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Remarks by David Dodge, Governor of the Bank of Canada, to the Couchiching Institute on Public Affairs, Geneva Park, Ontari...	David Dodge: Economic integration in North America Remarks by David Dodge, Governor of the Bank of Canada, to the Couchiching Institute on Public Affairs, Geneva Park, Ontario, 7 August 2003. * * * For more than 70 years now, the Couchiching Institute on Public Affairs has been bringing Canadians together with the purpose of asking some thought-provoking questions and encouraging lively, stimulating debates and action on a variety of key public policy issues. For example, it was at Couchiching, 56 years ago, that the idea of creating a North Atlantic Treaty Organization (NATO) was first floated publicly by Escott Reid, a senior official with the Canadian Department of External Affairs. NATO was established a year and a half later, reflecting almost exactly the vision that Reid outlined in his speech at Couchiching. I am delighted to have been invited to participate in this year's conference, the theme of which is “Continentalism: What's in It for Us?” True to form, here again is a topic that is thought-provoking and, some might say, provocative! Before I venture any thoughts on the subject, let me make it clear that I am not here as an advocate for greater North American integration. This is very much a political decision for Canadians and their elected governments. It is a big decision, and all of us, as a democratic society, will have to determine what we really want. I'm not a politician; I'm an economist. So, what I intend to do tonight is to lay down some parameters for an appropriate discussion of the issues relevant to greater economic integration in North America. First, I would like to review the benefits and costs of economic integration. By economic integration, I mean the free movement of goods and services, capital, and labour and the harmonization of the rules governing the operations of these three key markets. I will briefly review the progress Canada has made on each of those fronts, and the benefits we have derived from opening up our markets to international competition and to the free flow of capital. Next, I will talk about the remaining impediments to fuller economic integration. And finally, I will briefly discuss where we might go from here. The economic benefits and costs of open markets (i) Free trade International trade in goods and services takes place because countries have different resource endowments and labour skills and because consumer tastes vary from country to country. David Ricardo, a 19th-century British economist, argued that a country could gain from trade even when another country had an absolute advantage in producing all goods and services. He argued, rightly, that by concentrating on producing those goods and services in which a country was relatively more efficient, and importing those products in which it was relatively less efficient, it could increase its national income. And this would be so even if that country was absolutely less efficient in producing all products. This is the famous principle of comparative advantage. It is on this principle that economists base their view that barriers to trade reduce economic welfare in all countries. When countries export goods and services in which they are most competitive and import those in which they are less competitive, consumers everywhere benefit, the potential output of all nations increases, and so does the global standard of living. Opening up national borders also opens the door to greater global competition. And this acts as a potent incentive for businesses everywhere to become more efficient and productive. To relate this to Canada, international competition puts pressure on our domestic market to be more competitive, even in industries where the optimal scale may have only one or two Canadian firms operating. In the end, competitive pressure leads to greater efficiency, greater productivity, and higher standards of living. So there are clear economic benefits to greater economic integration with the rest of the world. Of course, there are adjustment costs to be borne as barriers to trade are removed. Some firms and some industries will not be able to meet the foreign competition, and will die or contract. This is part of 1/6 the process of releasing resources - both human and physical - to those industries or firms that are taking advantage of new markets abroad. So some kind of mechanism to equitably share the short-run costs of adjustment is important to reap the medium- and longer-run benefits of freer trade. Since the Second World War, Canada has had a history of being open to global markets for goods and services. In my view, this interaction with the rest of the world has proven very successful and has benefited Canadians, and our foreign partners, enormously. As you know, the Canada-U.S. Free Trade Agreement (FTA) of 1989 and the North American Free Trade Agreement (NAFTA) of 1994, which added Mexico to the partnership, were initially viewed with a great deal of skepticism in this country. And at first, the adjustment to the FTA was difficult. But, by the late 1990s, it was clear that freer trade in North America was bringing major benefits to Canada. FTA and NAFTA have opened up U.S. and Mexican markets, providing Canadian businesses with tremendous opportunities. They have also put pressure on our entrepreneurs to be more efficient - a challenge they have clearly risen to. Canadian exports have flourished, and consumers in this country now benefit from greater product choice and lower prices. Under the FTA and NAFTA, we have achieved much freer trade in manufactured goods. And we have gone quite a distance with respect to certain services. But we still have problems in some key sectors. For example, we certainly have a long way to go when it comes to agriculture. And even though, nominally, we have free trade in forest products and steel, complications do arise because the United States retained its ability to apply trade-remedy laws. The current softwood lumber dispute is an example of the problems we face with U.S. trade-remedy laws, specifically anti-dumping and countervailing duties. It is partly because of such problems that some analysts in Canada have recently been advocating a customs union, or some type of common market, with the United States. Clearly, some sections of NAFTA need further work if we are to eliminate all non-tariff barriers (such as countervailing and anti-dumping duties) and reduce the costs to industry of complying with a number of special rules, such as rules of origin. Dealing with these problems also means closer integration of regulatory regimes in North America. Let me now turn from issues related to trade in goods and services to issues related to capital flows. (ii) Free capital flows Canada eliminated wartime foreign exchange controls in the early 1950s. Thus, for most of the postwar period, we have benefited greatly from the free movement of capital and from competition in financial markets. Capital flows have played a very important role in Canada's development as a modern economy. Indeed, particularly through the 1950s, 1960s, and early 1970s, we were able to use foreign savings to finance the large investment projects that were necessary to develop our industrial infrastructure and increase our production potential, especially in the resource and manufacturing sectors. At the same time, Canadians have been able to set up businesses and pursue investment opportunities abroad. Through two-way direct investments, Canada has also had access to, and benefited from, technological innovations and processes developed elsewhere. In a North American context, freeing up capital flows has not been part of formal negotiations between Canada and the United States. In both countries, this has largely been a domestic endeavour. By that, I mean that the integration of Canada-U.S. capital markets has proceeded as fast as we, and the Americans, have been able to reduce domestic impediments to freer capital flows. (iii) Free movement of workers Now, let me consider labour markets and the movement of labour between Canada and the United States. Back in the 19th century, there was considerable labour mobility between the two countries. But the movement of workers across the border suffered a serious setback after the First World War, particularly in the wake of the Great Depression. Today, the border between Canadian and U.S. labour markets is somewhat more open than it was at the end of the Second World War. But, in comparison with the markets for products and capital, it is still the least open. This is because of immigration policies and a multitude of different provincial, state, or federal licensing laws in the two countries. To achieve the full benefits of a single market, significant 2/6 freeing up of laws and regulations that impede labour mobility would be needed. But I recognize that this is extremely difficult, particularly in a Canada-U.S.-Mexico context. This completes my brief review of the key Canada-U.S. markets for goods and services, capital, and labour. Having done that, I believe that it would be fair to say that, although there are now fewer “formal” tariff and non-tariff barriers between the two countries than there were 15 years ago, the reality is that borders still do matter. As John Helliwell reminds us, “border effects are still too large to be ignored and too complex to be easily classed as good or bad.” (iv) Regulatory regimes As I just pointed out in discussing labour markets, there are many non-tariff impediments to achieving the full benefits of economic integration. Among these, importantly, are the different national, provincial, or state regulatory regimes. Here, it seems to me that one of the key questions we should be asking ourselves is whether we have given sufficient consideration to “harmonizing” a number of our regulations with those of the United States. By “harmonizing,” I mean working to make the regulations of the two countries compatible or convergent, but not necessarily identical. My sense is that, on this score, we have made some but not much progress. I will expand on this point later. Where do we go from here? So, where do we go from here? Free trade within North America has brought us great benefits. Of that, there is no doubt. Ideally, though, what we should be striving for, as a country, is the removal of multilateral barriers to trade, so that the whole world can be open for business. The world community has been trying to do this since 1947. But it has been a very slow process because building consensus continues to be an uphill battle, as we are witnessing with the current Doha round of trade negotiations. For me, free world trade is still the ideal. We in Canada cannot, and should not, lose sight of that goal by focusing only on free trade in North America. But, if we cannot tear down barriers multilaterally, we should at least continue to tear them down between provinces in Canada, between Canada and the United States, between Canada and Mexico and, indeed, throughout the Americas. As I said earlier, a number of analysts in this country have recently been calling for fuller economic integration in North America - to be pursued through arrangements ranging from a customs union to some type of common market, and all the way to full economic and monetary union. Of course, not everyone in Canada is convinced of the merits of fuller economic integration within North America. In fact, as you will probably hear later in this conference, many Canadians are concerned about the implications of such a move for our political sovereignty and policy independence. Once again, I am here as an economist. So I will leave the political questions aside and focus instead on the factors that I see as relevant in the context of pursuing fuller economic integration. But I should point out that, although the interest for Canada in further integration is primarily economic, it is quite clear that the Americans see border security as an important element of that integration. So, as we in Canada consider deeper economic integration, we also have to consider what measures we would take to actually build a common security perimeter around North America. I do not intend to elaborate on this, since there are others at this conference who are much more knowledgeable and able to comment. But it is very important to recognize that, for our southern neighbours, security integration and economic integration are clearly linked. With that, let me return to the question, Where do we go from here? Helliwell, JF 1998. How Much Do National Borders Matter? Washington, DC: The Brookings Institution. 3/6 Let's start with trade. The key issue for Canada is to reduce “border risk,” that is, guarantee Canadian producers and service providers access to U.S. markets without hassle and expense at the border, and without the risk of suddenly being shut out of those markets by some discretionary U.S. action. This is important. Here are some of the steps that could help in this respect: · a common external tariff - that is, a customs union and common border practices for imports from, and exports to, overseas markets · harmonization of trade and commercial policies and regulation · an end to the application of trade remedies within North America and · a uniform policy with respect to federal and state/provincial subsidies. We could also work towards broadening NAFTA coverage to include agricultural products, although there are clear difficulties in this area. And we could work to remove barriers to trade in cultural, legal, financial, and communication services, although, here again, harmonizing regulatory regimes at the federal and state/provincial levels would be very difficult. I must tell you that arriving at an agreement on measures to reduce border risk or to broaden the scope of NAFTA won't be easy. Most of the easier steps have already been taken. Remember, too, that the Americans have different concerns with respect to Mexico than they have with respect to us. There are many practical and political challenges to be overcome on the way. But if we could reach agreement on deepening and/or broadening NAFTA, it would be extremely valuable. It would spread the benefits of competition across more industries, reduce uncertainty stemming from unilateral trade actions, and greatly reduce non-tariff barriers (which are often even greater impediments to trade than tariffs). And if we could agree on common external trade rules and tariffs, rules of origin could be eliminated and matters at the border would be enormously simplified. Let me now turn from trade in goods and services to other issues related to economic integration, or what the Europeans call, the creation of a “single market.” These issues largely relate to the harmonization of regulatory regimes, not only with respect to the market for goods and services, but also the markets for capital and labour. There are efficiency gains to be made from moving to common regulatory standards in North America. Not only would common standards reduce the costs of compliance; they would also allow our entrepreneurs to compete with the Americans on a more level playing field. But, as the European experience demonstrates, achieving such common standards is a long, painstaking, and difficult process. What the Europeans did, in many instances, was to write a whole new set of rules to replace the often very divergent rules in the 15 member countries of the European Union. We do not face as daunting a problem in North America (at least in Canada and the United States) because the basic structure and philosophy of the regulatory frameworks governing commerce, labour, and financial markets are similar - though far from identical. So the job of harmonization at the national level will be somewhat less onerous than in Europe. But it will still be a lengthy and difficult process. Furthermore, the problem for us is that, given the size and weight of the United States, reaping the benefits of harmonization will mean that, by and large, we would probably have to move towards U.S. regulatory standards. Clearly, there are some drawbacks to harmonizing our regulatory standards and procedures with those existing in the United States. U.S. standards may not always be absolutely ideal in a Canadian context. But the point is that we should not reject them out of hand because they are not perfect. Rather, we should assess them very carefully. And we should always be asking, Would we be better off adopting U.S. standards, so we can have harmonized regulatory regimes across North America, rather than adhering to our own, even though ours might be better suited to our unique circumstances? What I'm saying is that, if we are going to preserve different regimes of economic regulation, we'd better have solid reasons for doing so. And we'd better make sure that the differences we maintain will indeed lead to better outcomes for Canadians. To be sure, there are some things that we may want to do differently in Canada, based on social or political grounds. For example, one issue that Canadians are currently debating is the provision of health care and the regulation of public health and drugs. Immigration policy is another. All these issues deserve careful consideration. And we should encourage our analysts to examine closely the 4/6 benefits and costs of maintaining divergent regimes versus the benefits and costs of pursuing regimes that move us closer to harmonization. One last point I would like to make with respect to regulation is that, domestically, we have a big problem in Canada. I am referring, of course, to the diversity of provincial standards in such key areas as labour markets, financial markets, and the markets for some services. Different criteria for professional certification of tradespeople, different provincial securities regulations, and different rules related to transportation come readily to mind. By and large, this kind of diversity does not serve us