Mr Thiessen gives an update on the Canadian economy
and on the state of Year 2000 readiness in the Canadian financial sector
Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chamber of Commerce
Regina, Saskatchewan on 23 September 1999.
* * *
It is always a pleasure to return and speak to people in my home province. This time, we are here for a
meeting of the Bank of Canada's Board of Directors. Once a year, our Board meets outside Ottawa, in
a different part of the country. This year, we are delighted to be in Regina.
Today, I would like to give you an update on the Canadian economy - its recent performance and its
prospects. I would also like to brief you on the state of Year 2000 readiness in the Canadian financial
sector.
The recent performance of the Canadian economy
Here in Saskatchewan, you know only too well that the last couple of years have been difficult for the
Canadian economy, especially for producers of primary commodities. But there is reason for optimism
as we look ahead. To fully appreciate why, we need to understand the international shocks that have
buffeted our economy since mid-1997 and how we have dealt with them.
The global financial crisis, which started in Southeast Asia in mid-1997 and spread to other countries
during 1998, led to a sharp decline in the world prices of primary commodities. By this time last year,
the average price (in US dollars) of key commodities produced in Canada had fallen by about 20%
over the course of the previous 18 months.
And when Russia declared a standstill on the servicing of its debt in August 1998, the effects were felt
far and wide. Conditions tightened in financial markets everywhere. Many highly rated corporate
borrowers in the industrial countries were faced with a reduction in the availability of credit and with
higher borrowing costs - the same conditions that faced governments from emerging-market
economies.
Nevertheless, the Canadian economy has fared surprisingly well over the past year. Of course, we
have not experienced booming conditions. Indeed, some of our primary sectors, such as farming,
continue to struggle with low prices. Grain prices, in particular, have been plagued by ample global
supplies and weak demand. But, on the whole, the economy has performed well. I expect that when
the numbers for the third quarter of this year are out, they will show that output has grown by about
4% since the third quarter of 1998. This compares with growth of only 21⁄2% over the same period the
year before.
To be sure, the economic impact of the Asian crisis on Canada has been moderated by the strength of
the US economy and by the prompt response of major central banks, particularly the US Federal
Reserve, to the global financial difficulties. And the efforts made by emerging-market economies in
Asia to deal with their problems have helped to gradually repair confidence and improve world
economic conditions.
Although these positive developments are certainly important, it is also true that we have coped better
with this crisis than in the past because our economy is now operating from a firmer base than it has
for some time. This reflects a number of fundamental improvements in our economic structure. I
would highlight three in particular:
• first, our low-inflation record and the Bank of Canada's commitment to keeping inflation
low;
• second, the virtual elimination of government deficits and the beginning of a downward
trend in the high level of public debt to the size of our economy (as measured by the ratio of
public debt to GDP);
• third, the major restructuring of Canadian businesses during the 1990s in response to
stronger global competition and to technological change.
It has not, of course, all been smooth sailing. You will recall that throughout the summer of 1998 our
currency kept losing ground in reaction to the sharp fall in commodity prices, which was made worse
by the fallout from events in Russia. And with signs of a potential loss of confidence in Canadian
dollar assets, the Bank of Canada moved to raise short-term interest rates significantly in August 1998.
But once we got through that period of unusual global turmoil, we were able to reverse that increase
rather quickly. Consequently, Canadian interest rates for all maturities fell back to levels below those
in the United States, consistent with Canada's lower inflation rate.
The downward movement in the Canadian dollar, besides softening the impact on our resource sector,
encouraged a rather prompt increase in exports of manufactured goods. This helped to compensate for
the reduction in receipts from commodity exports. With this shift of economic activity out of the
resource sector and into manufacturing, conditions in the labour market did not deteriorate as one
might have expected. In fact, the unemployment rate has continued to decline over the past 12 months
- from 8.3% to its current level of 7.8%. And despite the loss of jobs in the resource sector, close to
350,000 net new jobs have been created across the economy over this period.
