the dollars borrowed originally. in a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn. although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. this burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing ( perhaps rapidly increasing ) real value. when william jennings bryan made his famous “ cross of gold ” speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed america ’ s post - civil - war return to the gold conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. i don ’ t know of any unambiguous example of a supply - side deflation, although china in recent years is a possible case. note that a supply - side deflation would be associated with an economic boom rather than a recession. the nominal interest rate is the sum of the real interest rate and expected inflation. if expected inflation moves with actual inflation, and the real interest rate is not too variable, then the nominal interest rate declines when inflation declines - - an effect known as the fisher effect, after the early twentieth - century economist irving fisher. if the rate of deflation is equal to or greater than the real interest rate, the fisher effect predicts that the nominal interest rate will equal zero. the real interest rate equals the nominal interest rate minus the expected rate of inflation ( see the previous footnote ). the real interest rate measures the real ( that is, inflation - adjusted ) cost of borrowing or lending. standard. the financial distress of debtors can, in turn, increase the fragility of the nation ’ s financial system - - for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. japan in recent years has certainly faced the problem of “ debt - deflation ” - - the deflationinduced, ever - increasing real

stephen s poloz : opening statement before the house of commons standing committee on finance opening statement by mr stephen s poloz, governor of the bank of canada, before the house of commons standing committee on finance, ottawa, ontario, 31 october 2017. * * * good afternoon, mr. chairman and committee members. senior deputy governor wilkins and i are happy to be before you today to discuss the bank ’ s monetary policy report ( mpr ), which we published last week. when we were last here in april, we were celebrating the fact that we had upgraded our economic forecast following a long period of disappointment. i am happy to tell you that many of the positive trends that we saw then have continued. sources of economic growth have broadened across sectors and regions, and the process of adjustment to the oil price shock is essentially complete. the bank raised its policy interest rate twice since our last visit, in july and september. we did this in the context of very strong economic growth over the first half of the year and solid progress in the labour market. over the summer, we saw evidence of firming inflation and an economy that was rapidly closing its output gap. with these two rate increases, we have taken back the cuts we made in 2015, which were crucial in helping the economy adjust to the oil shock. growth in the first half of the year averaged just over 4 per cent at an annual rate. this reflected strong consumer spending backed by rising employment and income, together with increased business investment and a jump in energy exports. we are now starting to see signs of moderation in the second half, which we forecast in july. growth in consumption and investment is expected to ease, and growth in housing is projected to slow further, in part because of the measures introduced by the ontario government in april. all told, we forecast that the economy will expand by 3. 1 per cent this year, before slowing to 2. 1 per cent in 2018. this is still faster than the growth rate of potential. we estimate that the economy is now operating close to its capacity. inflation should reach our 2 per cent target in the second half of next year, a little later than earlier projected because of the temporary impact of the stronger canadian dollar this year. we are at a crucial spot in the economic cycle, and significant uncertainties are clouding the way forward. in our mpr, we identified the four most important sources of uncertainty. i will touch on these now. the first issue is inflation