well. So it is very important that we also harmonize regulatory standards at home. While most of the regulatory integration issues I have spoken about tonight apply to labour and capital markets as well as markets for goods and services, I want to make a couple of points specifically related to further integration in labour and capital markets. Labour market integration would be greatly aided if Canada and the United States had procedures in place - procedures that were rapid, simple, and inexpensive - to grant work permits allowing citizens of either country to cross the border to take up jobs. Needless to say, this would be easier to negotiate if we were to simultaneously adopt a common immigration security perimeter for North America, although, logically, adoption of such a perimeter is not a prerequisite. To ensure that there are real welfare gains, initiatives to open up labour markets would also call for greater harmonization of licensing standards, so that people could actually be employed on both sides of the border. Of course, a good first step in this area would be harmonization of policies and adoption of common licensing standards in labour markets across provinces within Canada! Canadian and U.S. capital markets are already highly integrated and, as I said earlier, Canadians (and Americans) have benefited greatly from this open, transparent, and competitive market. As we all seek to improve corporate governance and to achieve greater transparency in the wake of recent corporate scandals, this is a real opportunity to achieve greater harmonization of rules in North America - not to mention globally. There is a willingness at the moment, on the part of authorities everywhere, to try to find a reasonable mix of principles and rules for accounting standards and securities regulation. We should seize the opportunity - and I believe we are in the process of doing so - to achieve greater uniformity of standards, not only with the United States but also among Canadian provinces. In sum, to achieve maximum economic benefits, harmonization of regulatory standards and practices, particularly with respect to capital and labour markets, should be a priority as we move forward. Economic integration and monetary union One last issue I would like to address briefly tonight is that of monetary integration. I have been asked the question, If there was a political decision in Canada to adopt policies of deeper North American integration, would it still make sense for us to keep our own currency? Or should we be thinking about adopting the U.S. dollar as our currency? First, let me stress that monetary union is an issue that should be considered once we have made more progress towards establishing a single market for goods and services, capital, and labour. Without a single, well-functioning market for labour, a single currency could impose great adjustment costs on workers. But suppose we were on track to achieve a single market. Should we then be thinking of a monetary union as well? The response to this, which I have set out in earlier speeches, is that it depends, to an important extent, on how close or how far apart are the industrial structures of the two countries. Although it is always possible that at some future time those structures could converge (they could also diverge!), the reality is that, right now, they are quite different. This means that economic shocks tend to affect our two economies differently. In these circumstances, a separate floating currency facilitates adjustment to those shocks at least cost, in terms of lost output or higher inflation. But suppose we were well on our way to achieving a true single market for goods and services, labour, and capital. Then it would be sensible to consider a common currency in the context of the industrial structures prevailing at that time, with a view to ascertaining whether the benefits of lower transaction costs associated with a common currency outweighed the higher costs of economic adjustment. 5/6 Conclusion Let me wrap up by summarizing my main points. Fundamentally, the decision to deepen economic integration in North America is a political one that Canadians and their governments will have to make. From a purely economic perspective, I have, as an economist, a strong predilection for continuing to tear down barriers to trade - preferably, multilaterally, but, realistically, first within Canada and North America. Over the long haul, that is going to encourage a more efficient, productive economy, greater opportunities for Canadian entrepreneurs and workers, and, most importantly, higher living standards for Canadians. To be sure, certain costs are involved in all of this. Fuller integration with the United States could make us more vulnerable to fluctuations in economic activity in that country. And we may no longer be able to tailor policies to fully meet our own needs or to foster particular Canadian industries. These are issues that we ought to be aware of and analyze very carefully. But economic theory and our experience so far support the view that, on balance, the benefits of opening up to the rest of the world outweigh the costs. Tonight, I have laid down some of the factors that I consider relevant in trying to come to a judgment about the desirability of further economic integration in North America, and about what needs to be done if Canadians decide to pursue this. I am looking forward to the insights that others may have on this issue as the conference unfolds. 6/6	bank of canada	2,003	8
Speech by Mr David Dodge, Governor of the Bank of Canada, to the Spruce Meadows Roundtable, Spruce Meadows, Alberta, 5 September 2003.	David Dodge: Canada’s experiences of the past few decades Speech by Mr David Dodge, Governor of the Bank of Canada, to the Spruce Meadows Roundtable, Spruce Meadows, Alberta, 5 September 2003. * * * Thanks to my colleagues from around the world for giving such a comprehensive review of the vital issues facing the global economy. One of the hazards of speaking last in these kinds of sessions is that those who speak before you may cover all the interesting territory, leaving you with the unenviable task of trying to tie everything together. In this case, however, going last is not so bad. That’s because, in order to tie together the issues discussed so far, we need to take a global view of the economy. And as far as Canada is concerned, taking a global view has always been important. Of course, every country is affected to some extent by what happens in the world economy. But Canada, with its very open economy, has a particular need to keep an eye on the changing fortunes of the international scene. Canada’s reliance on foreign trade has required us to be active internationalists for decades. Louis Rasminsky, who went on to become Governor of the Bank of Canada, was one of Canada’s delegates at the Bretton Woods Conference that led to the creation of the International Monetary Fund (IMF) and the World Bank. Rasminsky played an important role, formal and informal, at the talks. Not only was he the Chair of the drafting committee, he was also the peacemaker between the British delegation, led by John Maynard Keynes, and the U.S. delegation, led by Treasury Secretary Harry Dexter White. In the months leading up to Bretton Woods, it was Rasminsky who kept the two key delegations talking. Without his work, both as a skilled drafter and as a go-between, it’s entirely possible that the talks at Bretton Woods could have ended in failure. Canada was also present at the 1947 Havana Conference, where we pushed for the establishment of an international trade organization. This was meant to be a body parallel to the IMF, designed to establish and monitor a set of global trade rules. We didn’t get quite what we wanted, but the result was still certainly positive: the birth of the General Agreement on Tariffs and Trade (GATT). In 1995, nearly five decades later, we were more successful, as we pushed the effort to turn the GATT into the World Trade Organization (WTO). So Canada’s credentials as a supporter of institutions designed to promote free trade and a sound international financial system are well established. Of course, much has changed in the global economy during the more than half-century since those institutions were founded. Of profound significance, transportation and communications have become very much cheaper and faster today than they were after World War II. Because of this, the potential economic gains from increased international trade and finance are now much greater than ever before. At the same time, individual countries are more vulnerable to economic and financial shocks originating outside their borders. So the need for a coherent international financial system is also much greater today. And our international institutions must evolve to take all of this into account. To help us maximize the potential gains from increased trade, and to minimize the risks stemming from greater interdependence, we need to encourage trust, domestically and internationally. Let me explain what I mean. When I use the word trust, I am talking about the understanding that can develop when people recognize that everyone benefits when everyone plays by the rules. In this atmosphere, the rules that govern behaviour reinforce people’s actions and help them choose to “do the right thing.” This kind of trust allows for what game theorists call “positive-sum outcomes,” where progress can come through “win-win” situations. It also allows national economies, as well as the global economy, to be strengthened. This kind of trust begins at home. What all of us as national public policy-makers must do, and must be seen to be doing, is work to maintain and increase trust. We need to put in place the right incentives so that, in general, people will do the right thing. To be sure, the need to enforce sanctions when people do the wrong thing is critical. But when people can operate in an atmosphere of trust, they can spend less energy keeping tabs on others, and can concentrate on more productive activities. We have seen over the past decades that trust is important to a well-functioning financial system. And a well-functioning financial system is necessary if we are to have an appropriate allocation of savings, which is a fundamental element of solid economic growth. I would argue that five lessons can be drawn from our experiences since the time of the Bretton Woods and Havana agreements. All of them underscore the importance of trust. The first lesson we have learned is the critical importance of having a robust legal framework. When a country has the appropriate legal structures, it creates a sense of certainty. Citizens, investors, and corporations have the security of knowing that contracts will be honoured, and that those who break the rules will be caught and punished. The protection of property rights and a tradition of contract law are prime examples of these structures. Certainly, in recent years, we have all recognized the importance of a robust legal framework as we have watched countries in Eastern Europe, Latin America, and Asia struggle to make the transition to a market economy. But we in North America have also learned over the past two years, in a rather painful way, that issues of corporate governance are extremely important as well. So when we think of legal structures, we should now also think about high standards for accounting, transparency in corporate reporting, and adequate enforcement of the rules. The second lesson we have learned is that our fiscal policies must always be based on prudence. When public debts are allowed to mount unabated, the trust of investors and citizens can vanish quickly. In its place comes fear that the debt will either be inflated away, or that a future government may default. Since the late 1990s, Canada has seen the benefits that can come from fiscal prudence. Putting our fiscal house in order has helped to establish credibility for our macroeconomic framework. And once fiscal credibility is established and a country has a low public debt-to-GDP ratio, the “automatic stabilizers” - which kick in to increase government spending to cushion the impact of difficult economic times - can operate without undermining the trust of citizens and investors. The third lesson we have all learned is the importance of being open to trade. When a country opens its industries and markets to international trade, this may force painful short-term adjustments in some sectors. But at the same time, the country gains from ongoing competitive pressures which act to spur productivity improvements and raise living standards. In the end, the country as a whole is better off. But what is equally important is that those countries that have opened up to international trade play by the rules. Otherwise, we run the risk of falling into destructive “lose-lose” situations, where countries don’t trust each other and resort to unilateral actions that escalate trade disputes. Fourth, we have learned the importance of a central bank that promotes trust in the value of money, free from political interference. When a central bank delivers an environment of low, stable, and predictable inflation, the public, and especially middle- and lower-income groups, can feel more confident that their savings and purchasing power will not be eroded by high inflation. And all borrowers can be more confident that the burden of their debt will not be increased through deflation. Low inflation also helps to win the public’s trust in the functioning of a market economy. As former Bank of Canada Governor Gerald Bouey put it, “inflation melts the glue that holds free societies together.” In Canada, we focus on inflation in a symmetric way. In doing so, we aim to avoid inflation while also minimizing the risks of deflation. Such an approach brings important economic benefits. But it also assures creditors that the value of their investment will not be eaten away over time. And it assures debtors that the burden of their debt will not increase in the future because of deflation. The fifth lesson has to do with capital flows and exchange rates. Open markets and the free flow of capital can greatly accelerate development. But, as I noted before, open markets and capital flows can make individual countries vulnerable to shocks that originate elsewhere. So there is a need for countries to have a mechanism in place that helps their economies adjust to shocks. Recent experience has taught us how important it is to have this kind of adjustment mechanism in place and, in particular, how a floating exchange rate can play this role. I know that not everyone here would agree that the floating exchange rate is the best adjustment mechanism for every country. Based on Canada’s long experience with a floating currency, I can certainly say that it has served us well. But I’m sure that we can all at least agree that there will always be shocks, that such shocks will have different effects on national economies, and that flexible exchange rates can help to facilitate the necessary adjustments. This lesson was clearly brought home during the Asian crisis of 1997-98. Many Asian countries, but also countries like Canada that are particularly vulnerable to sharp fluctuations in commodity prices, made relatively quick adjustments to a difficult situation through the floating exchange rate mechanism. How does this relate to trust? Through the need to trust in market forces, I would say. When exchange rates float and capital moves freely, investors can trust that market forces are being allowed to do their job. There is an assurance that when shocks arise, countries will not be shielding their economy from market forces through restrictive trade practices, arbitrary controls on capital flows, or fixed exchange rates. So those are some of the key lessons we can draw from our experiences of the past few decades. In Canada, we have tried to apply these lessons to our own economic situation. And I would argue that doing so has helped us handle economic shocks better recently than in the past. Now, if we apply the principle of trust that is behind those lessons to our international financial institutions, we can get some idea of how these institutions might evolve to better work for the global economy. Game theorists will tell you that the best results come when the players see each other’s behaviour and learn from it. Put simply, actions speak louder than words. We have already seen the GATT evolve into the WTO, which establishes the ground rules for international trade and calls to account those countries that are not playing by the rules. Such an institution is essential if we are to reduce the frequency of “lose-lose” trade disputes I mentioned earlier. But for the WTO to go further, as it should, it is clear that progress needs to be made in the areas of greatest interest to the poorer nations. After all, the current round of talks is supposed to be the “Development Round.” So it is incumbent on us in the developed world to “do the right thing,” and overcome domestic political difficulties to open our markets in areas such as agriculture and textiles. Recently, we have seen the IMF take steps to strengthen its surveillance function. These steps should be supported. Countries should strive to meet the highest standards for data dissemination and should welcome assessments of their economies and financial systems. Only when all the players have complete trust in the numbers - whether they are part of a nation’s economic statistics or a firm’s balance sheet - will investments be made most efficiently and effectively. The IMF’s other role, for which it is perhaps better known, is as provider of emergency liquidity. By the end of the 1990s, the Fund had increasingly found itself providing financial assistance many times in excess of a country’s quota, in situations where sustainability, not a lack of liquidity, appeared to be the real issue. This is problematic, for a number of reasons. Perhaps most importantly, when debtors or creditors presume that there will be large official bailouts, there is the possibility of “moral hazard.” This is a case where policy-makers have not provided the incentives for debtors and creditors to do the right thing. In recent years, the Bank of Canada and the Bank of England worked together to develop a “middle-ground” approach to crisis resolution. This approach, which was detailed in a joint paper published in 2001, was designed to provide the right incentives for debtors and creditors. It contained three basic elements. First, “presumptive limits” to official assistance, which would be known in advance. Secondly, the possibility of exceptional official lending, but only in the unlikely event that a crisis threatened global financial stability. Third, orderly standstills or temporary suspensions of debtservice payments to give distressed debtors some time to take steps, including debt rescheduling, to address their problems. Since that time, the G-7 finance ministers and central bank governors have adopted much of this approach in the context of their Action Plan for crisis prevention and resolution. What is important now is that we support that Plan and enforce the rules that have been put in place. If we ignore the rules that have been established, we risk losing the trust that we are trying so hard to build. To conclude, I hope that I have been able to illustrate the importance of trust. By strengthening this trust, we can make the global financial system work better. And by doing so, we can deal with the changing fortunes of the world economy and find a more efficient means of financing world growth.	bank of canada	2,003	9
