Tiff Macklem: Promoting growth, mitigating cycles and inequality - the
role of price and financial stability
Remarks by Mr Tiff Macklem, Senior Deputy Governor of the Bank of Canada, presented to
the Brazil-Canada Chamber of Commerce, São Paulo, Brazil, 12 March 2012.
* * *
Introduction
Good afternoon and thank you for the kind invitation to speak to the Brazil-Canada Chamber
of Commerce.
The climates and geographies of Brazil and Canada couldn't be more different. Yet our
countries have much in common.
We are both resource- and land-rich - Canada is the world's second-largest country, Brazil
the fifth largest. We are both among the world's top 10 oil producers. We share a democratic
system of government and market-based economies. And our monetary policies are both
anchored by an inflation target with a flexible exchange rate.
In recent years we both faced a global financial crisis that emanated from beyond our
borders. We weren't immune but came through it better than most.
Among G-7 countries, Canada had the shortest recession and one of the strongest
recoveries. The recession in Canada lasted three quarters and our GDP is now 3.3 per cent
above its pre-recession peak. Even more impressive is the recovery in Brazil, which returned
to growth after just two quarters. Your GDP is now 8.2 per cent above its pre-recession peak.
Globally, the cost of the crisis has been enormous. The ensuing recession was the worst the
world has seen since the 1930s and the most globally synchronous in history. Almost
28 million jobs disappeared. Output losses to the global economy amounted to at least
US$4 trillion. The recoveries in the United States and the euro area are the weakest since
the Great Depression and risks are elevated. These global headwinds continue to challenge
the Brazilian and Canadian economies.
The devastation wrought by the crisis has focused attention on rising levels of income
inequality in most advanced countries. The ensuing recession inflicted the greatest hardship
on the most vulnerable. And this comes against the background of a disquieting trend. Not
only have lower- and middle-income households borne a disproportionate share of the cost
of the Great Recession, they reaped less than their proportional share of the income gains
during the Great Moderation. Those gains were skewed to higher-income households.
The growing disparity between rich and poor has prompted young people and business
leaders, workers and the unemployed, and academics and policy-makers alike to ask some
fundamental questions - first, about the role and structure of the financial system and, more
recently, about capitalism itself. From the supporters of the Occupy Wall Street movement to
the editors at the Financial Times, the market economy is under acute scrutiny.
In my remarks today I want to address these concerns. I have three main messages.
First, markets work better than anything else at delivering opportunity and prosperity.
Second, an efficient and resilient financial system is an essential enabler to growth and
inclusion. But, third and critically, markets only work well within sound policy frameworks. All
markets - and financial markets in particular - need clear rules, diligent oversight, and
consistent enforcement of the rules. Systemic crises are not the inescapable product of
capitalism, and inequality is not the necessary by-product of growth.
Central banks play an important role in supporting well-functioning markets by promoting
both price and financial stability. These are essential public goods that sustain growth and
mitigate cycles and inequality.
Growth, cycles and inequality
Over the past quarter century, steady advances in transportation, communication, and
information technologies, underpinned by the widespread adoption of market-based
economic policies, have globalized and expanded economies everywhere, especially those
of Brazil, India and China. Never in history has economic integration involved so many
people, such a variety of goods, and so much capital.
This has dramatically narrowed the gap between rich and poor countries, lifted hundreds of
millions of people out of poverty and created the potential for hundreds of millions more to
share in the benefits. The shrinking disparity between the United States and China is
particularly striking. In 1990, GDP per capita in the United States was almost 30 times higher
than in China; by 2010, this ratio had fallen to just 6 times.
However, at the same time as inequality between countries has been declining, the gap
between rich and poor within many countries has increased (Chart 1). Countries as diverse
as China, Denmark, Germany, Japan, New Zealand, Sweden, the United Kingdom and the
United States have all seen inequality rise, as measured by their Gini coefficients.1 Again, to
use the example of the United States and China, from the mid-1980s to the late 2000s, the
Gini coefficient in the United States increased from 0.33 to 0.37, while inequality in China
increased from 0.29 to 0.44.
Among advanced countries, income inequality in the United States is at the high end of the
range and has trended upward since the early 1980s. In 1981, the income share of the
wealthiest 5 per cent of U.S. households was 16.5 per cent. By 2010, this share had
increased to 21.3 per cent. Over the same period, the income share of the bottom 20 per
cent shrank from 4.1 per cent to 3.3 per cent. With the onset of the crisis in 2007, the decline
accelerated as rising unemployment affected workers at the lower end of the income
distribution, particularly younger and less-educated workers. The last time inequality in the
United States was so severe was during the 1920s.
In short, market forces have been a powerful mechanism for creating wealth and narrowing
the income gaps between countries. At the same time, however, globalization, combined with
technological change, is concentrating wealth in fewer hands within many countries.
Brazil and Canada
Let me turn now to Brazil and Canada. The economic record of our countries in recent years
provides an important counter-example to those questioning capitalism. In the face of the
global crisis, neither country was obliged to bail out its banks. Our policy frameworks
performed well under stress. And our economies proved resilient in the face of a global crisis.
To an important degree, this outcome reflects the guidance we took from our own past
mistakes in the 1980s and 1990s. Learning from bitter experience, Canada and Brazil put in
place robust economic frameworks to support markets, including flexible inflation-targeting
regimes, prudent fiscal policies, sound financial sector regulation and proactive oversight.
In Canada we tend to compare our economic performance with that of the United States, for
obvious reasons. Our financial systems and economies are highly integrated. So when the
United States plunged into recession in the autumn of 2007, Canada was affected through
trade, financial, and confidence channels. But with our well-regulated financial system, a
credible monetary policy framework and a record of fiscal prudence, monetary and fiscal
stimulus proved highly effective in dampening the cycle and spurring the recovery.
This resilience had a profound impact on the relative performance of our labour market. The
United States lost 8.6 million jobs in the recession and, despite the recent improvement in job
creation, only about half of those jobs have been regained. In Canada, on a proportional
basis we lost about 40 per cent of the jobs that were lost in the United States. Moreover, by
early 2011 all of these had been recouped and employment is now 1.5 per cent above its
level at the start of the recession in Canada (and 2.4 per cent above its level at the start of
the recession in the United States) (Chart 2).
In Canada, as elsewhere, low-income workers were hit hardest by the recession. But with a
less-severe contraction in employment and a faster recovery, they fared far better than those
in the United States. The unemployment rate for U.S. workers with less than a high school
education almost doubled, rising from 10 to 19 per cent. And for younger workers aged 16 to
19, the rise in unemployment was even bigger, increasing from 15 to 26 per cent. By
comparison, in Canada the unemployment rate among youth and the least educated rose by
4 to 5 percentage points (Chart 3 a, b).
Similarly, while Canada has not escaped the trend toward higher levels of inequality,
inequality in Canada is substantially lower than it is in the United States (Chart 4). Over the
past quarter century, economic growth in Canada and the United States has been virtually
the same, averaging close to 2.6 per cent. But Canada has achieved this comparable rate of
growth with less inequality.
I won't presume to lecture you on the history of the reforms instituted here in Brazil, but I will
suggest that the world needs to hear more about Brazil's success story. The impact of the
changes put in place more than ten years ago is both impressive and instructive. As the
Brazilian economy became more open to the rest of the world and more market oriented,
annual economic growth rose from about 2.4 per cent in the early 2000s to 7.5 per cent by
the end of the decade. Brazil's exports of goods and services, as a share of GDP, increased
from 6.6 per cent in 1996 to 11.2 per cent in 2010.2
The most remarkable measure of success is that this step-up in growth was achieved with a
declining rate of inequality - proof positive that economic growth isn't inevitably shadowed by
a widening gap between rich and poor. Inequality peaked in Brazil in the 1980s as the
economy endured a series of crises, culminating in hyperinflation. But by the 1990s, growth
and equality began to improve. With market-based reforms starting in the 1990s, combined
with Brazil's move to inflation targeting and a flexible exchange rate in 1999, fiscal reforms
that put public finances on a sustainable track early in the 2000s, and social programs tied to
education and health, this virtuous cycle accelerated (Chart 5). The decline in inequality has
been significant, with the Gini coefficient falling from 0.60 to below 0.55. This combination of
faster growth and declining inequality helped lift some 20 million Brazilians out of poverty
between 2004 and 2009. Moreover, the potential to raise millions more out of poverty
remains.
Indeed, broader cross-country evidence suggests that lower inequality may in turn be good
for sustaining growth. Based on the historical experiences of a broad sample of countries,
recent research at the International Monetary Fund (IMF) suggests that for a country with
median inequality (i.e., with a Gini coefficient of 0.40), a 10-percentile decrease of the Gini
(to 0.37) increases the expected length of a growth spell by 50 per cent.3 Extrapolating from
this study for the case of Brazil, these point estimates suggest that the decline in the Gini
coefficient from 0.60 to 0.55 would be associated with a better than 75 per cent increase in
the expected length of a growth spell, all other factors being equal. This bodes well for the
future in Brazil.
BIS central bankers' speeches
BIS central bankers' speeches
What can central banks do?
How economies enter the virtuous circle of growth that both reduces inequality and is more
sustainable is a complex subject involving a broad range of factors and the full array of policy
frameworks, including education, health, openness to trade, foreign investment, financial
development, and fiscal, labour market and environmental policies. Needless to say, these
step well beyond the mandates and expertise of central banks. But within this matrix, central
banks have two limited but important roles to play: promoting price and financial stability.
Price stability
Low, stable and predictable inflation promotes growth, mitigates economic cycles and
protects the purchasing power of money.
In 1991 the Government and the Bank of Canada adopted an inflation-targeting regime,
which was renewed again in 2011 for another five years. Canadians have benefited in a
number of important ways from this regime. An improved inflation environment has allowed
consumers and businesses to manage their finances with greater certainty about the future
purchasing power of their savings and income. Interest rates have also been lower in both
nominal and real terms across a range of maturities. More broadly, low, stable and
predictable inflation has helped to encourage more stable economic growth in Canada and
lower and less-variable unemployment
(Table 1).
The reduced cyclical variability in unemployment has particularly benefited more vulnerable
households. Unemployment rates for younger workers and those with less education are
considerably more variable than those for well-educated, prime-age workers (Table 2). More
stable economic growth in Canada in the 20 years since we began inflation targeting has
reduced the cyclical fluctuations in unemployment for workers across all age and educational
categories, but the largest declines in variability have been experienced by younger and
lesseducated workers. Mitigating cycles is good for equality.
Inflation control also offers a more direct benefit to lower-income households. Inflation is a
tax on cash, and the proportion of household assets held in cash decreases as income
rises.4 As a result, the burden of inflation borne by low-income households is significantly
higher than for the wealthy.
High and unstable inflation also imposes particular hardships on those individuals whose
incomes do not keep pace with rising prices, especially people on fixed incomes, such as
pensioners.
Recent research at the Bank of Canada and elsewhere suggests that when inflation
increases from 2 per cent to 5 per cent, average consumption by the poor declines by about
1.4 per cent, about four times the decline that occurs among the wealthy. And the drop in
consumption among the elderly is about 1.8 times larger than that experienced by the
young.5

