David Dodge: Focusing on the long term
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Council of Chief
Executives, Washington, D.C., 7 April 2003.
* * *
Thank you for the invitation to join you this evening. It was exactly a year ago that I met with you in
Montréal. It has not been an easy year. All of you have been running companies and making decisions
under very uncertain conditions. You have had to deal with corporate and accounting issues. Markets
have been volatile. And geopolitical events have shaken confidence.
At times like these, it's easy to get caught up in trying to make one's way through current events that
cloud the outlook. But the present uncertainties make it even more important to maintain a focus on
strategies that will promote the health of businesses over several years-not just over the next few
months or quarters.
The same holds true for economic policy-makers. Failed experiments in previous decades have taught
us that, in times of uncertainty, it is extremely important to stick to policies that will foster long-term
economic growth.
A longer-term focus
Many of us in this room have reached a stage in life where we have at least two pairs of glasses-one
for close-up, and one for distance. We're acutely aware that wearing glasses to focus on something
very close makes us lose perspective on things further away. And if we focus only on the here and
now, we can lose sight of the future. We need a set of economic bifocals, if you will, to see the impact
of current events, as well as the best path to future prosperity.
Tonight, I'd like to speak about that longer-term economic vision. Through more than a decade of
macroeconomic reform, we Canadians have created a framework to meet both immediate and
longer-term challenges. Even as short-term events have buffeted our economy, we have followed four
key long-term policy principles: trade liberalization, structural reform, sound fiscal policy, and low
inflation.
Recent Canadian economic performance demonstrates the merit of continuing to set policies with a
longer-term view. Short-term adjustments are sometimes unavoidable in the face of extraordinary
events-and we've had more than our share of extraordinary events in the past few years! But, on the
whole, these basic principles have stood Canada in good stead through the recent difficulties in the
world economy. Let me talk about each one in a bit more detail.
Trade Liberalization
The first principle is trade liberalization, and our economic relationship with the United States has
reflected that goal. As you and I discussed last year, the Canadian and U.S. economies made difficult
adjustments to freer trade in the early 1990s. The Canada-U.S. Free Trade Agreement and the North
American Free Trade Agreement exposed many Canadian companies to stiffer competition. But freer
trade also opened up new markets. And Canadian companies have risen to the challenge. Some of
the sectors that we used to protect the most-such as furniture, clothing, and wine-have established
a strong presence in international markets. On the whole, Canadian industry has flourished with the
competitive pressures generated by these agreements. And so has
the trading relationship between Canada and the United States.
As you can see from Chart 1, freer trade has clearly meant
increased volumes of exports and imports. And now that we have
made the adjustment, the more open trading environment is clearly
helping to raise living standards for Canadians.
That should strengthen our resolve to see freer trade extended both
within and beyond North America. We need to continue to work
towards reduced trade barriers, both within NAFTA and at the Doha
round of multilateral talks. It won't be easy, but the long-term economic benefits will make our efforts
worthwhile.
Structural Reform
The second principle focuses on improving the structure of national economies, to facilitate adjustment
to changing economic conditions and to ensure the longer-term viability of social- and income-security
arrangements. A number of initiatives have been undertaken in Canada, but I'm going to focus on only
three. I am sure that you're familiar with them, and many of you have participated in the debate
surrounding these reforms.
First, Employment Insurance (EI) benefits were restructured to
strengthen the incentive to work. With these changes, and with
improved economic performance, EI payments as a share of GDP
have declined significantly over the past decade, from more than
2 1/2 per cent to just over 1 per cent, as shown in Chart 2.
Second, the Canada and Quebec Pension Plans were revamped,
to put them on a sustainable
footing. The reforms meant
some restructuring of benefits
and a sharp increase in
contributions-moves that were necessary, if unpopular. The
results are shown in Chart 3. The assets of the CPP are now
managed by the independent Canada Pension Plan Investment
Board, the mandate of which is to invest the contributions in
markets, in order to generate the best possible returns. These
changes mean that Canadians no longer have to worry about the
sustainability of their CPP and QPP pensions.
Third, governments have improved the efficiency of their tax and spending programs. I know that you
are familiar with the major federal and provincial efforts to make direct government spending more
efficient. Although more work always needs to be done, governments in Canada have also undertaken
significant structural changes to our tax regime. They have reduced distortions in the personal income
tax system and implemented the goods and services tax to replace the outdated manufacturers sales
tax. Structural reform has also included changes to Canada's corporate tax regime-changes that,
when completed, will eliminate the federal capital tax and reduce the average statutory corporate tax
rate in Canada to a level that is below current U.S. rates.
Of course, there are other structural improvements left to be made. I'm sure many of you have views
and suggestions about how to make them. You have been discussing some of them here today. In my
view, it is critical that Canada's private and public sectors continue to work together to further improve
the structure of our economy and increase our ability to adjust to changing world economic conditions.