Speech by Mr David Dodge, Governor of the Bank of Canada, to the Vancouver Board of Trade, Vancouver, British Columbia, 10 September 2003.	David Dodge: Fostering confidence Speech by Mr David Dodge, Governor of the Bank of Canada, to the Vancouver Board of Trade, Vancouver, British Columbia, 10 September 2003. * * * Good afternoon. It’s great to be back in Vancouver and to renew acquaintances at the Board of Trade. I’m going to spend some time today discussing the Bank of Canada’s outlook for the Canadian economy and inflation, and how we are responding. But in order to understand the current economic situation, we need to look at some of the extraordinary events of the past year or so and how those events have affected the economy. My last public speech here was almost exactly a year ago. You will recall that, at the time, markets were still in turmoil in the wake of Enron, WorldCom, and other corporate governance and accounting scandals of late 2001 and early 2002. In the United States and Canada - as well as in many other countries - corporations, regulators, and governments were beginning to respond with measures aimed at restoring and maintaining investor confidence. Then came 2003 - which could well be named “The Year of the Shocks.” There was the war in Iraq, which is still being played out. The worldwide outbreak of severe acute respiratory syndrome (SARS) was a blow to Canada and to Asia. The human toll of SARS in Toronto was accompanied by a severe drop in Canada’s tourism and travel industry. We also had an isolated case of mad-cow disease that blocked our exports of beef and cattle. Many of these export restrictions remain. And the forest fires in British Columbia have caused extensive financial and emotional pain. Meanwhile, the softwood lumber dispute with the United States has not been resolved. And recently, Ontario suffered through North America’s biggest-ever power outage. However, the good news is that Canadian consumers and businesses have been remarkably resilient through the past year or two in the face of all these shocks. But these kinds of shocks can have a significant impact on consumer and business confidence, especially when they happen in quick succession. Today, I want to talk about the role that confidence plays in our economy and the measures that are being taken to strengthen it. Trust and confidence are essential if markets are to operate efficiently, so that businesses can finance themselves in good times and bad. And Canadians need to maintain confidence in the macroeconomic framework so that we can all reap the benefits of a smoothly functioning economy. The role of confidence in monetary policy At the Bank of Canada, we spend a lot of time thinking about confidence, because it is important to the conduct of monetary policy, which is focused on inflation targeting. We aim to keep the trend of inflation at the 2 per cent target midpoint of a 1 to 3 per cent range. When the trend strays away from that midpoint, either upwards or downwards, we take action to return it to 2 per cent over the medium term. We do that by adjusting our target for the overnight interest rate. Over the past decade or so, we have successfully kept inflation at around 2 per cent, on average. Here’s where the confidence factor enters into the equation: Canadians now expect that inflation will stay near the target - not just for the near term, but into the future. They believe that the value of their earnings and savings won’t be eroded by inflation and that the real burden of their debt won’t be increased by deflation. That confidence has paid a real dividend in terms of monetary policy effectiveness. Inflation targeting works best when Canadians believe that it will work - in other words, when they have confidence that we will keep inflation near the 2 per cent target. With this confidence, inflation and inflation expectations, as well as interest rates, have become more stable - and this benefits the whole economy. How did we achieve this confidence dividend? By establishing a track record of credible, consistent monetary policy, together with greater accountability and transparency. Like many other major central banks, we have embraced the notion that monetary policy is more effective when people can understand what their central bank is doing and why. That is the motivation behind our semi-annual Monetary Policy Reports and Updates, our eight interest rate announcements every year, and our many public appearances and speeches. Of course, monetary policy does not function in isolation. It works best when it is complemented by fiscal policies aimed at avoiding deficits and lightening government debt burdens. Reducing, and ultimately eliminating, the federal deficit in the 1990s helped Canada’s international credibility, lowered the risk premium demanded by investors, and gave Canada more flexibility to adjust to changing economic circumstances. And continued fiscal prudence has given us the flexibility to weather the recent economic turmoil rather well. Canadians have now seen the benefits of low, stable, and predictable inflation, and balanced budgets. And they expect that their central bank and their governments will continue to deliver those benefits through responsible monetary policy and prudent fiscal management. Confidence in markets So, good monetary and fiscal policies deliver a confidence dividend. But, of course, trust and transparency are crucial factors all across the economy and the financial system. We all know that a business will not last long if it squanders the confidence of its customers, suppliers, and investors. The corporate finance and accounting scandals of 2001 and 2002 hurt more than just profits and portfolio gains. They also sideswiped the confidence of financial market participants. The problems that brought down Enron, WorldCom, and others were not limited to those companies. In fact, the international task force appointed by the International Federation of Accountants - and chaired by John Crow, a former Bank of Canada Governor - correctly notes that Enron was the event which, by its sheer size, awoke many to issues that had been significant for some time. What’s encouraging is that this awakening has happened quickly and that considerable effort is being made to address those issues and reinforce trust in the financial system. The Sarbanes-Oxley Act in the United States, for example, is aimed at restoring trust in corporate financial reporting. Other international efforts are underway to improve both reporting and monitoring of public companies. In Canada, federal and provincial governments have been working with the private sector to review and improve the framework governing public companies and capital markets. These initiatives are summarized in a document entitled Fostering Investor Confidence in Canadian Capital Markets, which can be found on the Department of Finance’s Web site. Efforts are focused on four areas: · improving financial reporting and disclosure; · enhancing the quality of the audit process; · strengthening corporate governance and management accountability; and · toughening enforcement. All of these efforts are aimed at building the confidence needed to allow markets to protect the interests of investors and creditors and to operate efficiently so that businesses can finance their operations at the lowest cost. Steps to foster confidence Let’s look first at what’s been done to date to improve financial reporting and disclosure. Our system, which has already worked quite well for Canadians, is being strengthened. The proposed new changes are aimed at building confidence while keeping compliance costs relatively low. New guidelines on continuous disclosure obligations of public companies are being drafted by the Canadian Securities Administrators. The goal is to implement them by January 2004. There are also new guidelines from the Canadian Institute of Chartered Accountants (CICA) on stock options, financial guarantees, and off-balance-sheet arrangements. And the Investment Dealers Association (IDA) has developed new rules to promote the independence of financial analysts. To improve the quality of the audit process, a new Canadian Public Accountability Board will oversee the practices of firms that audit publicly listed companies. Its chairman is Gordon Thiessen, my predecessor as Governor of the Bank of Canada. And David Scott, a senior partner with PricewaterhouseCoopers, was recently appointed as CEO. The Board will inspect audit firms and will make recommendations on accounting and assurance standards, rules of conduct, and governance practices. Its efforts are being augmented by the new Auditing and Assurance Standards Oversight Council, which is designed to provide perspectives from outside the accounting profession on the oversight and setting of corporate audit standards. Critical initiatives to restore investor confidence are also being taken in the areas of corporate governance and management accountability. Most importantly, many companies have taken, or are taking, action on their own in this regard. Their efforts are being supported by the actions of provincial securities commissions. In January, the Office of the Superintendent of Financial Institutions released new guidelines on corporate governance for federally incorporated financial institutions. In last February’s budget, the federal government announced a plan to strengthen the corporate governance standards in the Canada Business Corporations Act and the financial institutions statutes. Institutional investors have also been pushing for better corporate governance practices and management accountability. They have established the Canadian Coalition for Good Governance, chaired by Michael Wilson, former Minister of Finance. The Coalition recently published new Corporate Governance Guidelines for Building High Performance Boards. There has been a perception that the authorities have not been vigilant in enforcing the rules with respect to fraud and insider trading violations. Recent studies suggest that Canadian firms pay a penalty, in terms of their market valuations, as a result of this perception. That is why it is encouraging to see that steps have been taken to toughen enforcement. The B.C. government has draft legislation to increase fines, give more power to the provincial Securities Commission, and increase the rights of investors. Ontario and Quebec have passed legislation to increase penalties and to broaden the investigative powers of their securities commissions. New guidelines from the IDA include stiffer penalties for securities dealers that break IDA rules. In last February’s budget, the federal government announced stronger enforcement measures to combat fraud in capital markets. Amendments to the Criminal Code will make it easier to prosecute lawbreakers. More money will be dedicated to investigating serious cases of capital market fraud. And special teams of investigators, forensic accountants, and lawyers will be set up in key financial centres. These are just some examples of the progress that has been made in Canada by companies, regulators, and governments to build investor confidence in our financial markets. Of course, these efforts also promote better corporate decision-making, greater efficiency, and stronger corporations. That is why it’s in the interest of all of us that we make further progress. What should we bear in mind as we continue to make these improvements? First, we must not be lulled into thinking that all the problems are behind us. Unless we remain vigilant and rigorous in our efforts, we risk squandering the good work done so far. Second, while we must apply the same principles to all companies, they must be applied in ways that do not impose undue compliance costs, especially on smaller businesses. Third, while our standards don’t have to be identical to those in other countries, they must be seen to be as effective. Canadian and U.S. capital markets are already highly integrated and Canadians (and Americans) have benefited greatly from these open, transparent, and competitive markets. Indeed, since world markets are increasingly integrated, there is a great benefit to having standards that are globally consistent. Right now, there appears to be willingness on the part of authorities in a number of countries to find a reasonable mix of principles and rules for accounting standards and securities regulation that could be applied globally. The International Accounting Standards Board and the U.S. Financial Accounting Standards Board are cooperating in such an undertaking, with the support of other countries, including Canada. It is important that Canada continue to work towards sensible global standards. We must identify how our practices should change to fit those standards in order to help our capital markets stay competitive in an increasingly global environment. Markets work more efficiently when they all operate under clear, transparent, and reasonable rules and principles - both internationally, and also within Canada. That is why we at the Bank of Canada encourage efforts to achieve uniform securities law, regulation, and enforcement across this country. Finally, as we set new rules to promote confidence, we must be careful to avoid creating a regime that stifles financial market innovation. We need to create a framework that balances the necessity for effective and enforceable rules to promote confidence with the need to facilitate new and innovative methods of corporate financing to improve the allocation of capital. This type of framework is the best support we can provide for the efficient operation and continued growth of our financial markets. But it won’t do the whole job. A sound legal and regulatory framework must be combined with strong and widespread ethical standards. CEOs and other corporate officers must take it upon themselves to communicate with investors clearly, openly, and fairly. Investors, for their part, have a responsibility to take into account all available information. And regulators, politicians, and public servants must all perform their functions in a way that reinforces trust. We all benefit when everyone plays by the rules. Only by reaffirming the integrity of individuals, corporations, and public institutions can we restore and maintain the confidence dividend. Indeed, as I said at the outset, the resiliency of Canadian consumers, investors, and businesses has helped us weather recent economic shocks. Confidence will be critical to strengthening our economy in the months ahead and to a sustained expansion over the medium term. So let me now briefly discuss the Bank’s views on the economy and inflation. The current economic situation Since our Monetary Policy Report Update in July, inflation pressures in Canada have continued to ease. Part of the recent decline in inflation has come from an increase in the amount of slack in the economy. The pace of growth in the second quarter of this year was interrupted by a number of near-term factors, especially SARS and trade restrictions on Canadian exports of cattle and beef because of an isolated case of bovine spongiform encephalopathy (BSE). Growth in the third quarter will also likely remain below the economy’s potential because of the remaining trade restrictions on beef and cattle, as well as the effects of the power blackout in Ontario and of forest fires in Western Canada. The prices of some services have been temporarily depressed by SARS. In addition, there has been a greater-than-anticipated reduction in the prices of a number of goods, such as motor vehicles, clothing, and household furniture and appliances. We had expected our core rate of inflation - which strips out the eight most volatile components of the consumer price index, as well as the effect of changes in indirect taxes on the remaining components - to decline below the 2 per cent target. In fact, that happened earlier than the Bank had anticipated. Our core inflation measure is likely to decline somewhat further in the next few months. And we see the trend of inflation remaining below the 2 per cent target for some time. As I’ve said, part of this lower trend in inflation is a result of the slack in the economy that has opened up in 2003. In addition, prices of many traded goods have fallen worldwide because of excess supply. The rise in the Canadian dollar earlier this year pulled down the price of imported goods, and some retailers have passed on these savings to consumers. As well, vendors are