Stephen S Poloz: Opening statement before the Senate Standing
Committee on Banking, Trade and Commerce
Speech by Mr Stephen S Poloz, Governor of the Bank of Canada, to the Senate Standing
Committee on Banking, Trade and Commerce, Ottawa, Ontario, 29 October 2014.
* * *
Good afternoon, Mr. Chairman and committee members. I am pleased to introduce you to
Carolyn Wilkins, who assumed the post of Senior Deputy Governor of the Bank of Canada
on 2 May of this year.
Before we take your questions, let me give you some of the highlights of the economic
outlook. I'll draw mainly on the October Monetary Policy Report (MPR), which the Bank
published last week, but I'll also reflect back a bit further since it has been some time since
we last met. I'll touch on some new advances in our thinking, and talk about how the
environment is driving an evolution in the way central bankers conduct monetary policy.
Our outlook for the global economy continues to show stronger momentum in 2015 and
2016, but the forecast profile has been downgraded since July. The good news for Canada is
that the U.S. economy is gaining traction, particularly in sectors that are beneficial to
Canada's exports.
And our exports do appear to be responding, with some additional help from a lower
Canadian dollar. Our conversations with exporters indicate that they are seeing a better
export outlook from the ground.
However, it is clear that our export sector is less robust than in previous cycles. Last spring,
as you may recall, we identified which non-energy subsectors could be expected to lead the
recovery in exports, and which would not.
We have since investigated in more detail the subsectors that have been underperforming.
After sifting through more than 2,000 product categories, we have found that the value of
exports from about a quarter of them has fallen by more than 75 per cent since the year
2000. Had the exports of these products instead risen in line with foreign demand, they
would have contributed about $30 billion in additional exports last year.
By correlating these findings with media reports, we could see that many were affected by
factory closures or other restructurings. In other words, capacity in these subsectors has
simply disappeared. This analysis helps us understand a significant portion of the gap in
export performance.
Our research also tells us that most of the sectors expected to lead the recovery in
nonenergy exports still have some excess capacity. Our Business Outlook Survey interviews
indicate that while companies plan to invest in new machinery and equipment, few are
planning to expand their capacity, at least so far. This helps explain why business investment
might be delayed relative to what would be expected in a normal cycle.
This research has important implications for Canada's employment picture. We know that
when companies restructure or close their doors, the associated job losses are usually
permanent. If companies can meet increased export demand with existing capacity, the
associated employment gains can be fairly modest, with most of the increase in output
coming in the form of higher productivity. The bigger employment gains will come when we
enter the rebuilding phase of the cycle - when companies are sufficiently confident about
future export demand that they begin to invest in new capacity and create new jobs.
These considerations enter into our estimation of the output gap - the difference between
GDP and potential GDP - which is the key macroeconomic determinant of the outlook for
underlying inflation. When the economy moves into a position of excess supply, inflation
declines, and when it moves into a position of excess demand, inflation rises.
There is no single preferred measure of capacity in the economy. Traditionally, we have put
the most weight on measures based on output, or GDP. Each October, we do a full analysis
of the determinants of potential output, and its future trend. We have done so in this MPR,
but in future we will update this analysis in every MPR. This time, we also offer a special
technical box that considers the dynamics of excess capacity in longer business cycles like
this one.
The reason this is important is that in such longer business cycles, the restructuring or
closure of firms reduces potential output while creating permanent job losses. This means
that the output gap can appear smaller than the labour market gap, which is our current
situation. This difference persists until after the rebuilding phase of the recovery I discussed
earlier, when the excess capacity measures eventually converge.
Our judgment is that we have considerable excess capacity and that continued monetary
stimulus is needed to close the gap and bring inflation sustainably to target. But we take
account of our uncertainty around the degree of slack by considering a range of possible
slack estimates in our deliberations.
Another important building block of our policy framework is the neutral rate of interest. The
neutral rate is the rate of interest that should emerge once all the dust has settled - inflation
is on target, the economy is operating at its full capacity, and all shocks have been worked
out. Carolyn discussed this in an important speech last month; there is also a discussion
paper about it on our website and a box in this MPR. The neutral rate, too, is uncertain. We
estimate that it now lies between 3 and 4 per cent, which is well below pre-crisis levels. But
since the difference between current rates and the neutral rate is our best estimate of
monetary stimulus, understanding the risks around this is also important.
After weighing these considerations, it is our judgment at this time that the risks around
achieving our inflation objective over a reasonable time frame are roughly balanced.
Accordingly, we believe that the current level of monetary stimulus remains appropriate.
Just as our analysis of the economic forces has been evolving with events as they transpire,
so is the way we conduct monetary policy adapting in real time to the changing environment.
There is now particular emphasis on the incorporation of uncertainty into policy decision
making. We published a discussion paper on the subject earlier this month.
We have begun putting our growth and inflation forecasts in the form of ranges rather than
points, and have given even more prominence to uncertainty and risks in the MPR. We've
refined our analysis of financial stability risks and raised the profile of our Financial System
Review. And, we have begun to offer a more fulsome description of how those risks are
entering our policy deliberations, particularly in the opening statement that precedes our
press conferences. These changes have brought more transparency to our decision making,
and our policy narrative has shifted from one traditionally seen almost as "mechanical
engineering" to one now characterized as "risk management."
One powerful risk management tool that policy-makers have in their tool kit is forward
guidance - the ability to provide to markets more certainty about the future path of interest
rates. This effectively takes uncertainty out of the market and places it firmly on the
shoulders of the central bank. There are costs as well as benefits to using this tool, and so
we have decided that forward guidance will be reserved for times when we believe the
benefits to its use are clear - periods of market stress, periods when traditional monetary
policy tools are constrained, and so on. Otherwise, we will let markets do their job, which is
to deal with the daily flow of new information and grind out new pricing, without specific
interest rate guidance from the Bank, but supported by the increased transparency around
our outlook for inflation and the risks we are managing.
And with that, Carolyn and I would be pleased to answer your questions.