Sheryl Kennedy: Adjusting to economic change
Remarks by Ms Sheryl Kennedy, Deputy Governor of the Bank of Canada, to the Greater Saskatoon
Chamber of Commerce, Saskatoon, Saskatchewan, 22 February 2007.
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It's a pleasure to be here in Saskatoon.
The last time someone from the Bank of Canada spoke to this Chamber of Commerce was five years
ago, when Governor Dodge discussed "Inflation Targeting During a Difficult Year." Just five years ago,
but what a different world it was then. The world economy wasn't nearly as strong. Commodity prices
were soft. From that vantage point, it would have been difficult to predict what happened over the next
five years. Who could have foreseen the price of potash rising 50 per cent, oil prices going up about
200 per cent, or the price of uranium appreciating fivefold? Who could have known that the Canadian
dollar would appreciate by more than a third? More importantly, who could have predicted that the
Canadian economy would fare so well in dealing with these significant changes?
The past five years have indeed been a period of great and relatively rapid economic change, both
here in Saskatchewan and across the country. In my remarks today, I'd like to describe this change
and discuss its significance to our economic well-being. Then I'd like to look at some of the factors that
explain the success of the adjustment process thus far. Finally, I'd like to suggest what needs to be
done to ensure that we'll continue to be up to the task of meeting the challenges ahead.
Changes in the economy since 2002
Let's start by turning back the clock, and looking briefly at what was going on five years ago. Of
course, the big news five years ago this month was the Olympics in Salt Lake City. There, the fastest
woman on ice, Saskatoon's Catriona LeMay Doan took gold - again, as she'd done in 1998 - in speed
skating. And the women's hockey team, led by another Saskatchewan athlete, Hayley Wickenheiser,
won all five games they played, and also took home the gold medal.
Now, how was the economy faring? Well, it wouldn't have won a gold medal, but the economy wasn't
doing too badly, especially considering the slowdown that occurred in the wake of 9/11 in 2001. The
world economy was growing at just over 3 per cent, and the Canadian economy at just under 3 per
cent. The national unemployment rate was 7.7 per cent. And inflation, at just over 2 per cent, was
under control.
Let's turn now to what has happened since 2002. In each of the four years that followed, world GDP
growth has been over 4 per cent in real terms. Last year, it was 5.2 per cent. In fact, the world
economy has grown more during this period than in any other five-year period since the second world
war.
Of course, strong non-inflationary growth of the global economy is desirable and good for most
countries. But it is particularly true for Canada, given that so much of our economic well-being is
derived from trade with the rest of the world. The strength of the global economy has had the
important effect of increasing the demand for - and raising the prices of - many commodities that
Canada exports, including oil and natural gas, copper and nickel, potash and uranium. At the same
time, the prices of many imports have fallen, owing in part to global competition. This has resulted in
what is called a "positive terms-of-trade shock" - the prices we get for our exports have increased
relative to the prices we pay for our imports. As a result, we are richer as a country.
In tandem with this improvement in our terms of trade, we've seen a major rise in the external value of
our dollar. In February 2002, the Canadian dollar was at a historic low. Today, at around 85 cents, the
dollar is worth about 37 per cent more against the U.S. dollar than it was then, and about 30 per cent
more against a trade-weighted basket of currencies. This rapid and substantial movement in the
exchange rate reflects fundamental changes in the economy. But that doesn't mean that adjusting to it
has been easy. Adjusting to such an appreciation in the external value of the dollar can be difficult for
many companies and workers, especially when competition is fierce, as it is now. But a strong dollar
also presents opportunities. Businesses, for example, can more easily buy productivity-enhancing
machinery and equipment from abroad, and the evidence is that they are doing just that. Consumers
benefit because the prices of imports are lower when they're bought with a stronger dollar.
Changes in our terms of trade also have implications for the allocation of resources within our
economy. The strong commodity prices I mentioned have led to increased profitability in mining and oil
and gas extraction. This, in turn, has prompted strong gains in both investment spending and
employment in those sectors of the economy. Most sectors with a low exposure to international trade
(such as personal services) have also experienced relatively strong levels of profitability and solid
gains in employment. On the other hand, with the substantial rise in the exchange rate and increased
competition from many of the Asian economies, many industries with a high exposure to international
trade - typically manufacturers - have faced difficult adjustments since the end of 2002. This has been
reflected in lower rates of profitability, modest gains in production, and declines in employment.
