David Dodge: Canada's economic performance after an eventful year
Remarks by Mr David Dodge, Governor of the Bank of Canada, at the University of British Columbia,
Vancouver, 18 September 2002
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Good afternoon. I was delighted to accept your invitation to speak to you today. I'd like to spend some
time reflecting on the evolution of the Canadian economy and what we as Canadians have achieved in
the past few years. Then I will talk a bit about the outlook and the uncertainties facing the global
economy, and how Canada's successes on the fiscal and monetary fronts will help us weather those
uncertainties.
But first, I'd like to say how much I appreciate the chance to return to the University of British Columbia
campus. Five years ago, I was here as a Senior Fellow in the Commerce Faculty. While my current job
is different, there is one common thread that unites this institution and, indeed, all Canadian
universities, with the Bank of Canada-a commitment to excellence in research.
The Bank of Canada fellowship program
Indeed, a strong research environment has long been a hallmark of the Bank. We also want to
encourage research relevant to our business, especially with respect to monetary policy and financial
system stability, at universities all across Canada. That is why I am very pleased to announce today
that the Bank of Canada is launching a Fellowship Program to foster high-calibre research in crucial
economic areas.
The program will be open to professors at Canadian universities who have a record of high-quality
research. The Bank fellowships will pay a salary stipend and provide funding for graduate research
assistants and expenses.
We plan to award two fellowships the first year, and one each year after that, for a total of six
fellowships by 2007. We hope the program will expand the pool of leading-edge research conducted
across this country and strengthen Canadian expertise in areas critical to our mandate, such as
macroeconomics, monetary economics, international finance, and the economics of financial markets
and institutions.
Expanded research and a broader knowledge base will benefit the Bank of Canada, universities
working to build strong economics departments and, indeed, all Canadians. And I am particularly
pleased to be launching our Fellowship Program here, at a university that is committed to producing
the type of ground-breaking analysis we hope to encourage.
Improving the policy framework
When I first arrived at UBC in the fall of 1997, Canada was completing a decade of struggle to get our
economic policies right.
During the period 1988 through 1997, we took some important steps towards improving both our
monetary and fiscal policies. The Bank of Canada, responding to the high and unpredictable inflation
rates of the 1970s and early 1980s, adopted at the end of the 1980s a monetary policy aimed at
achieving price stability. To make this commitment more concrete, the Bank and the Government of
Canada agreed in 1991 on a series of inflation-control targets aimed at bringing the 12-month CPI
inflation rate down to 2 per cent - plus or minus 1 per cent - by December 1995. The decline in inflation
was achieved in fairly short order - by January 1992, inflation was close to 2 per cent. The agreement
has subsequently been extended three times, retaining the 2 per cent target midpoint.
For almost ten years now, inflation has been well under control, and households and businesses now
believe we will continue to achieve the inflation targets. Inflation expectations are well anchored, not
just for the near term, but well into the future. Almost a decade of low inflation makes it easy to forget
how difficult it was to achieve our inflation targets, and the economic price that was paid to achieve the
tremendous benefits of low and stable inflation.
Back when I was teaching here, federal and provincial governments were in the midst of the painful
but necessary process of fiscal consolidation. The federal government had been working to curb the
rising debt-to-GDP ratio, but it really wasn't until 1995 that the government had done enough to tip the
scales decisively toward deficit reduction. And it was 1997 before the cumulative effects of all those
deficit-reduction measures put federal fiscal policy back on a sustainable track.
The debt-to-GDP ratio at the federal level has since fallen to less than 50 per cent, from a peak of
71 per cent in 1995. And while some provinces are still struggling to maintain budget surpluses, all
have taken important steps to put their fiscal houses in order.
Governments and the Bank of Canada were working to get public policies - the fiscal and monetary
framework - right. The private sector was also restructuring to take advantage of the opportunities
provided by the Canada-U.S. Free Trade Agreement and to increase its productivity and
competitiveness. It is not surprising that during those years of adjustment we had slower growth than
the United States. But by the late 1990s, our economy was beginning to reap the benefits of those
restructuring efforts. The end result of all this effort - the adoption of inflation targets, the fiscal
improvement and the private sector restructuring - was that Canada's economy became better able to
weather major shocks such as the Asian crisis, or last year's global slowdown.
Indeed, over the period from 1997 to 2001, Canada averaged annual economic growth of about
4 per cent, while the U.S. average was about 3.5 per cent. And while the U.S. economy fell into
recession last year, ours did not.
Although the productivity growth of Canadian companies has not been as strong as that of firms in the
United States, we have seen encouraging signs that investments in technology and training are
leading to greater productivity gains here. Indeed, business sector labour productivity in Canada grew
at an annualized rate of 2.0 per cent from 1997 to 2001, much higher than the 1.2 per cent average
over the 1990-96 period, and only a bit below the revised 2.3 per cent rate of productivity growth
recorded in the United States.
As we look forward, we see positive signs for future productivity growth in Canada, thanks to the
efforts of Canadian firms to adjust to new technologies and incorporate them into their business
processes.
The shocks of 2000-2001
Indeed, the economy has held up remarkably well when you consider that we have been hit with four
major shocks during the past couple of years. First, there was the meltdown in the technology and
telecommunications industries, which began in late 2000 and the effects of which are still being felt
today. The second was the broader economic slowdown in 2001 that affected, to various degrees, the
economies of most countries.
Third, and overshadowing every other event last year, was the 11 September terrorist attacks. With
the first anniversary just passed, this seems like an appropriate time to reflect on the extraordinary
events that have buffeted the North American economies since that terrible day, and to review how the
Bank of Canada responded to those events.