The three factors I mentioned earlier - low inflation, reduced budget deficits and debts, and business
restructuring - have provided a sound base for the Canadian economy during this turbulent time. They
have also helped smooth the process of exchange rate and economic adjustment that I have been
describing.
Because of our good inflation record in recent years, achieved through the Bank's commitment to
inflation targets, inflation remained subdued, even as our currency was falling and causing prices of
imported goods to rise. Low inflation and a much improved fiscal position have helped to keep interest
rates down. At the same time, because of restructuring, many more Canadian firms have been in a
strong position to take advantage of the low Canadian dollar and increase their sales abroad. Low
interest rates have also made it easier for businesses to finance investments so that they can expand
production capacity and increase their foreign sales.
The outlook for the Canadian economy
The fundamental improvements in our economic foundation and the way that Canada has coped with
these recent external financial difficulties give us good reason to be optimistic about the future.
The export sector has been an important source of strength for the Canadian economy for some time
now. Recently, the stimulus from spending by Canadian households and businesses has also been
growing. Indeed, with the waning of last autumn's global strains, consumers have regained the
confidence to go out and buy a new car, a house, or furnishings. And businesses have revived their
plans for investment in machinery and equipment (including continued buoyant spending on computer
upgrades, partly related to Year 2000 readiness). With improved confidence, relatively low interest
rates, and gains in employment, these trends should continue.
Clearly, conditions outside Canada remain crucial to our economic outlook. In Europe, prospects for
stronger growth now look better than they did a few months back. Even for the troubled Japanese
economy, next year should be brighter. Forecasts for a number of emerging-market economies,
particularly in Asia, have also been revised up. And with these improved global prospects, the prices
of a number of our key commodities - especially energy, base metals, and minerals - have risen.
Of course, for Canada the external influence that matters the most is the US economy. That economy
has turned in an amazing performance in the past seven years - robust output growth, low
unemployment, and low inflation. But with US consumers and businesses continuing to spend
strongly, and labour markets tightening further, some signs of cost pressures have emerged recently.
This has rekindled concerns about a pickup of inflation down the road. And it has prompted the US
Federal Reserve to reverse part of last autumn's easing, by raising interest rates twice this summer, in
an effort to return the economy to a more sustainable, non-inflationary pace.
The Fed's success in preventing the US economy from overheating and bringing it down to a "soft
landing" is critical for the world economy and especially for Canada. The worst case for us would
have been for the Fed to have delayed action and risked another inflationary boom. Not only would
this require more drastic tightening by the Fed down the road, but it could well lead to a recession -
another episode of boom and bust.
The Bank of Canada did not follow the two interest rate increases made by the Fed this summer.
While there is no reason that changes in US interest rates should automatically trigger similar
movements here, neither is it the case that such developments are irrelevant for us. Canada is closely
integrated into the world economy and international financial markets. Developments in the United
States, the world's largest economy, will always have a major global impact. When it comes to
Canada, the central bank must carefully assess the economic and financial circumstances in the United
States that are behind any move by the Fed and their likely implications for our economy. Sometimes
this will mean that the Bank of Canada will respond to a Fed move and sometimes it won't.
The interest rate actions taken by the Fed this summer improve the odds of continued, non-inflationary
economic expansion in the United States. This is good news for all concerned. But it also means that
we cannot count on the US economy to provide the same strong stimulus for Canadian exports in the
future as it has in the recent past. Thus, the improved outlook for Europe and the firmer markets for
primary commodities are particularly welcome developments for Canada. These external factors,
along with the relatively low domestic interest rates and improved employment conditions that I
mentioned, bode well for sustained economic expansion in Canada. Altogether, our economy should
continue to grow at a healthy pace and take up slack in production capacity.
Core inflation is expected to stay low over the next year, in the bottom half of the Bank's 1% to 3%
target range. But as the economy begins to produce at full capacity, monetary policy will have to be
mindful of the potential for price pressures.