lowering prices to clear their inventory, especially in the automobile sector. Price pressures that we saw from higher insurance premiums earlier this year appear to be dissipating as the year progresses. The total CPI inflation rate has come down from 4.6 per cent in February to 2.2 per cent recently, because of the decline in core inflation and because of smaller increases in energy prices. Swings in energy prices remain a risk to our total inflation outlook in the months ahead, although we assume oil prices of about US$27 per barrel in 2004. Notwithstanding the temporary factors that have affected the economy in the second and third quarters of this year, we see indications that the conditions are in place for stronger economic growth. Here’s why. Growth of final domestic demand has remained robust, and the adverse effects of the shocks that I just mentioned are beginning to dissipate. The economic rebound in the United States began earlier, and will be stronger, than previously expected. More robust consumer demand and strengthening business investment in the United States should augur well for Canadian exports. We are also seeing a strengthening trend in Asia. As well, the tone of capital markets remains favourable. So, despite current weakness, the accumulation of economic evidence to date reinforces the Bank’s view that growth in the Canadian economy will strengthen towards the end of 2003 and through 2004. Last week, we lowered our target for the overnight rate by one-quarter of one percentage point, to 2 3/4 per cent. With this decision, policy interest rates will support the return to levels of economic activity that are consistent with an overall balance between supply and demand in the economy. Achieving that balance will work to return inflation to the target over the medium term. Conclusion Canadians have been through a lot this year. But each shock also represented an opportunity - to learn, to improve our ability to handle a crisis, and to strengthen our sense of community. No one can predict what kind of shocks our economy will face in the future, but we know that shocks will occur. What’s important is that we have a robust economic and financial framework that allows us to deal with those disturbances and to seize opportunities as they arise. It is that strong framework that gives businesses and investors the confidence to take risks and to innovate. We are making progress in building the framework that supports the confidence dividend. During the 1990s, we improved our fiscal and monetary policies. Now, as I have described, we’re working to make our financial systems more robust and efficient. These continuing efforts promote confidence. They improve our ability to withstand all types of economic shocks and to capitalize on opportunities.	bank of canada	2,003	9
Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Mon...	David Dodge: Economic and financial trends in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, Ottawa, 22 October 2003. * * * Today, we released our October Monetary Policy Report. The Report reviews economic and financial trends in the context of Canadaâ€™s inflation-control strategy. Since our April Report, the Canadian economy has been hit by a number of unusual shocks: SARS, BSE, the Ontario electricity blackout, and the severe forest fires in British Columbia. Inflation has also fallen faster and further than expected. This drop in core inflation reflected several unforeseen developments. These included a broad-based weakness in the prices of goods, substantial reductions in the prices of tourism-related services because of SARS, and a slightly faster easing of pressures from auto insurance premiums. The substantial fall in the value of the U.S. dollar added to the weakness in goods prices. We now estimate that there is more slack in the economy than was projected in April. The prospects for near-term growth in the global economy have improved since April, and geopolitical uncertainty has continued to decrease. The near-term outlook for the U.S. economy is much improved. The economy in the euro area is still weak, but prospects for Asia look bright, led by China and India. The Japanese economy is performing better than anticipated. We expect growth in the Canadian economy to strengthen during the fourth quarter and through 2004. On balance, the expansion should be above the rate of potential growth, relying primarily on solid household spending and increased business investment. Stronger growth abroad should boost foreign demand for Canadian products, but this will be dampened by the higher value of the Canadian dollar. Growth is expected to average a little over 3 per cent in the second half of 2003 and 3 1/4 per cent in 2004. With growth above potential, the slack in the economy should be absorbed by early 2005. We expect core inflation to average just over 1.5 per cent for the rest of 2003, and to fall to just above 1 per cent in early 2004, as the effects of earlier increases in auto insurance premiums dissipate. Core inflation should return to 2 per cent by mid-2005, as economic slack is taken up. Total CPI inflation will continue to be importantly affected by swings in the price of crude oil. If prices ease to US$ 27 per barrel next year, total CPI inflation would likely fall below core inflation in 2004. However, there are significant risks to this economic outlook. These risks relate to the timing and magnitude of global demand, price, and exchange rate adjustments to economic imbalances. In particular, there is uncertainty both about the likely changes in key global exchange rates and their effect on the Canadian economy. There is also uncertainty about the sustainability of U.S. growth beyond mid-2004. We continue to assess the implications of all these developments - both past and future - for output and inflation in Canada, and what this means for monetary policy.	bank of canada	2,003	10
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the David Dodge Tribute Dinner, hosted by the Canadian Founda...	David Dodge: On economic education Remarks by Mr David Dodge, Governor of the Bank of Canada, to the David Dodge Tribute Dinner, hosted by the Canadian Foundation of Economic Education, Toronto, Ontario, 3 November 2003. * * * It’s an honour to be here with you tonight and to receive this award. One of the great privileges of working in the public sector is interacting with so many outstanding individuals from all parts of Canada and, indeed, from around the world. To be here tonight, surrounded by people I have worked with over the years, and whom I can truly call my friends, is very exciting and tremendously rewarding. The program this evening focuses on the value of public service and the importance of economic and financial literacy for the well-being of Canadians. These two themes have special significance for me, as my career has involved time spent in the public service as well as teaching. My long-standing interest in public service and economic education (indeed, education more generally) was sparked and nourished through my formative years at Ridley College and Queen’s University. Ridley’s motto is Terar Dum Prosim (which roughly translates into May I Be Consumed in Service). And Queen’s is Sapientia et Doctrina Stabilitas (that is, Wisdom and Knowledge Shall Be the Strength of Thy Times). So there it is: wisdom, knowledge, and service. Education focuses on wisdom and knowledge. And education confers an obligation to serve. Others here tonight have explored ways to strengthen the contribution of the public sector to our wellbeing. But I would still like to make some general remarks on the subject before moving on to economic education. As an economist, the question I most often ask myself is, How can we as a country increase our economic well-being? And when I look around the world, one thing is clear to me. The societies that have been the most successful in improving the welfare of their citizens are those that have provided a social climate in which the dynamism and creativity of individuals and businesses can thrive. They are societies that, in the words of Robert Wright,1 are able to create “win-win” situations for their citizens. They are the “efficient societies” that Joseph Heath talks about in his book of the same title.2 To move in that direction, we should, among other things, continue to work towards strengthening the relationship between the public and the private sectors. In particular, it is important that we get the incentives right for those working in government to encourage and facilitate the drive in the private sector towards higher productivity and innovation. But we should also have the right incentives for the private sector to work towards enhancing the public good and the productivity of collective action by governments. The problem is that the private and the public sectors too often act as if they are completely different worlds. So, the difficulty and the challenge is for both to more fully recognize the symbiotic nature of their relationship and thus the importance of interaction and cross-fertilization. The bottom line here is that, as a society, we cannot afford to have the private and the public sectors operating as two solitudes. Individuals and businesses need a well-functioning public sector to ensure, first, the efficient operation of markets and, second, the cost-effective provision of public goods. At the same time, the public sector has a responsibility to understand how individuals and businesses work in order to provide the appropriate framework for the efficient functioning of markets. While this applies to all parts of the public sector, it is perhaps most critical for those of us (including the Bank of Canada) who are responsible for the economic and financial framework within which businesses and individuals operate. Wright, R. 2001. “Nonzero: The Logic of Human Destiny.” Random House. Heath, J. 2001. “The Efficient Society: Why Canada Is as Close to Utopia as It Gets.” Viking Canada. A moment ago, I talked about the symbiotic relationship between the public and private sectors. Nowhere is that relationship more important than in the development of human capital through education, training, and learning-by-doing. What I want to explore here is how the public and private sectors can interact to enhance the development of the “economic” capital of individuals. By “economic” capital I mean the ability of individuals to contribute more productively at work - as employees or entrepreneurs - or in their personal lives, as managers of their own economic and financial affairs. To frame this issue in economists’ terms, if we are looking to increase our output of goods and services, to become more productive, and to improve our well-being as a nation, we need to augment our investment in physical capital. But, as technology becomes more complex and the global environment more competitive, it is equally, if not more, important that we also augment our investment in human capital. This primarily means improving the skills of our workforce. So it is incumbent on all of us to think hard about how to do this. And about how to give individuals the tools they need to become more efficient at work and more knowledgeable and competent in conducting their own affairs. This requires that we focus on both the quantity and the quality of education - whether that education be formal or informal. There is a vast body of literature on the returns to investment in formal education. Much of this literature focuses on the benefits of completing high school and post-secondary education. This kind of analysis generally shows that more formal education leads to higher earnings. Partly because of this analysis, we in Canada have focused on keeping children in school longer and ensuring that they go on to complete post-secondary education. This has paid enormous dividends, and should continue to feature on our agenda. But what we should also consider is how to make schooling more productive. And that is not simply about increasing the resources for education, but also about using more effectively the most critical and most valuable resource in this process - students’ time. How do we do that? For starters, in the future, we will have to pay more attention to early childhood development, so that a greater proportion of our 6-year-olds arrive in school ready to learn. I have talked about this at some length in a speech I gave last May to the Sparrow Lake Alliance.3 We should also focus more on the development of literacy skills in primary grades, given evidence that this really pays dividends later on. But one of the keys to making schooling more productive and relevant for our times lies in linking formal education to practical experience - in other words, “building a bridge to the real world.” Learning-by-doing can help build that bridge. These practical forms of education can be delivered by the community inside and outside the school, by parents, and by businesses - in other words, pretty much by everyone in this room here tonight! Unfortunately, this type of education has been largely neglected in the economic literature, which is why I would like to spend the next few minutes talking about it. When I was in Russia in the early 1990s, the thing that struck me was that, even though people had technical skills and some of them also had theoretical knowledge of a market economy, they could not relate to markets intuitively. They had not had the opportunity to absorb informally, by “doing,” the skills that are absolutely critical in order to function effectively in a market economy. What does this mean? In part, it means ensuring that our school system does a better job of bringing students to a level of “functional literacy,” and I will have more to say about this in a moment. But it also means ensuring that children have an opportunity to really understand how the economy works. Based on my experience in Russia, it is not that the Russians that I worked with had not studied the theory of the market economy at university, but that they did not have the opportunity to experience at an early age how a market economy works, and to learn from that experience. Dodge, D. 2003. “Human Capital, Early Childhood Development, and Economic Growth: An Economist’s Perspective.” The great advantage that we in Canada have is that most of us do understand intuitively how the market system works. That’s because we have had exposure to it while growing up, in one of two ways: as mini-entrepreneurs, delivering newspapers, cutting grass, or babysitting; or as young employees, working at a fast-food joint, or packing and carrying out groceries at a supermarket. As mini-entrepreneurs, we learned that, if we delivered a wet newspaper, we wouldn’t get paid. If we didn’t show up on time for babysitting, we wouldn’t be called again. As young employees, we learned that, if we flipped the hamburger onto the floor, or if were rude to the customer, we would get fired. Importantly, we also learned that there is a relationship between the quality of our service and remuneration. Today, some of these “early commerce” experiences and learning opportunities for children are gone. For example, the morning paper is now delivered by adults who can get up at 3 a.m. And, in the interests of health and occupational safety, some Canadian provinces have labour laws that prevent anyone under 16 years of age from even being on a construction site. Because some of these “early commerce” experiences are gone, and because more are likely to disappear as technology changes, all of us, as parents, employers, and public policy-makers will have to keep thinking of ways to provide new opportunities for our youth to learn by doing. As parents, we can encourage our children to seek out “early-commerce” experiences. As employers, we can offer opportunities to teenagers, as interns or part-time workers. As educators, we can do more to integrate work experiences with schooling. And as public policy-makers, we can ensure that workplace regulations do not prevent youth in school from gaining valuable work experiences. We should all be doing what we can to provide opportunities for high-school kids to work with skilled tradespeople on the shop floor, with computer technicians and programmers in our businesses and offices, and even with economists at the Bank of Canada. As we all know, kids are fascinated with computers. We should build on this fascination to provide opportunities for children to be exposed to the working world. Computers also provide boundless opportunities for interactive learning in our schools, which we should try to exploit more fully. Textbooks still have an important role to play - especially if done well and if properly adapted to Canadian youth. But the Internet, and especially interactive tools, such as games that simulate real-life situations, can be very valuable, effective learning vehicles. Kids can have fun with them and learn a lot in the process - about money and credit, about how the economy works, and about how government and other institutions function. Again, as I said earlier, the problem is that we often tend to think of the world as separate boxes private sector here, public sector there; academic world here, work world over there. But, in fact, there are great benefits to be had by building bridges between the academic experience and the real world both the world of business and the business of daily living. We must encourage our youngsters, while still in school, to start familiarizing themselves with the world of banking, finance, and the economy more generally if we want them to be “functionally literate,” capable of handling their daily affairs effectively as tomorrow’s adult citizens. Individuals with a good knowledge of economic and financial basics can make more informed decisions - to their benefit and to the benefit of the entire economy. Not only can they manage their personal affairs and their households better, they can be more effective and productive members of society. They can also be better citizens, capable of making reasonable