But overall, Canada has adjusted well to the challenges of the past five years. Since 2002, our labour
markets have performed well - the unemployment rate is now close to a 30-year low. And our average
annual economic growth rate has been greater than the average growth rate of the G-7 countries as a
whole.
That's the national picture. In many respects, Saskatchewan is a microcosm of these trends. Real
provincial GDP growth is solid and close to the national average. In the past five years, Saskatchewan
has seen its labour participation rate increase significantly - from 65.7 to more than 70 per cent - and
the unemployment rate has dropped from 5.4 per cent in February of 2002 to 4.1 per cent last month,
indicating a robust labour market. Of course, Saskatchewan has been helped a good deal by the
increase in world commodity prices that I mentioned earlier - especially for energy, potash, and
uranium, while manufacturers here have faced challenges similar to those faced by manufacturers
elsewhere in Canada.
To summarize, the past five years have been a time of large and significant economic adjustment.
Despite the stresses and strains that such a change can cause, Canada has done very well, all things
considered. The economy is strong, Canadians are working, and they have seen increases in wealth
and income.
What are some of the factors that explain this successful adjustment?
What explains the success of the adjustment process?
In an open economy like Canada's, the most important factor is flexibility. By flexibility, I mean the
ability of the economy to adjust to changes in circumstance - that is, for resources to shift from areas
of weakening demand to areas of strengthening demand - and for the economy to return to its
production potential quickly, with as little cost as possible. But flexibility doesn't just happen - it's a
function of structural policies, human capital, and our business culture. And flexibility is facilitated by
two other elements that are required for success in economic adjustment - sound monetary and fiscal
policies. Let's look at monetary policy first.
The two key components of our monetary policy framework are inflation targeting and a floating
exchange rate. These work together and reinforce one another to promote stability and to facilitate
economic adjustment. How does this happen? Let's look first at inflation control.
Low, stable, and predictable inflation provides many benefits. It helps people deal with change. One
way it does this is by allowing prices to send clear signals, which in turn help individuals and
companies to make sound, long-term economic decisions. In addition, and very importantly, when
inflation is contained, monetary policy can be set to keep the economy running close to capacity,
acting as an automatic stabilizer, so the economy can more effectively absorb shocks.
These benefits are complemented by our flexible exchange rate. A floating dollar also acts as an
automatic stabilizer, helping the economy to absorb shocks - especially external shocks that affect our
economy differently than the economies of our major trading partners. Movements in the exchange
rate are also important for the information they contain. They send signals to businesses and
consumers about where to make investments and purchases, thus helping them adjust to the shifting
currents of the global economy.
But monetary policy cannot do its job well if it's not accompanied by sound fiscal policy. The federal
government has had a budget surplus every year since 1997-98, and since 1999-2000, the provinces
and territories as a whole have, more often than not, also been in a surplus position. Fiscal discipline
is important, first, because it frees resources - resources that would otherwise be required to service
debt - for more productive uses, and second, because it gives governments room to manoeuvre to
deal with unanticipated events. Our sound fiscal situation has clearly helped Canada to weather the
changes of the past five years.
But sound monetary and fiscal policies are not enough to explain the success of the adjustment
process. The flexibility of our economy has also been extremely important. When I say flexibility, I
mean first and foremost the ingenuity and skills of our workers and business leaders. That's why
education and training are so vital. Of significance for Saskatchewan's future well-being is the recent
rise in what is called the "educational attainment" of its labour force. But flexibility is also a function of
the ease and speed with which resources can be reallocated in an open economy. That's why we
need to ensure that there are no unnecessary structural impediments to economic adjustment -
impediments such as barriers to investment, to labour mobility, and to trade. In the past five years, the
Canadian economy has demonstrated increased flexibility. But, as I'll explain in a moment, more can
be done.
Finally, I should point out that the adjustment process in the past five years has been helped a good
deal by the favourable backdrop of strong growth in the global economy. Robust demand for Canadian
goods has helped to offset some of the stresses and costs of adjustment. With this in mind, I think it's
can
useful to point out that while Canadians control their monetary policy and fiscal situation, and can,
through various measures, encourage flexibility, we have less control over the external environment.
And it's only prudent to keep in mind the possibility that the external environment may not always be
favourable. So, the question arises: what do we need to do so that Canada remains able to respond
effectively to the challenges of the future, in both good times and bad?
Meeting the challenges of future economic change
All Canadians have a stake in the national economy. And we all have a role in helping to promote
policies and actions that foster sustainable economic growth - whatever the backdrop. For its part, the
Bank of Canada will continue to work toward the goal of keeping inflation low and stable, and we will
do our part in promoting a sound and efficient financial system.