Our most immediate responsibility was to keep Canada's financial system functioning. Our next
responsibility was to promote consumer and investor confidence. Therefore, the Bank of Canada took
extraordinary monetary policy action. On 17 September last year, we reduced our key policy interest
rate outside our scheduled announcement dates. Between September 2001 and January 2002, we
lowered interest rates by a total of 200 basis points to help mitigate the impact of 11 September on an
already-weakening economy.
It turned out that consumer confidence in Canada was not as badly shaken as had been feared. As
the immediate geopolitical and economic uncertainties diminished, consumers responded strongly and
quickly to the monetary stimulus. Interest rate-sensitive sectors, such as housing and automobiles,
showed remarkable strength. Indeed, in the fourth quarter of last year we saw annualized GDP growth
of almost 3 per cent, when most analysts were expecting the Canadian economy to shrink.
However, as we recovered from the 2001 slowdown and from 11 September, the U.S. economy was
hit by a fourth shock - loss of confidence in the integrity of financial reporting and analysis as a result
of Enron, WorldCom, and other accounting and corporate governance scandals. Unfortunately, the
uncertainty caused by these problems in the United States has spilled over into other financial
markets, including ours. This has created additional caution for businesses and appears to have
delayed the expected recovery in investment worldwide.
In spite of these four economic shocks, Canada's economic performance has been, in comparison
with other countries, rather good. Clearly, this has been a difficult year for the mining and forestry
industries in British Columbia, for grains and oilseeds producers in the Prairies, and for the telecom
industry across the country. But overall, our economy has consistently exceeded the average growth
rates of the G-7 countries since 1997. And both the IMF and the OECD predict that Canada will post
the strongest growth rate of the G-7 in both 2002 and 2003.
I want to emphasize that Canada's recent strong performance isn't just good luck. It is the result of
having a solid policy framework, both in terms of inflation and fiscal control. The benefits of this
framework are well understood, not just by the government and the Bank of Canada, but by
Canadians in general. We stuck to that framework during the recent economic turmoil, and we are now
seeing a clear payback for the tremendous investment that Canadians made in opening this country to
free trade, and in getting our macroeconomic framework right in the 1990s.
That framework holds and will continue to serve us well. If anyone still needs convincing of that,
Canada's recent economic performance provides compelling evidence.
Canada's economic prospects
Canada's economic growth so far this year has exceeded expectations. Real GDP jumped by
6.2 per cent at annual rates in the first quarter of 2002 and rose by 4.3 per cent in the second quarter.
The Bank of Canada believes that keeping inflation low, stable, and predictable is the best contribution
monetary policy can make to strong and sustained growth in Canada. We run monetary policy in a
symmetrical way. That is to say, we pay equal attention to persistent pressures that could move us
away from our 2 per cent target - whether above or below.
When strong demand pushes the economy against the limits of its capacity and threatens to raise
future inflation above the target, the Bank will raise interest rates to cool off the economy and mitigate
those inflation pressures.
When demand is weak, as we saw in 2001, future inflation is likely to ease. So the Bank will lower
interest rates to stimulate the economy, and absorb economic slack, consistent with keeping inflation
on target. The significant easing of monetary policy during 2001 was a key factor behind the strong
growth of household demand in the first half of this year.
Let me now turn to the outlook. In our April Monetary Policy Report, we said that the recovery in the
Canadian economy began sooner, and was considerably stronger, than anticipated. Consumer
spending and residential construction were reflecting the stimulus from both monetary and fiscal
policy. Canada's export volumes had begun to grow once again, as the U.S. economy began to
recover. By the time of our Monetary Policy Report Update in July, we were also seeing a rebuilding of
inventories and an increase in spending on machinery and equipment. These were suggesting a
broadening of the recovery across economic sectors.
The July Update still reflects our view of the economy. As we said two weeks ago, domestic demand
in Canada remains stronger than expected, bolstered by the substantial amount of monetary stimulus
still in the economy. Canada's record of job creation has been nothing short of remarkable, with almost
400,000 new jobs since the beginning of the year. This strong job growth is reinforcing the confidence
of Canadian consumers. In addition, medium and small businesses continue to invest. All this paves
the way for higher output and ongoing strong domestic demand.
But at the same time, there are downside risks and uncertainties, mostly originating from outside
Canada. Near-term prospects for growth in the United States and the major overseas economies
appear to have weakened. Private and public sector economists have revised down their near-term
growth forecasts for the United States, Europe, and Japan. This could imply that Canada's exports,
which were already slightly weaker than anticipated in the second quarter, could continue to be
affected by slower growth in global demand.
The geopolitical situation remains quite unsettled. Finally, in the United States and Canada, we are still
working through the corporate governance issues that have contributed to this year's financial market
volatility. History has taught us that during periods of uncertainty, business and consumers tend to sit
on their hands until the outlook is clearer.
Let me conclude. It remains the Bank's view that as the Canadian economy continues to expand and
to approach capacity, further timely and measured reductions in the amount of monetary stimulus will
be necessary. Let me remind you what I mean by "timely and measured." "Timely" relates to the fact
that there is always a lag between our policy actions and their effect on the economy. "Measured"
relates to the judgments that we make at each fixed announcement date about the pace at which the
economy is approaching full capacity, taking into account new information and data as they become
available.
Our current view is that the fundamental underlying strength of the Canadian economy has not
changed since our July Monetary Policy Report Update. Domestic demand may well be stronger; at
the same time, the external uncertainties bearing on the outlook appear to be greater than they were
in early July.
We will provide a detailed view of our outlook for the Canadian economy in our next Monetary Policy
Report, on 23 October.
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This past year has certainly been full of challenges. Over the last decade, Canada has put in place the
right macroeconomic policy framework to weather major shocks and take advantage of opportunities.
We are confident that this framework will stand us in good stead in the future.