david dodge : recent review of the canadian economy opening statement by mr david dodge, governor of the bank of canada, to the senate committee on banking, trade and commerce, ottawa, 24 november 2004. * * * 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 parliamentarians and, through you, 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 april, we told you that we judged the economy to be operating significantly below its potential. that is no longer the case. the canadian economy grew faster in the first half of the year than we had projected, largely because of a surge in exports. the economy is now operating near its production capacity and continues to adjust to global developments. our latest monetary policy report, released on 21 october, presents the bank ’ s base - case projection for the period to the end of 2006. it calls for aggregate demand for canadian goods and services to expand, on average, at about the same rate as potential output. given the effects of higher oil prices and the past appreciation of the canadian dollar, economic growth in the report is projected to be slightly less than 3 per cent in 2005, and slightly more than 3 per cent in 2006. with the economy expected to remain near its production capacity throughout this period, core inflation is projected to move back up from the current level of 1. 4 per cent to the 2 per cent target by the end of 2005. this is essentially the same projection that we made last april. however, in october we expected that total cpi inflation would rise to near the top of the 1 to 3 per cent target range in the first half of 2005 before falling slightly below core inflation in early 2006. this projection incorporates the path suggested by futures prices for crude oil in mid - october, when we finalized the report. it is against that background, that the bank raised the target for the overnight rate to 2. 5 per cent on 19 october, our most recent fixed announcement date. the base - case projection in our october report assumes further reduction of monetary stimulus over time, to keep the economy near its production potential and to achieve the inflation target. we also emphasized that the pace of interest rate increases will depend on the bank ’ s continuing assessment of the prospects

that high inflation, large government deficits, slower productivity growth, and lower commodity prices have tended to complicate canada ’ s economic situation over the past 25 years. but as i said at the beginning, much of the greater sense of difficulty and concern that canadians have felt in the 1990s has to do with the after - effects of the strong medicine we have had to take to turn our economic performance around. the success we have had so far in this regard bodes well for our future. canada ’ s inflation rate has come down dramatically, averaging less than 2 per cent since 1992. and there are now agreed targets between the bank of canada and the government of canada to keep inflation low and stable in the future. more importantly, canadians have come to expect continued low inflation and to build that expectation into their plans. the federal government and most provincial governments now have balanced budgets or are running surpluses. the total government debt - to - gdp ratio, which peaked at 70 per cent in 1996, has since fallen to 63 per cent. with present prudent fiscal policies, it should continue to decline steadily. future gains in productivity are difficult to predict. certainly, our improved inflation and fiscal situation, together with the low interest rates that they have made possible, provide the best climate for fostering productivity that we have had in a long time. moreover, canadian businesses have undergone major restructuring during the 1990s in response to increasingly competitive world markets. business investment has been rising smartly recently and more firms have been adopting new production technologies. it is also interesting to note that, after eight years of economic expansion, productivity growth in the united states has picked up, rather than falling off as usually happens at this stage of the cycle. tight labour markets seem to have encouraged a record level of investment in that country and more efficient use of technology than before. while the pickup in canadian investment in machinery and equipment has lagged somewhat behind that in the united states, new technology is not the exclusive preserve of our u. s. neighbours. so i hope that in canada, too, we will see a similar payoff from the adoption of new technology and a comparable improvement in productivity. as for commodity prices, there has already been some turnaround this year, but a firmer recovery requires a strengthening world economy – in particular, a turnaround in japan and the rest of asia. the other point to note in this connection is that the relative importance of commodities in the canadian economy has declined. the share of