judgments on public policy issues that have a bearing on their personal prospects and those of the nation. Now, children are not the only ones who need to learn. In our rapidly changing world, adults too need to keep up with developments and advances in many areas. Learning ought to be a lifelong experience if we are to keep pace with a rapidly changing economic, financial, and technological environment. In this sense, it is important that all of us, as employers, pay greater attention to the management of knowledge and the management of learning. That way, our employees can continue to develop and function effectively in an increasingly complex, demanding environment. Community programs and organizations such as the Canadian Foundation of Economic Education (CFEE) can also provide learning opportunities for youths and adults to improve their economic and financial knowledge. I know that the CFEE, on its own and through strategic partnerships with educators and business, has already done a lot to further economic literacy in schools and among adult Canadians. And it plans to do considerably more as we look ahead. We at the Bank of Canada feel very strongly about the need for improved economic and financial literacy in Canada. An economically more literate public means a more effective monetary policy. When Canadians understand our functions, responsibilities, and policies, particularly with respect to the economy and inflation, they can plan for the future with greater confidence and make better economic decisions. I spoke at the beginning about the need to ensure that the private and public sectors in Canada do not operate as two solitudes, but that, instead, they talk to each other, work together towards national objectives, and do business in a more open and transparent way. It is in this spirit that the Bank of Canada has undertaken important initiatives to communicate with Canadians and to provide economic and financial intelligence. We do this through several vehicles. Our Web site is one. It supplies a wealth of information on economic and financial topics as well as interactive features, such as a graphic depiction of the transmission mechanism of monetary policy and an inflation calculator. We also intend to use our Web site to provide learning opportunities for our kids. For example, we have developed a program called “Inflation Busters,” designed to help senior highschool students learn about monetary policy through games, simulations, discussions, and group activities. This is currently available, on-site, in our Currency Museum, but will be up on our Web site in the new year. In addition, we have “Museum in a Bag” kits that teachers and others can use for presentations to students. And on-site, in our Currency Museum, we provide exhibits and interactive games for students to learn about money and inflation. Given the importance we attach to improving economic and financial literacy in this country, we will continue to develop educational programs and materials for students. We will also continue to enhance our communications with the Canadian public at large. ****************** Let me conclude. In an increasingly complex and competitive global economic environment, furthering our national economic welfare will depend importantly on the quality of our labour force. But it will also depend on the ability of our citizens to conduct their daily economic affairs competently and effectively. Improving skills and raising the level of economic and financial literacy in Canada will require, first, concerted efforts from all of us - parents, educators, employers, community organizations, and policymakers - and, second, greater understanding, interaction, and co-operation between our private and public sectors. Organizations like the CFEE have played, and must continue to play, a very important role. You are leading a nationwide initiative - the “Building Futures Program” - to promote economic and financial literacy among Canadians. We at the Bank applaud your efforts. Ladies and gentlemen, thank you very much for being here tonight. Your presence and your friendship over the years is my greatest personal reward.	bank of canada	2,003	11
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Office for Partnerships for Advanced Skills Annual Vision...	David Dodge: Global challenges, Canadian opportunities Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Office for Partnerships for Advanced Skills Annual Visionary Seminar, Ottawa, Ontario, 17 November 2003. * * * Good afternoon, ladies and gentlemen. Let me begin by congratulating OPAS for its work in advancing partnerships between industry and universities. These partnerships will be increasingly important for Canada in the years ahead. Let me also say how honoured I am to receive the OPAS Visionary Award for 2003. When I look at the list of distinguished business leaders who have received this award in the past - Charles Baillie and John Cleghorn, Ted Rogers and Mike Lazaridis, John Sheridan and Jean Monty - I must say that I am absolutely delighted to join them. It’s a particular pleasure to receive this award since it marks the first time that it is being given to a person who has made a career in the public sector. This award recognizes that the public sector has an important role to play in promoting the economic health of a country. Far too often, people think that the private sector is solely responsible for creating wealth, and that the best the public sector can do is to redistribute that wealth. The reality is far more complex. That’s what I want to talk about today: how those complexities give rise not only to challenges, but also to opportunities. In particular, I want to talk about the challenges posed by the globalization of the world economy, and how Canadians in the public and private sectors can take advantage of the opportunities that the global economy presents. It is certainly nothing new to say that economies have become increasingly globalized. In his 1962 book, The Gutenberg Galaxy, Marshall McLuhan observed that the electronic mass media were collapsing time and space barriers. This enabled people to communicate on a global scale. He coined the term “global village” to describe this change. Of course, even McLuhan couldn’t have foreseen the developments in transportation and communications that have taken place over the four decades since his book was published. These developments have converted McLuhan’s abstract concept into reality. Satellite technology gives us live broadcasts from anywhere in the world. Ideas are available simultaneously to those who have access to the Internet - and that number continues to grow at an exponential rate. As I stand here today, I can talk to, and hear from, thousands of people across the country at the same time. More to the point, these technological advances have allowed markets, not just of goods and services, but also of ideas, to expand as never before. Think of technology as the enabler of so many of the trends leading towards globalization. Technological advances have slashed the cost and the time it takes to reach across borders. But whether that turns out to be good or bad depends on all of us here today. For while technology enables us to make huge progress, it does not guarantee that this progress will occur. We are all working to understand the impact of globalization on economic and social development. We still have a lot to learn. But one thing is clear: the societies that have progressed the furthest in the last century are those that have embraced the opportunities that stem from being open and adaptive. As I look around the world, I see a number of societies that are seizing these opportunities for the good. What I also see is that those societies that are open both to ideas and to economic competition from abroad are societies that are making the most progress in improving the well-being of their citizens. The technological advances that created McLuhan’s global village will continue. While the pace of evolution may speed up or slow down, the world economy seems destined to become ever more global in nature. The question is then, What challenges and opportunities will this present? Let me raise three points, which can serve as the basis for our discussion later. Thinking and Acting Globally The first is the importance of having a global point of view. The old adage tells us to “think globally and act locally.” But we should really think and act globally. Let me put that idea in more concrete terms. During the 1980s and 1990s, free-trade agreements with the United States and Mexico focused Canada’s attention on the opportunities south of the border. Individual Canadians and businesses have been making the tough adjustments that are necessary to face increased competition and to take advantage of new opportunities. While keeping that continental focus, it is now important that we broaden our sights and focus on opportunities that are opening up in the rest of the world. In a very real sense, the rest of the world is becoming part of our world. With rising incomes, foreigners are acquiring a taste for Canadian products and ideas. At the same time, our tastes and interests are becoming more international. We’re all shopping in the same global village market - for goods, for services, and for ideas. Still, this is a large planet with a wide variety of cultures, each with its own perspective and ways of doing things. We Canadians need to continue to broaden our horizons, and to think of ourselves as citizens of that world. That means getting as much global exposure as we can. Canadians are fortunate to have much of the world’s diversity reflected across our country at large, and in our universities. Six continents’ worth of culture can be found here in one country, sometimes in one city. That diversity allows for mutual enrichment that benefits us all. It is important for those from different backgrounds to learn about the strengths and rich traditions of this country. It is equally important that those of us who were born here, into families with deep roots in Canada, to learn from the backgrounds and cultures of those who come from other continents. By listening to each other, we learn how to listen to the world. By speaking to each other, we learn how to speak to the world. That two-way learning adds a new dimension to the metaphor of the Canadian mosaic - the colours in the mosaic remain distinct, but they blend together to create a vibrant and dynamic picture. In short, Canada’s diversity is a real strength, and it will fall to you, the next generation of leaders, to ensure that we use this strength to our advantage. So that’s the first message I have: think globally, act globally, and experience the world’s diversity. The Importance of Finance During my career, I have spent a lot of time working with the financial sector in one way or another. From a global perspective, I have seen how people’s lives can be made better when countries choose to open their economy to outside investment. So let me now take a few minutes to talk about my second point - the opportunities that lie within the financial sector, in the context of increased openness and globalization. Nowhere have the advances in communication and information technologies had a greater impact than in the financial sector. Technological advances and increased openness have led to greater flows of capital and new methods of financing development. Capital flows have become global, as investors look across national boundaries for the best opportunities for their savings. This has benefited not only countries that receive investment, but also allowed our aging society to generate higher returns on its savings, both private and public. Of course, a country that truly embraces openness in its markets leaves itself open to increased risks. We have all seen what can happen when investment flows into countries with unreliable or underdeveloped financial sectors. We have also seen what can happen when investors send large capital flows abroad without doing their due diligence first. So seizing the opportunities that have come from being more open has required more effective risk management. For savings to flow smoothly around the world, the financial sector has had to evolve, inventing new instruments that facilitate appropriate investments. These trends are likely to continue, and those countries that have financial sectors that can deliver services efficiently, at home and abroad, will have an important advantage. But it is not only the private sector that has made advances in risk management. International financial institutions, such as the International Monetary Fund, have made significant strides in developing a more robust international financial architecture. And co-operation among governments and central banks has played an important part, whether within the G-7, the G-20, or the several specialized groups that have emerged, such as the Financial Stability Forum. These efforts have paid off. Despite several dramatic events that might have rocked financial systems worldwide, the work done by these groups has led to the development of ways to mitigate shocks that, in previous decades, would have been very destructive. But obviously, huge challenges remain both for private financial institutions and for the public sector nationally and internationally. The public sector in every country must take the necessary steps to ensure that its financial sector is appropriately regulated. And countries need to continue to work together to develop and implement best practices to promote financial stability. Once again, with the trend towards increasing globalization, the importance of the financial sector and the need to ensure that it is appropriately regulated will become even greater. So that’s my second message - recognize the opportunities that the world of finance offers not just in the private sector, but in the public sector as well. That leads me to my third point, which is the role of the public sector. The Role of the Public Sector As I said earlier, there is a popular but simplistic view that it is the private sector’s job alone to create wealth, and that the most the public sector should do is to make minimal attempts at income redistribution. Such a view grossly underestimates the nature and the scope of the public sector’s role in promoting a country’s economic health. It ignores history, which clearly shows that those societies that have done the most to improve the economic well-being of their citizens are those where the public sector has provided the right social climate for the dynamism and creativity of individuals and businesses to thrive. In practice, this means that those working in government must have the right incentives to provide the appropriate framework - one that facilitates higher productivity and innovation in the private sector. The flip side of the coin is that we should also have the right incentives for the private sector to work towards enhancing the public good and the productivity of collective action by governments. The bottom line is that we cannot afford to have the private and public sectors operating as two solitudes. To work efficiently, individuals and businesses need a well-functioning public sector and the appropriate framework that provides the right incentives. The public sector has a responsibility to understand how businesses and individuals work in order to provide the appropriate setting and support. While this applies to all parts of the public sector, it is perhaps most critical for those who are responsible for the country’s economic and financial framework - including us at the Bank of Canada. Creating and maintaining this framework, in the context of a changing global environment, will be a daunting challenge indeed. Part of that challenge will come from developing a public policy framework that has two dimensions. First, it must have enough consistency with the rest of the world so that we remain open to competition and to the flow of ideas from abroad. Second, our policy framework must create unique strengths for Canada so that our public sector is a source of competitive advantage and does not detract from our other advantages. What does this mean for students in terms of opportunities for tomorrow? It means that you should be thinking of careers that combine public and private sector experience, as well as academic. The lessons you learn in one place will give you a greater ability to work and contribute elsewhere. And this diversity of experience will give you a set of skills that you will find are in great demand. And it really doesn’t matter where you begin. For example, if you want to make a real contribution as an academic, some experience in either the private or the public sector will be tremendously important in letting you bring more to the table as a teacher. In the private sector, academic or public sector experience will let you view the world strategically, which is difficult if your experience is confined to just one firm or industry. And if you want to contribute in the public sector, as I have already said, it is extraordinarily important to have private sector experience so that you can better understand how business functions. Why? Because, in the end, public policies must foster the effective and efficient delivery of public goods and provide the incentives to encourage private activities that will create positive outcomes for the benefit of everyone. Developing such policies is much easier said than done. But in the last 15 years, we in Canada have made considerable progress in our macroeconomic policies. The challenge in the future will be to maintain that progress and to make comparable progress in microeconomic policies. Progress will need to come from the federal, provincial, and municipal levels of government, in such diverse areas as labour market policies, intellectual property law, health, environment, and infrastructure investments. This is where challenges lie, but it is also where opportunities present themselves. Conclusion Having mentioned opportunities, let me close by saying a few words about the opportunities for Canada and young Canadians in the years ahead. I talked earlier about the great advantage of Canada’s cultural mosaic. In a globalized world, this provides a real opportunity because it gives us the ability to understand what is going on elsewhere on the planet, while at the same time drawing on the real strengths we have in terms of our unique Canadian social and economic culture. When I travel abroad, I am always amazed by how welcoming foreign businesses and public entities are towards Canadian participation. At the same time, I am also amazed by how little effort we sometimes make to take advantage of this good will. As young people, you are going to have to capitalize on these opportunities. So I hope that you will take my three messages to heart: have a global perspective, recognize the importance of the financial sector, and understand the crucial role of the public sector. With the global economy continuing to evolve, it will become increasingly important to act on these ideas, no matter where your career path leads you.	bank of canada	2,003	11
