past decade in restoring healthy
public finances that we can now afford to let these automatic stabilizers work.
Now, sound macroeconomic policies, while necessary, are not sufficient if we are to improve the
structure and performance of our economy in coming years. I would like to think through with you what
other policies and steps we might need.
As we look ahead, the one thing we can be sure about is that world markets for goods, services, and
finance will become more and more globalized and competitive. Canada, as a very open economy,
must operate in full recognition of that fact. In particular, in light of the heightened security concerns in
the United States, it is important that we all work to facilitate the continued flow of goods and services
between our two countries. Beyond this issue, there are many challenges for all Canadians. But there
are also new opportunities for our firms to increase their global reach and to reap the benefits of
largescale production-provided they pursue new initiatives to enhance productivity and find more efficient
ways to deliver products and services to domestic and foreign customers.
This is where innovation enters the picture.
. . . exploiting the potential of new technologies
The world is in the midst of far-reaching changes-changes that are transforming national economies
and societies around the world through the widening application of new information and
communication technologies. And more change is on the horizon-change that will come from
dramatic advances in biotechnology and nanotechnology.
Technologies like these take time to spread and spawn new applications across a broad range of
economic sectors-pretty much like the electric motor did in the past. But to realize the full potential of
these new applications, major changes in the organization of a firm, of an entire sector or, indeed, of a
whole economy, are often necessary. It is the combination of these applications and adaptations that
leads to rising productivity and rising incomes.
Like many other economists who have studied these issues, I am optimistic that, over the next couple
of decades, productivity will grow significantly faster than it did from 1975 to 1995, although perhaps
not as fast as in the high-growth years of the 1950s and 1960s.
But while experience shows that innovations take time to diffuse widely, it is important to remember
that the prime opportunities go to those firms and those economies that are quick to take advantage of
the new realities. Through the first half of the 1990s, Canada lagged behind the United States in
making the investments that are necessary to take advantage of new technologies. But since 1996,
there has been a surge in such investments in Canada. And in the last couple of years, we were
beginning to see the first signs of a productivity payoff. Once the prevailing global uncertainty and the
cyclical forces that are now constraining output and investment growth in Canada dissipate, we will
likely see more efficiency gains from those past investments and more capital spending on
innovations. And once the necessary adjustments are made to deal with the need for heightened
security, those innovations will mean rising standards of living for Canadians.
. . . redesigning organizational structures and upgrading skills
But, as I just said, to benefit fully from technology, changes and improvements in the structure of our
economy and in the way we run our businesses are necessary.
At the company level-and that applies also to government departments and to the Bank of Canada-
this means organizational changes and changes in management and work practices. It also means
upgrading skills. Simply installing state-of-the-art equipment will not be enough. And it will, most
certainly, not deliver efficiency and productivity gains if organizational structures and management
practices are outmoded and if workers do not know how to use the new technology to advantage.
Some of these issues will no doubt sound familiar to many of you here in the Atlantic provinces, where
considerable effort and progress have been made in recent years to diversify the regional economy
and to move into areas that make greater use of new technologies. And this is especially clear here in
Moncton where, over the past decade, you have enjoyed the strongest employment growth in the
province-12,000 new jobs created since 1990-thanks to your ability to attract call centres and other
information-technology companies.
. . . enhancing productivity
Now, the reason for adopting new technologies, revamping management and work processes, and
upgrading labour skills is that we, as a nation, can become more efficient and more productive.
Productivity growth is the key to rising real incomes and improved standards of living over the longer
run.
But, you may ask, how does monetary policy fit in all this? And what can the Bank of Canada do to
promote higher productivity and rising real incomes?
An increase in real incomes is a key component of the good overall economic performance that the
Bank aims at through a policy focused on low inflation. The Bank supports initiatives to improve
productivity by delivering a climate of low and stable inflation that encourages well-informed, long-term
business decisions, including decisions to invest in new high-tech machinery, equipment, and
software.
. . . ensuring that Canada's financial system and markets work efficiently
The Bank also concerns itself with another factor in supporting good economic performance-a sound,
innovative, and efficient financial sector. A stable, highly developed financial sector helps to channel
savings into investments and allocates capital efficiently.
This is particularly important in these times of rapid technological change, when we want companies
that plan to adopt new technologies to have access to proper financing. But of course, we also want to
ensure that this is done in a way that preserves the stability of the financial sector. Appropriate
safeguards and sound policies aimed at fostering financial stability improve overall economic
performance.
The Bank of Canada is helping to promote financial stability in a number of ways. Here at home, we
oversee major payments systems and provide ordinary and emergency liquidity to the financial
system. We also work with other federal entities and provincial securities commissions to ensure that
financial markets function well. And through international organizations, such as the Bank for
International Settlements and the International Monetary Fund, we work with other central banks and
financial regulators around the world to promote global financial stability.