Financial stability
Low, stable and predictable inflation promotes growth and can help mitigate cycles and
inequality. However, the financial crisis has been a stark reminder that low inflation is no
guarantee of financial stability.
The causes of the financial crisis are many and complex. Its epicentre was the U.S.
subprime-mortgage market, the growth of which was fuelled, in part, by rising levels of
inequality as lower- and middle-income Americans took on more debt to compensate for
stagnating incomes and wealthy investors searched for yield.6
The consequences have been severe and will be with us for years to come. History suggests
that recessions following financial crises tend to be deeper, and the recoveries shallower. On
average, the loss of output in a recession after a financial crisis is two to three times the loss
in a normal recession. And typically, it takes output twice as long to return to its
prerecession level after a financial crisis than after a normal recovery.
Sadly, the recoveries in the United States and Europe show no signs of escaping this lesson
from history. Both are experiencing the weakest recoveries since the Great Depression. The
resulting unemployment, particularly long-term unemployment, is exacerbating inequality. In
the United States and the euro area combined, more than 11 million workers have been out
of work for more than a year.
The other side of the coin is that an efficient and resilient financial system is essential to
growth, and financial development has proven an important ingredient to reducing inequality.
A well-functioning financial system is a key enabler to growth, channelling savings to
productive investments, and helping households and businesses manage risks. Increasingly,
cross-country evidence also suggests that financial development eases inequality by
reducing transactions costs. This provides the opportunity to accumulate assets and smooth
consumption, make financing accessible to local entrepreneurs, and promote inclusion in the
formal economy. Recent research finds that financial development, measured as the ratio of
private credit to GDP, both raises growth and reduces inequality. For the poorest quintile,
60 per cent of the benefit of financial development comes from overall economic growth and
40 per cent from greater income equality.7 In short, there is a virtuous circle of financial
development, growth and reduced inequality.
This points to the imperative of a dynamic and robust financial system.
The excesses and abuses in the financial system that led to the crisis have been a lightning
rod for public discontent.
Understandably so.
But the answer is not to dismantle the financial system. It must be rebuilt. That process is
well under way.8
The G-20 financial reform agenda, launched in the depth of the recession, is suitably
sweeping. Its key elements include:

capital and liquidity buffers to make banks safer;

broadening the span of regulation and oversight so that all systemically important
financial institutions, markets and products are included;

stronger infrastructure so that core financial markets continue to function in periods
of stress; and

credible and effective resolution regimes for all financial institutions so that no
institution is too big to fail.
Many of these reforms are now being implemented. Others are still in the policy development
stage.
These reforms are not without costs. Higher capital and liquidity standards will raise the cost
of funds. But the benefits of reducing the frequency and severity of crises are much larger.
Under conservative assumptions, a cost-benefit analysis by the Bank of Canada suggests
that strengthened international liquidity standards and a 2-percentage-point increase in bank
capital ratios globally would generate net gains to Canada in present-value terms of about
13 per cent of GDP, equivalent to about $200 billion.9 The gains for the world economy are
even greater, reflecting the higher historical frequency of crises globally. The cumulative net
present value gain of these higher global standards is equivalent to more than 35 per cent of
global GDP.10
Conclusion
Let me conclude.
Markets work better than anything else. They have proven over time to be the best generator
of prosperity. But markets need to be guided by sound policy frameworks with clear rules that
must be enforced with consistency and transparency. Effective inflation control, combined
with well-regulated financial systems, are critical ingredients to sustained economic growth
and shared prosperity.
The forces of globalization and technological change that have propelled global growth and
driven rising inequality within many countries are not likely to abate. We need to harness
these sources of growth while increasing opportunity for all our citizens. Brazil is showing the
world how.
Thank you.