Lecture by David Dodge, Governor of the Bank of Canada, to the Lecture by David Dodge, Governor of the Bank of Canada, to the Memorial University of Newfoundland, St. John¿s, Newfoundland and Labrador, 20 November 2003.	David Dodge: Low and predictable inflation and the performance of Canadian labour markets1 Lecture by David Dodge, Governor of the Bank of Canada, to the Memorial University of Newfoundland, St. John’s, Newfoundland and Labrador, 20 November 2003. The references can be found at the end of the speech on the Bank of Canada’s website: www.bankofcanada.ca. * * * The goal of Canadian monetary policy is to contribute to solid economic performance and rising living standards. The best way we can do this is by keeping inflation low, stable, and predictable. This has important implications for labour market performance. Although inflation is now low, stable, and predictable, this has not always been the case. Indeed, in the 1970s, inflation was high, unstable, and unpredictable. This led to the establishment of the Anti-Inflation Board (AIB) in 1975, where I worked as Research Director. Tonight, I would like to reflect on what we have learned since the AIB closed its doors almost 25 years ago to the day. I’ll begin with a brief discussion of the theoretical foundation for the role that inflation expectations play. Expectations are important for both price- and wage-setting, but I will concentrate on the wage-setting aspects. I would next like to discuss the Bank of Canada’s inflation-targeting framework, which serves to anchor inflation expectations. I will also address the issue that our inflation target may be too low because nominal wages are downwardly rigid. And I will discuss Canada’s labour market performance and how it has improved substantially with the change in our monetary policy framework since 1991. Finally, I will say a few words about the conduct of monetary policy today, and offer some brief concluding remarks. 1. Inflation and the role of inflation expectations Let me begin by going back to the 1970s. When we started that decade, the inflation rate was around 3 per cent. But it quickly rose to over 12 per cent in the span of three years. Not only was inflation rising, it had become more variable, creating uncertainty over the future rate of inflation.2 This made it difficult for workers and employers to decide on the appropriate rate of inflation to incorporate into wage settlements. In this environment, it was not surprising that some workers demanded wage increases, both as compensation for past inflation and as a precaution against future inflation. And many employers granted them. When they did not, workers often went on strike. On average, in the 1970s, over seven million person-days were lost to strikes each year. This was an enormous loss of output. High and variable inflation also triggered large wage settlements. This fuelled inflation expectations and contributed to both a wage-price spiral and a wage-wage spiral.3 In the economics literature of the day, there was a lot of confusion over the role that inflation expectations play in the wage-formation process. The literature stressed that workers and unions sought to catch up with inflation that had already occurred. But against this background, Milton Friedman argued that forward-looking expectations were more important in wage bargaining than catching up with past inflation. In particular, he stressed that workers bargain over real, and not nominal, wages. When signing a new contract, workers demand higher wages if they expect prices to increase over the life of the contract so as to preserve their real wages. The oral presentation by Governor Dodge at Memorial University is an abridged version of this paper. The Governor would like to thank Robert Fay, Assistant Chief, Research Department, Bank of Canada, for his contribution to this paper. Variability is measured as the standard deviation. At the time, workers and unions were pushing for wage increases to compensate them for the risk of higher inflation over the life of their contracts. But employers in some sectors were also willing to offer high wage increases. The public sector, for example, saw larger revenues with rising inflation. And some firms in the private sector experienced a boost in profits generated by inflation and were therefore willing to grant relatively large wage increases. In some cases, this led workers and unions to demand similarly large wage increases, irrespective of the conditions in their particular sector. Thus, he argued that it is not the recently observed rate of inflation, but rather the expected rate of inflation that plays a prominent role in wage-setting. But with inflation rising and becoming more variable, there was considerable uncertainty over what the future rate of inflation would be. Indeed, high and variable inflation meant that there was no anchor for inflation expectations, and this lack of an anchor led to considerable turbulence in wage-setting.4 Although contractionary macroeconomic policies were required to lower the double-digit inflation rate, such policies operate with a lag and would have resulted in higher levels of unemployment during the transition period. One train of thought in the early to mid-1970s was that temporary wage and price controls could alleviate the negative impact on unemployment by ensuring that, over a period of time, wage- and price-setting behaviour would become consistent with the more restrictive macroeconomic policies. The Anti-Inflation Board was therefore established to try to anchor inflation expectations through wage and price controls. The objective was to ensure that wage growth was in line with a set of targets for inflation of 8, 6, and 4 per cent over a 3-year period. This was done with the assumption that monetary and fiscal policy would be set to be consistent with such a result.5 The imposition of wage and price controls was very controversial, to say the least. One well-known academic even described them as “how to do a lot of harm by trying to do a little good.”6 There were three principal arguments against the use of controls. The first was that they would create distortions in the economy and that the longer the controls were in place, the greater these distortions would grow. The second was that controls are very difficult and costly to administer. Third, there was doubt as to whether the controls could really engineer a permanent reduction in inflation. In particular, would policy-makers place too much emphasis on controls and not enough on supporting macroeconomic and structural policies? The empirical evidence that followed suggested that the controls were responsible for a reduction of about 2 to 3 percentage points in wage increases.7 Ultimately, however, neither monetary nor fiscal policy was restrictive enough to maintain a lower rate of inflation, although, at the time, monetary policy was thought to be sufficiently tight. Subsequent research at the Bank, however, showed that the links between movements in the narrow monetary aggregate M1 and changes in prices were not as close in the short run as had been expected. And the size of the short-run changes in interest rates required to keep the money stock within its target band were not enough to have much of an impact on real output or prices.8 The fact that the link between any monetary aggregate and inflation did not prove to be very tight over time led the Bank to suggest in 1988 that it should focus directly on price stability as the anchor for monetary policy.9 This led to the introduction of the inflation-targeting framework in 1991, one important objective of which is the anchoring of inflation expectations. We did this because we had learned that, once inflation expectations are anchored, they contribute to more stable output and employment growth, allowing for more durable gains in real income over time. 2. Inflation targeting and the behaviour of inflation In February 1991, the Bank and the Government of Canada jointly announced a series of inflationreduction targets. In addition, the economy was buffeted by shocks that had not been seen before. For example, the economy was hit by adverse oil-price shocks that fed directly into inflation expectations in the absence of a clear nominal anchor for monetary policy. And these shocks, combined with other structural changes, made it difficult for workers and employers to judge how to respond. For an overview of the causes of inflation, as well as the goals of the AIB, see Dodge (1976). Lipsey (1977). Auld et al (1979). Thiessen (2000). In other words, the interest rate elasticity of M1 demand was too high. In the second half of the 1970s, the nominal anchor for monetary policy was a series of target ranges for growth in M1. These were abandoned in the early 1980s as the relationship between movements in the narrow money aggregate and changes in nominal spending broke down. Another problem with using the monetary aggregate M1 as the target for monetary policy was the uncertain impact of financial innovation, which weakened the relationship between M1 and other macroeconomic variables. Crow (1988). These targets were aimed at gradually bringing the 12-month rate of inflation down to 2 per cent, the midpoint of the inflation-control target range, by December 1995. Given the empirical evidence for Canada, which showed that the appropriate horizon for aiming at an inflation target was about 1½ to 2 years, the first formal target was set for December 1992 at a rate of 3 per cent (plus or minus 1 per cent). Since that initial agreement, the inflation target has been extended three times, with the latest agreement covering the period to the end of 2006. In each case, the midpoint of the inflation-control target range has been maintained at 2 per cent. The measure of prices chosen for the target was the consumer price index (CPI). This index is well understood by workers, unions, and employers, partly because of its use in cost-of-living (COLA) agreements. The operational guide for the Bank, however, is core inflation.10 The reason for using a core inflation measure is to focus on the underlying trend in inflation on which monetary policy can have an effect. Given the lags between monetary policy actions and their impact on inflation, shocks that are expected to dissipate within that time frame are generally outside the scope of central bank action, unless such shocks have an impact on inflation expectations. Since the adoption of inflation targeting, the inflation rate has fallen significantly. Indeed, by January 1992, inflation was already close to 2 per cent, down from its average of over 5 per cent between 1988 and 1991. Although at times it has approached the boundaries of the range, and exceeded it earlier this year, over the medium term, the average inflation rate has remained around 2 per cent. Indeed, over the six-year period from 1996 to 2002, it was just under 2 per cent. Moreover, not only has the inflation rate fallen, it has become more stable. In other words, movements away from the target have not been persistent. When inflation has moved away from the midpoint, it has shifted back towards 2 per cent as the shocks have worn off. Not surprisingly, the Bank has undertaken considerable research to better understand the dynamics of inflation. One strand of this research has examined the persistence of inflation by allowing for potential changes in inflation regimes.11 The results show that the inflation process in Canada can be divided into three distinct regimes: one with extremely high persistence and high inflation rates, one with fairly low persistence and moderate inflation rates, and one with low persistence and low inflation rates. In the first regime, which prevailed in the 1970s and early 1980s, when inflation moved up, it tended to stay up. Since that time, the economy has moved into the second and third regimes, with inflation becoming much less persistent. Indeed, persistence fell considerably over the 1980s and essentially disappeared in the late 1990s.12 This decline in the persistence of inflation was the result of the change in the monetary policy regime that has fostered more forward-looking inflation expectations. Traditional analysis of the inflationunemployment trade-off using the Phillips curve, however, has typically modelled inflation expectations as the weighted sum of past lags of inflation.13 More recent research has therefore moved towards embedding forward-looking expectations in this analysis. Cross-country analysis covering OECD inflation-targeting countries indicates that, since the adoption of the targets, inflation expectations have become more forward-looking, and that they are anchored around the official targets.14 In our own empirical research for Canada, we have also found that expectations have become more forward looking.15 When the targets were first introduced, core inflation was defined as the CPI excluding food and energy prices and the effects of changes in indirect taxes on the remaining CPI components. We now have a more refined measure that excludes only the eight most volatile elements of the index as well as the effects of changes in indirect taxes on the remaining components. One reason for moving to the new measure of core inflation was that it is a better predictor of future inflation than the previous measure (Macklem 2001). Ricketts and Rose (1995), Demers (2003). St-Amant and Tessier (1998) find that this has also been the case in other major inflation-targeting and non-targeting countries. The restriction that these lags sum to one is usually imposed so that there is no long-run trade-off between inflation and unemployment. Clifton, Leon and Wong (2001). Khalaf and Kichian (2003). Because traditional Phillips curves are reduced-form equations, changes in the monetary policy regime can undermine their use for policy purposes (the Lucas Critique). Research at the Bank has therefore also examined whether the New Keynesian Phillips curve adequately represents inflation dynamics in Canada. Guay, Luger and Zhu (2002) have found that this is not the case, although their work highlights the importance of including forward-looking expectations in the analysis. Work has also been undertaken on estimating the so-called sticky information Phillips curve based on the premise that firms change prices slowly because of the costs of acquiring new information relevant to that decision. See Khan and Zhu (2002). Another fact about the inflation process in Canada is that inflation has become less uncertain - in other words, more predictable. After the oil-price shocks of the 1970s, inflation variability rose sharply. Although it fell during the years when the AIB was in operation, it rose again in the 1980s. However, between the 1980s and the latter part of the 1990s it dropped almost fourfold.16 This reduction in inflation variability linked to the low-inflation environment allows people to take a longer-term view with respect to their planning, which leads to a better allocation of economic and financial resources. In Canada, policy credibility has clearly increased over time. Work carried out using data to the mid-1990s suggested that, while central bank credibility had improved in inflation-targeting countries, it was difficult to say whether explicit inflation targets had made any additional contribution to that credibility.17 More recent evidence suggests that the inflation target has, in fact, played an important role in enhancing credibility. For example, since the mid-1990s, long-term inflation expectations have fallen close to the midpoint of the target range, which is also close to the mean of inflation.18 In Canada, expectations of forecasters and businesses began to fall in line with the targets soon after they were introduced.19 At first, this was for expectations at the 2-year horizon. Gradually, this lengthened to 6 to 10 years. By 1997, long-term expectations of inflation in financial markets, as expressed by the difference between 30-year yields on conventional and index-linked bonds, had fallen in line with the 2 per cent target midpoint. They have been firmly anchored at that level ever since, despite the various shocks that have hit the Canadian economy. This is in strong contrast to earlier periods in our history when future expectations had been fairly tightly linked to recently observed inflation rates.20 And this change in behaviour is not because there have been fewer economic shocks. In fact, over the past few years, we have witnessed economic crises in Asia and Russia, oil-price shocks, and the tragic events of 11 September 2001 in the United States. Despite all of this, inflation expectations have remained well anchored. This is in absolute contrast to earlier periods. And it points to the important role that monetary policy plays in anchoring inflation expectations. In general, there is real evidence to support the argument that, with the inflation target becoming increasingly credible, the whole nature of the inflation process has changed. The short-run response of inflation to measures of excess demand and supply appears to have fallen. And similarly, the response of inflation to relative price shocks, such as changes in the exchange rate and energy prices, also seems to have declined. These changes have had the effect of reinforcing the stability of the inflation process and, therefore, of inflation itself. And this, in turn, has produced a more stable macroeconomic environment. Moreover, by keeping average rates of inflation close to the inflation target, and by indicating that the Bank will act symmetrically to shocks that drive inflation away from the target in either direction, we have been able to contain inflation expectations. Indeed, under a credible monetary regime, there should be fewer forecasting errors in the bargaining process, since uncertainty about inflation is low. Thus, there is less need for workers to demand additional wage increases to protect themselves against the risk of unexpectedly high future inflation - increases that can contribute to a wage-price spiral. Nor are employers as likely to offer such increases. Similarly, both employers and workers can look through periods when inflation is below the target. Thus, wage-setting becomes focused on actual developments in the particular sector. And workers and unions are able to place greater emphasis on real factors, such as productivity, that will help to boost income and living standards. 