Sound Fiscal Policy
Now, the key to good economic performance is sound macroeconomic policy. The Bank of Canada is
responsible for monetary policy. But monetary policy operates within a larger macroeconomic context.
So, let me start with fiscal policy.
For Canada, the commitment to the principle of sound fiscal policy has meant putting our public debt,
as a proportion of GDP, on a sustainable downward track. Many of you remember the difficult and
unpopular decisions that had to be taken by federal and provincial
governments during the 1990s to achieve this goal.
Those efforts are paying off. Today, not only does Canada have
one of the lowest debt burdens in the G-7, but, as shown by the
arrows in that burden is expected to continue to decline.
Chart 4,
The federal government has paid down almost $50 billion of its
debt-bringing it down from a high of almost 70 per cent of GDP in
1996 to about 45 per cent in 2002, as illustrated in Chart 5. Thus,
the vicious circle of rising deficits and debts of the 1970s and
1980s has become a virtuous circle of balanced budgets and falling
debt.
Program spending for all levels
of government has dropped
from 42 per cent of GDP in
1993 to 34 per cent last year,
as you can see in the table.
And debt-servicing costs have
dropped from about 9 per cent
of GDP to less than 6 per cent.
Here's how Finance Minister Manley summed up this principle of
fiscal discipline in his February budget speech: "Keeping a
balanced budget, cutting debt and getting the best value for money are a constant challenge and a
constant imperative. These are the bedrock of our fiscal and economic strategy."
Low Inflation
Complementing a sound fiscal policy is a monetary policy focused on keeping inflation low and
stable-that's the fourth principle, and that is the Bank of Canada's responsibility. Canada's
inflation-targeting framework works in a symmetrical way to keep consumer price inflation at the
2 per cent midpoint of a 1 to 3 per cent range. If the trend of inflation moves away from the target, in
either direction, the Bank will take action to return it to the target within 18 to 24 months.
Through most of the past decade, we have managed to keep
inflation around the 2 per cent target midpoint, as you can see in
Chart 6. As a result, Canadians' expectations for inflation have
become firmly anchored around
2 per cent, as shown in Chart 7.
That is extremely valuable for
decision-makers in business,
government, and households.
This climate of low, stable, and
predictable inflation has helped
to smooth out the ups and downs
in the economy and to create the
best possible environment for longer-term economic growth in
Canada.
Let me now spend a few minutes describing the circumstances in which monetary policy is currently
operating. Even though growth slowed in the fourth quarter of 2002, reflecting global economic and
geopolitical uncertainties, our economy continues to operate close to capacity.
As we said in our January Monetary Policy Report Update, a number of indicators support this view.
They include high industrial-capacity utilization; a record-high labour force participation rate; a
record-high employment-to-population ratio; corporate profits at their highest level since early 2001;
and trend inflation that is running above target.
Canada's inflation numbers continue to reflect the impact of higher-than-expected prices for crude oil
and natural gas, further increases in auto insurance premiums, and price pressures in certain sectors,
such as housing, food, and some services. This higher inflation also suggests an underlying firmness
in the price-setting environment. Relative price increases wouldn't be pushing up trend inflation if there
was not sufficient demand.
So, in making our latest interest rate decision on 4 March, we weighed not only domestic inflation
pressures and the expectation that Canadian economic activity will remain near potential in 2003, but
also the stimulative stance of monetary policy and improved conditions in capital markets. Taking
these factors into account, we raised our key policy rate by one-quarter of a percentage point to 3 per
cent.
Even with this increase, the stance of monetary policy in Canada remains stimulative. Thus, over time,
further reductions in monetary stimulus will be required to return inflation to the target in the medium
term. But, as we have said, the timing and pace of increases in policy interest rates will continue to
depend on a number of considerations. These include: the strength of demand pressures; the
evolution of inflation expectations; the impact on confidence of global economic uncertainties; and the
way in which the war in Iraq affects demand and inflation, both globally and in Canada. The Bank
continues to monitor all of these factors and will adjust monetary conditions to keep Canadian inflation
low, stable, and predictable over the medium term. The Bank's next Monetary Policy Report, to be
released on 23 April, will provide a full update of our assessment of the economy and of the outlook for
inflation.
Conclusion
In closing, let me repeat that, in these trying times, it is tough indeed to maintain a clear view of the
current economic picture. But, if we spend all our energy focusing on the near term, we risk losing
sight of what's farther out. Your job is to build enterprises that will flourish over the longer term. And
our job as policy-makers, whether on the monetary or fiscal side, is to create the best possible climate
for sustained economic growth. In an uncertain world, the best thing we can do is to stick to sound
economic policy principles. They have proven to be the most effective tools to deal with short-term
turbulence and, at the same time, promote solid, sustainable economic growth and prosperity over the
longer term.