david dodge : views on the canadian economy and monetary policy opening statement by mr david dodge, governor of the bank of canada, to the standing senate committee on banking, trade and commerce, ottawa, 3 may 2006. * * * good afternoon, mr. chairman and members of the committee. we appreciate the opportunity to meet with this committee twice a year, following the release of our monetary policy reports. these meetings help us keep senators and all canadians informed about the bank's views on the economy, and about the objective of monetary policy and the actions we take to achieve it. when paul and i appeared before this committee last october, we said that the global and canadian economies were continuing to grow at a solid pace, that our economy appeared to be operating at full production capacity, and that it would remain at capacity in 2006 and 2007. total and core inflation were projected to average close to 2 per cent, beginning in the second half of this year. this projection assumed oil prices at roughly us $ 64 per barrel, a level then indicated by futures prices. our projection also assumed stable commodity prices, government spending that was growing roughly in line with revenues, and a canadian dollar continuing to trade in a range of 85 to 87 cents u. s. in our april monetary policy report ( mpr ), we say that the global economy has shown a little more momentum than had been anticipated : oil prices have been roughly us $ 10 per barrel higher than assumed ; metals prices have risen significantly ; and the canadian dollar had been trading in a range of 85 1 / 2 to 88 a½ cents u. s. in our report, the bank projects economic growth of 3. 1 per cent in 2006, 3. 0 per cent in 2007, and 2. 9 per cent in 2008. total cpi inflation will continue to be volatile and affected by developments in the markets for crude oil and natural gas, and will average close to 2 per cent in 2007 and 2008 ( excluding the effect of any changes in the gst ). core inflation is projected to rise to 2 per cent in the second half of this year and remain there through to the end of 2008. this projection is based on three key assumptions : first, that energy prices will remain roughly as indicated by futures prices ; second, that canadian governments will continue to run budgets that are roughly in balance ; and third, that the orderly resolution of global imbalances will involve a gradual depreciation of the u. s. real effective exchange rate.

the summer have also had some important implications for our role as the country's monetary policy authority. before explaining these implications, i should start with some background. the bank's policy rate is our target for the overnight interest rate. this rate is crucial for the transmission of monetary policy throughout the economy. when we adjust our target for the overnight rate, we set in motion a chain of consequences that influences other interest rates in financial markets and, through the cost of credit, spending, production, employment and, ultimately, the rate of inflation. by adjusting our target, we are aiming to keep total demand and supply in the economy in balance, thus keeping inflation low, stable, and predictable. during the summer, however, we saw a widening of the spread between short - term market interest rates, such as the rate for commercial paper, and our target for the overnight rate. should these wider spreads persist, it would represent a tightening of credit conditions in the economy that would occur independent from any movement in our target for the overnight rate. thus, any given policy rate would be somewhat more restrictive than was previously judged. this leads me to what is perhaps the most important lesson that central bankers can learn from these events. let me emphasize this by returning to the point i made earlier about how the process of securitization enhanced the ability of financial institutions to make loans. it seems to me that in recent years, central bankers may not have fully appreciated just how much the increase in securitization represented an easing of credit conditions. loans were being shifted off balance sheets, allowing more loans to be made. if securitization led to the creation of loans that would not otherwise have been made, then this was a source of demand in the economy that we as central bankers likely did not fully take into account. any given policy rate would thus be less restrictive than was earlier judged, implying that interest rates globally might have been lower than would have been optimal. however, since both global and domestic inflation have been largely contained over this period, we should not exaggerate the magnitude of this effect. a reduction in securitization now seems likely, and we can expect a degree of reintermediation by financial institutions. all other things equal, in canada, this will lead to a higher cost of credit relative to the overnight interest rate than was the case prior to this summer. but how much tightening will this lead to in the longer run? and will the process of re -