3. Inflation targeting: is the target set too low? Now I would like to turn to concerns by some analysts that the level of the inflation target is set too low. This is measured by the standard deviation of inflation, which fell from about 3 in the 1980s to 0.7 in the last part of the 1990s. Johnson (1997). In addition, long-term inflation expectations would appear to be better anchored in Canada than in the United States. See Kozicki and Tinsley (2002). Perrier and Amano (2000). Dodge (2002a). Inflation targets, whether in Canada or elsewhere, have typically not been set at zero. One argument for excluding zero is that there is downward rigidity in nominal wages. More specifically, it says that a little inflation is needed to “grease the wheels” of the labour market because nominal wages are downwardly rigid. Thus, it is argued that the target for the inflation rate should be in the 2 to 4 per cent range to facilitate adjustments in the real wage.21 You will recall that, in Canada, the target range is set at 1 to 3 per cent. One reason behind this argument is the belief that inflation allows firms to provide real wage increases to workers whose productivity is rising, while reducing real wages to less-productive staff without having to cut nominal wages.22 Therefore, for firms to achieve the desired adjustment in real wages in the face of adverse demand shocks, inflation would have to be above zero. Otherwise, unemployment would rise, perhaps at an increasing rate, as inflation approaches zero, because firms would have to resort to layoffs to keep wage bills at their desired level. Why might nominal wages be downwardly rigid? This could result from money illusion - for example, workers refusing to accept nominal wage cuts when, in fact, they may have suffered a similar reduction in real wages in the past because of inflation. Firms might also be reluctant to cut nominal wages because of notions of fairness. They might also have concerns that such cuts would adversely affect the quality of candidates they seek to attract, or lead to higher quit rates. On the face of it, downward nominal wage rigidity would seem to have little relevance for Canada.23 As I will discuss in more detail later, in the late 1990s, the unemployment rate fell sharply even though inflation had stabilized around 2 per cent. The question is, how far above zero should the inflation target be set? This is an empirical question about how important downward nominal wage rigidity is in practice. Is there evidence that there is so much resistance to nominal wage cuts in Canada that our inflation target of 2 per cent is too low? In the period leading up to the May 2001 renewal of the latest inflation target, the Bank undertook considerable research using a variety of tools and addressing a number of hypotheses to determine the extent of nominal wage rigidity in Canada.24 One way to examine the likely impact of downward nominal wage rigidity is to estimate what the wage distribution would look like in the absence of rigidity. On balance, this line of research demonstrates that downward nominal wage rigidity has not been an important feature of the Canadian labour market. Relatively more wage freezes do occur at low inflation rates, but this would be expected anyway, since the mean of the wage-change distribution varies with the rate of inflation. Econometric estimates suggest that the net effect of downward nominal wage rigidity on wage growth was in the range of only 0.07 to 0.18 per cent in the unionized private sector in the 1990s.25 It is important to note that what might appear to be downward nominal wage rigidity could also be a form of menu costs. By this, I mean the fixed costs associated with changing pay scales, a task that firms may be reluctant to undertake unless a large wage adjustment is required.26 The estimates of rigidity that I just mentioned incorporate these effects. Another strand of research has examined the employment effects of downward nominal wage rigidity in Canada. There are relatively few papers on this subject. Moreover, estimates of the employment impact tend to be sensitive to model specifications, which are typically reduced-form equations linking changes in employment growth to changes in output growth and to a variable that measures wage cuts or freezes. On balance, however, these studies do not support a significant employment impact.27 Fortin (1996), Akerlof, Dickens and Perry (1996), Fortin, Akerlof, Dickens and Perry (2002). Tobin (1972). Thiessen (1996). See Technical Background Document 1 from the renewal of the inflation-control target (May 2001). This can be found at http://www.bankofcanada.ca/en/press/annexe1.pdf. Crawford (2001), Crawford and Wright (2001). In addition, there are few small wage changes (up or down) in the data. Simpson, Cameron and Hum (1998) find relatively large effects, but Farès and Hogan (2000) and Faruqui (2000) show that, once their model is adjusted for possible endogeneity between wage freezes and output growth, the impact is insignificant. Most of the data used in the research I have cited come from wage settlements in the unionized sector, which begs the question as to whether the results would hold more generally for all workers in the economy. Evidence suggests that the wage-settlements data tend to overstate the amount of nominal wage rigidity in the economy, since base wage rates for workers outside the unionized sector are typically more flexible.28 For example, small firms tend to have more flexible pay practices, while variable compensation, including adjustments to non-wage benefits, also allows for more nominal wage flexibility. In addition to using micro-level data to examine downward nominal wage rigidity, aggregate data can also be used to examine the effect of unemployment or the output gap on inflation - in other words, the slope of the Phillips curve. If downward nominal wage rigidity exists, then the slope of the Phillips curve should have become flatter in the period of excess supply during the low-inflation period of the 1990s. Evidence from this research, however, does not support this hypothesis.29 Another line of argument that has been tested using aggregate data has been referred to as “nearrational” wage setting. It suggests that workers and firms might not worry as much about inflation when it is at low levels and, therefore, do not fully incorporate small changes in inflation into their inflation expectations.30 Supporters of this line of reasoning argue that unemployment can be sustained below the equilibrium rate over a range of low and moderate rates of inflation. Thus, there is some positive inflation rate that should be chosen as the target. One problem with this argument is that it is difficult to imagine why agents would continuously ignore the negative impact of low inflation.31 Although the cost might be small in a single period, it would clearly accumulate over time, which should induce them to become fully rational in their wage- and price-setting. There is little Canadian evidence in this area. That which exists, however, suggests implausibly high estimates of near-rational behaviour when inflation is at 3 per cent.32 In summary, there is little substantive evidence to suggest that downward nominal wage rigidity or near-rationality in wage-setting impedes appropriate adjustment at our currently targeted inflation rate of 2 per cent. But equally, there is little substantive evidence to suggest that a target lower than 2 per cent would lead to a measurable improvement in economic behaviour. Thus, because inflation expectations have become well anchored around 2 per cent, maintaining the 2 per cent target was judged to be appropriate.33 4. Canadian labour market performance In this part of my lecture, I would like to discuss how the labour market functions better than it did a decade ago and, indeed, better than when the AIB was wrapped up in 1978. First: As I said, inflation has become low, stable, and predictable. The impact of this development can be seen in the path of nominal wages.34 Indeed, the growth in nominal wages has also slowed, along with falling inflation. Since the introduction of the inflation target, average annual growth in nominal wages has been about 4 per cent, down from the approximately 14 per cent average growth recorded in the 1970s and the 8 per cent witnessed in the 1980s.35 Crawford and Harrison (1997). Farès and Lemieux (2000). Akerlof, Dickens and Perry (2000). O’Reilly (1998). Fortin and Dumont (2001). Their results imply that less than 50 per cent of agents take inflation into account when it is near 3 per cent. See Technical Background Document 1 from the renewal of the inflation-control target (May 2001). The relationship between movements in nominal wages and prices leads inevitably to the question of the direction of causality. The nature of these dynamics has been a source of debate over the years. In the 1970s, the prevailing view was that nominal wage inflation led to price inflation, largely because of wage “catch up”; i.e., workers and unions demanding additional wage increases to compensate them for unexpected inflation and to match settlements in other sectors of the economy, such as the public sector. In this context, the setting of wage guidelines by the Anti-Inflation Board was seen as instrumental in controlling inflation. Since then, our research suggests that causality tends to run - at least primarily - from prices to wages, and not the reverse. See Cozier (1992). These numbers refer to average annual growth in nominal wages, salaries, and supplementary labour income from the System of National Accounts over the periods 1971-1980, 1981-1990, and 1991-2000. In addition, the distribution of wage changes has narrowed as inflation has become more predictable. There are at least a couple of reasons why this might be the case. First, research points to a significant link between higher inflation and greater inflation uncertainty. Where there is increased uncertainty about inflation, firms and workers may set inflation adjustments incorrectly, creating relatively more dispersion in wage changes.36 Thus, as uncertainty about inflation falls in line with declining inflation, so should the dispersion around average wage changes. I will have more to say on inflation uncertainty in a few moments. Second, a lower cross-sectional variation in wage settlements could arise because downward nominal wage rigidity would impose a floor on the distribution. As I have already discussed, this seems unlikely to have had a significant impact in Canada. By contrast, others have argued that the variability of relative wage changes decreases when inflation rates accelerate. Essentially, the argument here is that higher inflation leads to a greater demand for indexed wage contracts - either explicitly through COLA clauses or implicitly when setting wages with employers - to protect workers from unexpected increases in inflation.37 Clearly, what actually happens to the dispersion of wage settlements when inflation and inflation uncertainty decline is an empirical proposition. A stylized fact of the Canadian economy is that, in the unionized private sector, the variance in wage settlements fell by about two-thirds as inflation declined.38 Although some have suggested that this could be because of greater downward nominal wage rigidity, this is not the case. We know this because the variability of wage changes above the median has also fallen significantly. Moreover, it has become apparent that wages no longer react quickly to large changes in relative prices such as those generated by oil-price shocks or, more recently, by auto insurance premiums. This is a very important contribution to labour market performance in Canada because it suggests that relative wages tend to better reflect demand and supply conditions in particular markets. There is, however, very little research in this area, and it is one where more in-depth analysis would be useful. Second: Another development in the 1990s was the relatively sharp increase in the average duration of labour contracts in the private unionized sector of the economy. Compared with the 1980s, the average duration increased by almost 10 months.39 Reduced inflation uncertainty is one explanation for this. As the variability of inflation has fallen, this has likely lowered the amount of uncertainty in the economy and has led to labour contracts that are longer in duration. Theoretical work in the late 1970s and early 1980s showed that lower uncertainty about inflation should result in longer contracts.40 Empirical evidence for Canada gathered in the early 1980s was consistent with this theoretical work.41 Using several measures of inflation uncertainty, researchers at the Bank of Canada have confirmed a robust negative relationship between inflation uncertainty and the duration of union contracts in the private sector.42 In other words, as uncertainty about inflation has fallen, the duration of labour contracts has lengthened. Indeed, it has been estimated that each percentage point decrease in inflation uncertainty increases contract length by about two months.43 One positive implication of Groshen and Schweitzer (1999). Hammermesh (1986). Crawford (2001). In the early 1980s, the annual standard deviation of wage settlements in the private sector was just over 3 per cent. This fell to about 1 per cent in the year 2000. The data are drawn from a database maintained by Human Resources Development Canada, which contains information on agreements signed in the unionized sector of the economy. Note that wage settlements in the public sector are excluded from the numbers presented in the text. Data in this sector are distorted by wage freezes in the 1990s as governments at various levels sought to control budget deficits. In 1980, average duration across all contracts in the private sector was approximately 27 months. In 2001, it was about 36 months. Gray (1978), Canzoneri (1980). Since then, advances in econometric techniques have allowed researchers to better specify and construct uncertainty variables and thus to measure the impact of inflation uncertainty on contract duration. For example, early empirical work by Christofides and Wilton (1983) used a rolling regression technique to calculate inflation uncertainty. New techniques, such as autoregressive conditional heteroscedasticity (ARCH) models, now allow researchers to better construct uncertainty variables. Fay and Lavoie (2002). This refers to the uncertainty measure derived from an ARCH model, and expressed in terms of the standard deviation of inflation uncertainty. Other measures of inflation uncertainty give different results. longer labour contracts is a savings in the resources dedicated to negotiation, or in other words, lower transactions costs. Another interesting finding is that the proportion of COLA clauses in private sector contracts has not changed much over the last decade, even though contract duration has increased.44 Once unions have bargained for such clauses, they appear reluctant to give them up, even if they are seldom triggered. Unions, of course, bargain for more than just wages and cost-of-living agreements. In the early 1990s, they became more preoccupied with job security for their members in the face of weak aggregate demand, increased contracting out, and the move towards hiring temporary staff as employers sought to contain costs.45 Thus, uncertainty over developments in the real side of the economy - which I shall refer to as real uncertainty - may have become more prominent at that time. Work at the Bank, however, finds no empirical support for the proposition that this type of uncertainty affects contract length.46 Third: Another concrete benefit of low, stable, and predictable inflation has been less disagreement over future inflation, leading to fewer strikes and, therefore, lower output losses. The number of person-days lost to strikes peaked in the early to mid-1970s when inflation was at double-digit levels and uncertainty was high. Since then, the number of days lost has trended down. Between the 1970s and 1980s, the number of days lost to strikes fell by about one-third. In the 1990s, it declined again by over 50 per cent relative to the previous decade. This represents a clear gain for workers and, indeed, for all Canadians. Fourth, and very importantly: greater stability has also been observed in output growth.47 Several reasons have been put forward for this, including better inventory management. The conduct of monetary policy has certainly been an important factor. By responding