be made, in an open economy, between real income and real output. i will then review the adjustment of the canadian economy to the recent sharp rise in our terms of trade and suggest some general implications for productivity and potential output. after this, i'll say a few words about the bank of canada's new economic model, totem, and conclude with some comments on the bank's outlook for the canadian economy. productivity, terms of trade, and living standards there is no doubt that advances in productivity underpin improvements in our standard of living. however, in an open economy, real income depends not only on the volume of output, but on the trading value of that output, that is, on the terms of trade. moreover, domestic production is not the only source of income, and not all income from domestic production accrues to residents. the tendency to identify standard of living with real gross domestic product ( gdp ) per capita overlooks these important dimensions. in my view, a better indicator of the standard of living would be gross national product ( gnp ) per capita deflated by domestic demand prices. 2 by focusing on gnp rather than gdp, this measure includes canadians'earnings from abroad and excludes non - residents'income earned in canada. by see, for example, r. lafrance and l. l. schembri. 1999 - 2000. " the exchange rate, productivity, and the standard of living. " bank of canada review ( winter ) 17 - 28. a similar view has been put forward by u. kohli. 2005. " switzerland's growth deficit : a real problem - but only half as bad as it looks. " available at http : / / www. snb. ch / d / download / referate / ref _ 050304 _ koh. pdf. deflating gnp by the price index for domestic purchases rather than by the gdp deflator - the price of domestic output - it captures the terms - of - trade effect. it is instructive to compare this measure of real income with that of gdp per capita over the past 35 years ( chart 1 ). while the two measures move broadly in sync for most of this extended period, they have diverged since 2003. since then, and for the first time in 25 years, real income per capita has grown consistently faster than real output per capita. from 2002 to 2005, the average annual growth of real income per capita was 3

david longworth : work in progress – the bank of canada's response to the financial turbulence remarks by mr david longworth, deputy governor of the bank of canada, to the canadian association for business economics, kingston, ontario, 26 august 2008. * * * good afternoon. it's been a little over a year since the first effects of a series of financial dislocations were felt. the financial turbulence over the past year has been costly and difficult for many individuals and financial institutions ; it's been challenging for policy - makers ; and it's had implications for the overall economy. but the episode has also led many to reexamine their assessment of risks, to question risk - management practices, and to improve policies and operations. this has certainly been the case at the bank of canada. in my remarks today, i'd like to describe how the bank responded to the liquidity aspect of the turbulence as the year unfolded, and the changes that we made in our liquidity - policy framework, both to deal with problems as they arose and to improve our ability to operate in the future. i'll also provide an overview of current conditions in canadian credit markets and a brief comment on economic developments since we published our monetary policy report update in mid - july. i'll begin by providing a summary of the origins of the turbulence. origins of the financial turbulence for a number of years, desired world savings exceeded desired world investment. as a result, long - term real interest rates decreased around the world, which led investors, in their " search for yield, " to take on risk at lower premiums than they had demanded in the past, and to accept much higher levels of leverage in financial products and on their balance sheets to obtain their hoped - for returns. the search for yield also led to rapid growth in the demand for, and development of, more complex structured financial products, such as collateralized debt obligations ( cdos ) backed by asset - backed securities or by other cdos and asset - backed commercial paper ( abcp ) backed by cdos, some of which, after 2000, were based on u. s. subprime mortgages. these complex instruments were rated by credit - rating agencies using the same scale that they had used in the past for " plain - vanilla " corporate debt. some sellers of these complex financial instruments emphasized that these products were highly rated – many were aaa – but placed little emphasis on their other features. a number of