There are other medium-term issues that we could usefully spend time discussing. But given that time
is limited, I would now like to turn to the current economic situation and the near-term challenges for
monetary policy.
Current economic situation and near-term policy challenges
Even before last month's events in the United States, evidence had begun to accumulate that the
economic slowdown in that country would be deeper and last longer than had been widely expected.
By mid-summer, economic activity outside North America had also begun to show more clearly the
effects of weaker U.S. growth and of the ongoing global retrenchment in the information and
telecommunications sectors. At the same time, there were signs that domestic demand in Canada,
which had held up well through the first part of the year, was softening and that the inventory
adjustment, particularly in the electrical and electronic sectors, still had some way to go.
This evidence, which had been accumulating through the summer, led the Bank to scale back its
previous expectations for economic growth during the second half of 2001 and the first half of 2002.
Consequently, on 28 August, we lowered interest rates to support domestic demand growth and to
keep inflation near the target of 2 per cent over the medium term.
The events of 11 September, and their repercussions around the world, added a further major element
of uncertainty to the near-term prospects for the global economy and for Canada. Because of this
heightened uncertainty, the Bank took the exceptional step of lowering interest rates by one-half of a
percentage point on 17 September, outside our regular schedule of fixed announcement dates. We
also moved immediately after the attacks, as did other major central banks, to provide additional
liquidity to the financial system to ensure its smooth functioning. At times like these, a key factor in
preserving confidence in the prospects for our economy is a financial system that continues to work
effectively.
The ongoing economic effects of last month's shock are very difficult to assess. We know that there
was a clear and immediate impact on certain sectors (such as air transportation and tourism) and on
those industries that rely on cross-border, just-in-time delivery. But how large the total impact will be
and how long it will last are very difficult to gauge. What is even more difficult to evaluate at this stage
are the implications for consumer and business attitudes. The recent events are unlike anything we
have ever experienced in North America. So it will take some time before we can fully understand their
consequences.
When we take into account the direct effects of the terrorist actions in the United States, their
immediate negative impact on business and consumer confidence, and the adjustments necessary to
deal with increased security risks, it is now clear that economic growth in Canada in the second half of
2001 will be close to zero or slightly negative. This means average growth for the year as a whole of
about 1 1⁄2 per cent.
How quickly growth will resume will depend crucially on geopolitical developments and on how soon
consumer and business confidence return to normal. By their very nature, geopolitical developments
are not easily predictable, although they will likely be more turbulent than usual for some time. Also
difficult to predict is the evolution of consumer and business confidence. One could think of a scenario
where confidence would be restored quickly. In such a case, fairly robust growth could resume by the
second quarter of 2002. On the other hand, consumer and business confidence in North America
could stay weak for quite some time. In these circumstances, growth could remain anemic through
most of 2002. While the timing of a rebound in economic activity is unclear, we are confident that,
once the uncertainty stemming from terrorist actions dissipates, healthy growth in output, investment,
and employment will resume, given Canada's sound economic fundamentals.
Under either of these scenarios, there will be less pressure on capacity through the balance of this
year and during 2002 than we had thought earlier. Indeed, by the end of 2002, the economy will still
be operating below potential. With less pressure on capacity, core inflation is expected to move below
2 per cent in early 2002, and to stay below through the remainder of the year. As for total CPI inflation,
it will likely drop to about 2 per cent by the end of 2001 and move below that during 2002, if energy
prices remain at or below their levels of early September.
Based on these considerations, yesterday, on our pre-set announcement date, we cut our key policy
interest rate-the target for the overnight rate-by 3⁄4 of a percentage point. It is now at 2 3⁄4 per cent-
a full 3 percentage points lower than at the beginning of the year. This action aims to further support
economic growth in Canada and to keep inflation close to our 2 per cent target over the medium term.
I do not have to tell you that, because of the many unknowns in the global economic environment, and
because of the uncertainty surrounding domestic demand in Canada, we will continue to monitor
developments very closely.
Concluding thoughts
To conclude, as we in Canada find ourselves in the middle of economic difficulties, and especially as
businesses, governments, and individuals struggle to come to grips with last month's tragedy, our
main preoccupation is, naturally, with near-term issues. That is understandable. But, at the same time,
it is critically important that we maintain a sense of perspective-that we step back and look past
current developments, focusing also on the longer-term trends in our economy and its potential.
Over the past decade, Canada has made remarkable progress in strengthening its economic
foundations. This should stand us in good stead, no matter what economic turbulence and near-term
uncertainties we face. And it gives us a firm basis to stand on as we embark on new initiatives to
improve our longer-term economic performance and meet the challenges of the twenty-first century.