However, there is a lot of uncertainty and imprecision in our estimates of the economy's capacity to
produce. For example, we do not know to what extent large investments in new technology and in
machinery and equipment during the 1990s may have raised production capacity. Consequently, the
Bank will be putting more emphasis on, and carefully watching, a range of indicators to assess the
degree of pressure on capacity and on inflation. The interpretation of developments on this front will
be an important challenge for monetary policy in the period ahead, one that will require a great deal of
careful analysis.
The Year 2000 changeover in the financial sector
With the end of the millennium approaching, any review of near-term economic developments would
be incomplete without a word on the efforts by financial sector participants and public sector agencies,
including the Bank of Canada, to deal with the implications of the Year 2000 date change.
As part of its commitment to Canadians, the Bank seeks to promote the safety and soundness of our
financial system. With this in mind, we have for some time now been working closely with various
Canadian and international organizations to minimize any effects on our financial sector as we head
into the year 2000.
Today, I can tell you that the Canadian financial sector has done its homework. It has been passing its
Year 2000 tests. And contingency plans have been made. So, at the dawn of the new year, the Bank
expects that it will be "business as usual," but we will also be ready if anything unusual happens.
Efforts to identify and fix potential Year 2000 problems in the Canadian financial sector started early.
And they have been exhaustive, with expenditures in the billions of dollars.
Operators of systems shared by the financial sector have made the necessary changes and fully tested
them. For example, last June, the Canadian Payments Association and its members participated in a
Global Payments Systems test to verify the ability of financial institutions around the world to send
and receive international payments. Domestic clearing and settlement systems have also been tested,
as have all systems used by the markets for transactions involving Canadian debt and other securities.
They are ready to operate in a Year 2000 environment.
At the same time, virtually all individual financial institutions have completed and tested changes to
their critical systems, including those that support automated banking machines, credit and debit cards,
and telephone banking. And major Canadian deposit-taking institutions have guaranteed the safety of
their clients' accounts and records from any Year 2000 computer-related disruptions. The Bank of
Canada has given the same guarantee for Canada Savings Bonds records.
Of course, the Bank of Canada's own critical computer systems have also been reviewed, upgraded as
necessary, and tested. And they are Year 2000 ready.
An important issue for the financial sector is the state of preparedness of providers of infrastructure
services (e.g. electricity, telecommunications). These, too, are reporting that they are Year 2000 ready.
With all the effort, time, and resources devoted to the task, it is not surprising that a number of
knowledgeable Year 2000 commentators have singled out the Canadian financial sector, especially the
banking sector, as one of the world leaders in Year 2000 preparedness. That is a strong vote of
confidence, which should help reassure Canadians.
Still, we cannot afford to be complacent and relax our efforts. Computer systems will continue to be
monitored and retested right up to the end of the year. There is also a need for ongoing clear,
responsible communication to keep the public well-informed and confident in a smooth Year 2000
transition. At the same time, increasing attention is rightly being paid to contingency plans.
In this connection, the Bank of Canada has recently announced a number of arrangements to provide
an additional measure of confidence to financial institutions and the general public. We are putting in
place a special line of credit to assure these institutions and the users of financial services that if there
is any unusual demand for liquidity around the turn of the year, it will be met. And the Bank is
prepared to accept a wider-than-normal range of collateral to support any liquidity loans it provides.
We have also made arrangements to counter any unusual pressures on money market interest rates
during this period.
All this should be enough to reassure the vast majority of Canadians that the safest place to keep their
money is with their financial institutions. In fact, they should prepare for the century-changeover
weekend much as they would for any other long weekend.
Nevertheless, there will be some who still feel that they need to take further precautions. Those who
prefer a little extra reassurance in the form of additional cash can rest easy - it will be readily
available. The Bank has increased considerably its inventory of bank notes. And it has been working
with financial institutions to ensure that the system can meet an increase in demand for cash across
Canada. But let me reiterate that there is no reason for Canadians to feel that cash is the only way they
can pay for goods and services over the New Year's weekend.
Overall, the Bank of Canada and other financial sector participants have every confidence that
Canadians can plan on it being "business as usual" in the financial sector heading into the year 2000.