Indeed, all policy-makers have a key role in promoting efficiency, productivity, and further economic
flexibility. In an increasingly competitive world, the bar is always rising, so we cannot rest on our
laurels. The policy areas in which we have more work to do will be familiar to you. In the financial
sector, which I know best, securities regulation needs to be made simpler and more efficient. And
generally, many business regulations need to be harmonized across Canada and some across the
NAFTA region. And barriers within Canada to the free movement of goods, services and labour need
to be removed. Tackling this issue is especially important now, as shortages of skilled labour are
becoming more pronounced. And it will become even more important as demographic challenges
begin to intensify. It would be helpful if trades and professional designations were recognized and fully
transferable across the country, and if we could resolve the difficult issue of recognizing the
qualifications of many talented immigrants. A related policy area that supports productivity and
flexibility is education and training. Canadian workers benefit - indeed, the whole economy benefits -
when they have the knowledge and skills required to take advantage of change and opportunity.
As I have already said, much of Canada's prosperity depends on active engagement with the wider
world. The recently re-started World Trade Organization talks to reduce barriers to international trade
are particularly important to us, and need to be brought to a successful conclusion. In addition, further
action should be taken to promote the orderly resolution of global financial imbalances - which refers
to the large U.S. current account deficit, mirrored by large surpluses in Asia and in major oil-exporting
countries. The United States needs to increase its savings rate, while Asia and the OPEC nations
need to increase their domestic consumption. And some countries, particularly China, need to develop
more flexibility in their currency arrangements.
So that's the challenge for policy-makers. Business leaders and workers also face the challenge of
adapting and prospering in a rapidly changing global economy. They have a stake in, and can lend
support to, initiatives in the policy areas I have just mentioned. But businesses also need to innovate
and aggressively tap new markets. They can invest in efficient machinery and equipment, and they
can invest in their employees. And workers do their part when they invest in themselves - by learning
and acquiring new skills.
Recent economic developments
Before I conclude, let me say a few words about how the Bank of Canada sees the Canadian
economy adjusting to the changes that have been taking place in the world. As stated in the January
Monetary Policy Report Update, the economy is judged at this time to be operating at, or just above,
its production capacity at the end of 2006, following weaker-than-expected growth in the second half
of the year. While the global economy has been expanding in a robust fashion, U.S. economic growth
slowed in 2006, with weakness concentrated in the housing and automotive sectors. This weakness
does not appear to have spread to the rest of the U.S. economy, and with signs that a significant
amount of the adjustment in these sectors has already taken place, U.S. economic growth is expected
to pick up through 2007. With continued solid growth in the rest of the world, the global economy is
expected to grow by 4.7 per cent in 2007, and 4.5 per cent in 2008. Non-energy commodity prices are
expected to decrease modestly from the very high levels reached toward the end of 2006.
This global outlook bodes well for Canada. Real GDP growth should average about 2 1/2 per cent in
the first half of 2007, rising to about 2 3/4 per cent in the second half of the year. In 2008, growth is
projected to stay in line with the growth of potential output, estimated to be 2.8 per cent, keeping the
economy operating near its full production capacity. The underlying trend of inflation, as measured by
core CPI inflation, should be close to 2 per cent through 2008. Total CPI inflation is expected to
average just above 1 per cent in the first half of 2007, returning to the 2 per cent target in 2008. In line
with this projection, in January we judged the current level of the policy rate to be consistent with
achieving the 2 per cent inflation target over the medium term.
The risks to this outlook for the Canadian economy are reasonably well balanced. The biggest
downside risk is sharper or more prolonged weakness in the U.S. economy, and the upside risk comes
from the strength of the Canadian housing market and credit growth putting upward pressure on
demand and inflation. In addition, there remains a small possibility of a disorderly resolution of global
imbalances, particularly if policy-makers fail to take appropriate actions.
I'll conclude now, and then I'd be happy to hear your comments and answer your questions.
Conclusion
The past five years have been a period of significant economic adjustment. Canada is a wealthier
country as a result of this change. We will continue to prosper, whether the external environment is
favourable or not, provided that we learn the larger lesson - that it is essential to be flexible and adjust
effectively to changes in economic circumstance.
The current favourable outlook, for both Canada and the global economy, should not lead to
complacency. We all have a stake in meeting the challenge of adjustment. As citizens, business
leaders, workers and policy-makers, we all have a role in ensuring that Canada can respond
effectively to changes in the economic landscape, and that Canadians can seize the opportunities that
such changes often bring.