gordon thiessen : the economic situation in canada and the prospects for inflation opening statement by mr gordon thiessen, governor of the bank of canada, before the house of commons standing committee on finance, ottawa, on 16 may 2000. * * * mr chairman, and members of the committee : it is always a pleasure to appear before you. since other parliamentary business precluded my appearance before you last fall, i especially welcome this opportunity to discuss the economic situation in canada and the prospects for inflation. last week, we released our 11th monetary policy report. since our november report, the canadian economy has outperformed expectations. bolstered by vigorous external and domestic demand, canada ’ s economic expansion strengthened in the second half of 1999 and into early 2000. the buoyant us economic picture, combined with canada ’ s high levels of business investment and solid employment gains, augurs well for continued strong growth in canada. given the strong momentum of demand, the bank of canada has raised its projection for growth in 2000 to a range of 4 to 4. 5 %. the trend of inflation in canada over the past six months has been lower than expected and is among the lowest in the industrial countries. nevertheless, pressures on capacity will likely intensify through the year. consequently, we expect the trend of inflation, as measured by the consumer price index excluding food, energy, and indirect taxes, to rise gradually to close to the middle of our 1 to 3 % inflation - control target range. to keep this core rate of inflation steady near 2 %, some deceleration in economic expansion or a more rapid increase in productivity and production capacity will be required during 2001. when it comes to the production capacity of the economy, there is currently even more uncertainty than usual. the lower - than - expected rate of core inflation would suggest that conventional measures may be underestimating the economy ’ s capacity to produce goods and services without adding to inflationary pressures. while the conditions that would permit an increase in productivity growth and in capacity have improved substantially in recent years, there has so far been no significant hard evidence of such an increase. this makes judging the balance between aggregate demand and supply in the economy an even greater challenge than usual for monetary policy. the other main risks to canada ’ s economic outlook include the possibility that the momentum of aggregate demand from the us economy will continue to be stronger than expected and the likelihood of a buildup of inflationary pressures in the united states spilling over into

analysis suggests that canadian exports would fall, as would canadian imports. prices would rise at a time when the economy is already operating at capacity, so inflation would rise at least temporarily, but the effect could persist. consumers would have less purchasing power, so demand would slow. meanwhile, the potential of the economy would be eroded as companies invest less and become less competitive. so, the economy would see shocks to both demand and supply, resulting in twosided risks to future inflation. furthermore, the net effect on the economy might be buffered by any fiscal actions that governments might take. now, as we said in the mpr, these various effects are likely to be small for the measures already taken. in contrast, a large tariff on canadian - made automobiles and parts would have a much greater effect on trade and the economy through these same channels. people are understandably concerned about this sort of escalation and want to know how monetary policy might react to it. indeed, there was speculation that the bank would not move interest rates today because of the possibility of further trade measures. the bank cannot make policy on the basis of hypothetical scenarios. we felt it appropriate to set aside this risk and make policy on the basis of what has been announced. given the multiple channels through which protectionist measures affect economies, it should be clear that monetary policy is ill - suited to counteract all of their effects. it may, of course, play a supporting role, in conjunction with other policies. but, to put it bluntly, the economy would slow, inflation would rise, and the exchange rate would depreciate, adding further to near - term price pressures in the canadian economy. therefore, the implications for interest rates of an escalation in trade actions would depend on the circumstances. let me emphasize that monetary policy by itself could not undo the long - term damage to jobs and income that could result from rising protectionism. all this being said, it is important to remember that our economy is in a good place. we are operating near capacity, companies are investing even if some are hesitating, the labour market has been strong, and, most importantly, inflation is on target. in this context, higher interest rates will be warranted to keep inflation near target. governing council will continue to take a gradual approach to adjusting rates, guided by incoming data. with that, senior deputy governor wilkins and i would be happy to answer your questions. 2 / 2 bis central bankers'speeches