promptly and symmetrically to demand shocks, and by focusing on the underlying trend of inflation - thus ignoring temporary inflation shocks unless they feed into inflation expectations - monetary policy will produce greater stability in output growth. Alongside greater stability in output growth, there has been more stable employment growth and less volatility in the unemployment rate.48 On the margin, other factors may have been at play as well. For example, there is evidence that the use of variable forms of compensation has increased over time.49 Variable compensation programs allow firms to adjust pay in the face of adverse shocks, rather than resorting to layoffs. This contributes to greater employment stability. It is also worth noting that changes in compensation practices that link individual performance to that of the firm also move in the direction of bolstering productivity growth.50 Greater stability in output growth has paved the way for a labour market with rising labour force participation rates, higher employment/population ratios and lower unemployment rates. Indeed, both Canada’s participation rate and the employment/population ratio hit record high levels this year. Moreover, this rising employment/population ratio has helped to boost our standard of living, and is a reflection of just how well the labour market is functioning. Newfoundland has also seen its aggregate In the 1980s, on average, 32 per cent of private sector contracts contained COLA clauses. This fell to an average of 25 per cent over the 1990s. In contrast to the private sector, the incidence of COLA clauses in public sector agreements fell substantially in the early part of the 1990s, after which it levelled off in the 1 to 7 per cent range. One indicator of the importance of labour unions is union density - the number of workers who are union members. This measure suggests that the importance of unions has not changed substantially. Trade union density over the 1980s averaged about 36 per cent in Canada. The average over the 1990s was only slightly lower, although it did begin to fall after 1997, closing the decade at around 33 per cent. Fay and Lavoie (2002). See also Murphy (2000), Rich and Tracy (2000), and Wallace (2001) for evidence in the United States. Debs (2001). This is measured as the standard deviation of each variable in the 1980s and 1990s. Crawford and Harrison (1997). The Conference Board of Canada (2002) also notes that while base pay represents the main element of compensation, it has made up a smaller percentage of total compensation over the past few years. In fact, 87 per cent of Canadian organizations had one or more types of variable pay plans in place in 2002, with cash bonuses being the most common type of short-term incentive plan. Stock options were the most common type of long-term incentive. Lebow et al (1999). labour force participation rate and employment/population ratio rise to record levels, although they still remain below the national average. The current situation is in contrast to that of the late 1980s and early 1990s when Canada faced a number of economic challenges that required painful policy action and difficult adjustments. Among these, inflation had to be lowered and public sector deficits had to be tamed. I discussed the linkages between monetary and fiscal policy elsewhere.51 Overall, an extraordinary effort was made to get the macroeconomic framework - that is, both monetary and fiscal policies - right, and we are now reaping the benefits of those efforts. To be sure, a number of other difficult policy choices have also contributed to better labour market performance, although it is difficult to isolate the specific contribution of each one of them. For example, there were reforms to labour market institutions such as changes to the Unemployment Insurance program. Trade has also been opened up to improve the efficiency of markets, namely through the FTA and NAFTA. The main point here is that all of these policies have worked in the same direction - towards improved labour market performance. Now let me turn to prospects for income growth.52 An important determinant of aggregate income growth is labour-productivity growth. On an economy-wide basis, productivity growth averaged about 1.4 per cent between 1970 and 1997. It then picked up, accelerating to 1.8 per cent, on average, between 1997 and 2002. This is still well below that in the United States, but the acceleration is a promising sign. Indeed, increased investment in machinery and equipment as well as in communications technologies in the late 1990s, combined with sound economic policies, will likely see productivity gains remain strong in the near and medium term. Furthermore, as I discussed earlier, the Bank of Canada plays an important role here by keeping inflation low, stable, and predictable, which is conducive to innovation, risk-taking, and investment.53 5. The conduct of monetary policy But keeping inflation at the 2 per cent target is not an easy task. And there are times when inflation temporarily moves away from the target because of unexpected developments and shocks. Recent experience provides a case in point. In early 2003, inflation was well above the 2 per cent target, and short-term inflation expectations had edged up. Although inflation was being pushed up by special factors, such as sharply higher oil prices and auto insurance premiums, there were also signs that strong domestic demand was working to broaden price pressures. Since then, however, the economy has weakened more than expected, and core inflation has fallen to 1.8 per cent. And virtually all measures of inflation expectations have decreased. Although we at the Bank had expected core inflation to ease, several unforeseen developments have caused this to occur sooner, and to be more pronounced, than we projected last April. These have included a slightly faster easing in pressures from insurance premiums and price discounting in certain service industries because of SARS. As well, the U.S. dollar has fallen substantially, adding to the recent weakness in goods prices in Canada. The average value of the Canadian dollar in terms of the U.S. currency in recent months represents a sharp increase from 69 cents in April. Clearly, the appreciation of the Canadian dollar is an important factor that we at the Bank are considering carefully as we evaluate the economic situation and the risks attached to our outlook. At the same time, we continue to assess other developments, notably a somewhat stronger-thanexpected recovery in world demand. Dodge (1998, 2002b). One way to approach this topic is to examine the share of labour in national income. Since the late 1970s, it has shown no observable trend, hovering around 64 per cent. The labour share of income rose sharply in the early 1990s when profits fell during the recession and payroll taxes rose. After this period, profits rose, and the labour share declined. When the share of labour income in GDP is unchanged, we would expect growth in labour income to be close to the projected growth in nominal GDP. A general rule of thumb would be for nominal GDP to increase by roughly 5 per cent per year, on average, over the medium term - 2 per cent from inflation and 3 per cent from average potential output growth. This 5 per cent growth in labour income can be roughly divided into 1 per cent growth in labour input (person-hours) and 4 per cent growth in labour compensation per person-hour. See Longworth (2003). Dodge (2002c). In this context, if it looked as though the appreciation of the Canadian dollar would more than offset the effects of stronger world demand, or that world demand was weakening, we would act to stimulate domestic demand with the intent of returning inflation to the 2 per cent target over the next 18 to 24 months. Such action would take the form of lowering interest rates. As I said in my recent testimony before the Senate Banking, Trade and Commerce Committee, the Bank continues to assess the implications of all past developments - domestic and external - for output and inflation in Canada. This kind of analysis and the typically difficult assessment of future developments are what we at the Bank have to consider at each monetary policy decision date. 6. Concluding thoughts Let me now conclude. Changes in the conduct of monetary and fiscal policy, as well as increased emphasis on structural policies, have worked together to produce a better-functioning labour market in Canada. The Bank’s particular contribution has been to anchor inflation expectations at the 2 per cent target. Because our monetary policy framework reduces uncertainty about inflation, it helps both firms and workers make better planning decisions. Thus, wage bargaining can be concluded by focusing on factors that are relevant to wage-setting, such as productivity growth, without the noise of variable inflation. This, in turn, leads to a more efficient bargaining process with lower transactions costs and less loss of output,54 as well as to a more productive allocation of labour in the economy. This has contributed to an economic environment where there are rising employment/population ratios, higher participation rates, and lower unemployment rates. Longworth (2002).	bank of canada	2,003	11
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the London Chamber of Commerce, London, Ontario, 8 December 2003.	David Dodge: Past adjustments and future trends in the Canadian economy Remarks by Mr David Dodge, Governor of the Bank of Canada, to the London Chamber of Commerce, London, Ontario, 8 December 2003. * * * Good afternoon, ladies and gentlemen. I’m happy to have this opportunity to visit the Forest City and to finally honour your long-standing invitation to address you. When giving a speech near the end of a year, it is common practice to look back over the past 12 months, consider what we have learned from the events and experiences of the year, and think a bit about what might lie ahead. I became Governor of the Bank of Canada in 2001 and, since that time, I have found myself saying at the end of each year, “Well, we won’t see another year like that again.” In 2001, we saw the bursting of the tech bubble and the 9/11 terrorist attacks in the United States. Last year, we had the fallout from Enron and other examples of corporate malfeasance, as well as the growing threat of war in the Middle East. And our currency dropped to an all-time low against the U.S. dollar. Not to be outdone, 2003 has also had more than its share of momentous events that had an impact on the Canadian economy. The list seems almost Biblical: war, pestilence, in the form of SARS and madcow disease, fires, floods, a hurricane, and a power outage. This year also brought another type of shock to keep Canadians preoccupied, and that is the sharp rise of our currency in foreign exchange markets. The Canadian dollar has jumped from under 64 cents U.S. at the start of the year to over 76 cents at the end of last week - an unprecedented movement. The Bank of Canada has closely followed the economic effects of all these events, including the rapid movement of the Canadian dollar. But to better understand what has happened in the economy over the past year or so, I will place my comments in the context of longer-term economic trends. The Adjustments of the 1990s Let me start by recalling the state of our economy as the 1990s began. Although inflation had come down from the very high levels seen in the early 1980s, it was still quite high by today’s standards. Several approaches had been tried to bring about an environment of low, stable, and predictable inflation. These included wage and price controls and the targeting of the money supply. But none of these methods provided a suitable medium-term anchor for inflation expectations. This made it difficult for individuals and businesses to form long-range plans with any degree of certainty. On the fiscal side, the picture was pretty grim at the start of the 1990s and getting worse. Public sector deficits would eventually peak at around 8 per cent of Canada’s GDP, and public debt levels were continuing to mount. Clearly, the situation was not sustainable. Adjustments were urgently needed. The first of these adjustments came in 1991, when the Bank and the Government of Canada agreed to adopt a series of explicit inflation-control targets. The agreement called for an inflation target-defined in terms of the annual rate of increase of the consumer price index - that descended gradually to 2 per cent, the midpoint of a 1 to 3 per cent range. That initial agreement has been extended three times, with the latest agreement covering the period to the end of 2006. In each case, the midpoint of the inflation-control target range has been kept at 2 per cent. This framework has worked well - better than might have been expected. By January 1992, inflation was already close to 2 per cent, and from the end of 1994 to today, inflation has averaged almost exactly 2 per cent. Moreover, not only has inflation fallen, it has become more stable. Indeed, the trend of inflation - as measured by what we call core inflation - has stayed within the target range almost continuously for the past 10 years. Just as importantly, we found that, after a few years of inflation targeting, the inflation expectations of Canadians fell into line with the 2 per cent target. And expectations have remained close to the target in recent years. The point of all this is that we have been successful in using monetary policy to create an economic environment of low, stable, and predictable inflation. With a credible monetary policy, the whole nature of the inflation process has changed. Inflation itself has become more stable and, in turn, this has led to a more stable and better-functioning economy. The second big adjustment began in earnest around the middle of the 1990s. As I said before, at that time, Canada was facing an unsustainable fiscal situation. Compounding this immediate fiscal problem were the looming challenges posed by our aging population. Spending had to be put on a viable long-term course, and the ratio of public debt to GDP on a steady downward track. By the middle of the decade, governments - federal and provincial - had begun to take the painful steps to balance their books and reduce their debt burdens. It did not take long for the benefits of those tough decisions to materialize. In most jurisdictions, the vicious circle of rising deficits and debts became a virtuous circle of balanced budgets and falling debt burdens. This fiscal adjustment helped Canada’s economic policy credibility and reduced the risk premium that investors demanded on Canadian government bonds. Not only did lower interest rates reduce debt-servicing costs, they stimulated economic growth, which brought in more revenues for governments. The federal government recently announced a sixth consecutive surplus in its budget. Our public pension plans are once again on a sound footing. The federal debt-to-GDP ratio has fallen to about 44 per cent, from close to 70 per cent at its peak. The ratio of total government liabilities to GDP has declined from a peak of about 100 per cent to about 80 per cent, according to the OECD. And Canada’s Triple-A credit rating has been restored. I don’t mean to suggest that inflation targeting and fiscal adjustments were the only factors behind Canada’s overall improved economic performance. Of equal importance was the difficult restructuring that had to be done in the wake of free-trade agreements in the 1990s. Businesses and employees made some difficult adjustments. None of this was easy, but it did leave Canada’s economy in a better position to grow sustainably and to handle economic shocks. Our economic record over the past few years, even in the face of all the events I have mentioned, is testament to that. Now, let me talk about the role of the Canadian dollar in this long adjustment process. On a day-to-day basis, there are a number of factors that can drive movements in the value of the Canadian dollar in foreign exchange markets. But my intention is to stick to a discussion of long-term trends. From this perspective, there were really two major factors at work on the currency in the 1990s. Governments were cutting spending to address their fiscal problems, and that led to a reduction in domestic demand. On top of this, commodity prices were down sharply in the second half of the decade. Historically, there has been a fairly strong correlation between the prices of non-energy commodities and the external value of the Canadian dollar. In the face of these two factors, Canada’s floating exchange rate did its job as a “shock absorber” for the economy. How? Given the tight fiscal policy of the time, the lower dollar - in the context of an easing in monetary policy - played an appropriate role in encouraging foreign demand for Canadian products at a time when domestic demand was weak. Further, while the lower currency cushioned the shock of falling commodity prices on resource producers, it also boosted the profitability of other sectors that were able to expand in the wake of free-trade agreements and strong foreign demand. This helped to facilitate the transfer of resources within the economy from sectors that were shrinking to those that were growing. The depreciating Canadian dollar of the 1990s also changed the relative price of labour and capital. At the time, there was a fair bit of excess labour in the economy, because of the structural adjustments that were taking place. The lower dollar raised the cost of machinery and equipment relative to labour. And that made it easier for some of the labour that was released by the shrinking sectors of the economy to be absorbed by those that were growing. Future Trends in the Economy That’s a quick look back at the 1990s. So what can we expect in the future? What are the major issues that we will have to grapple with in the coming decades? What adjustments will be needed? I don’t have a crystal ball, but a couple of issues seem fairly clear to me. As I already mentioned, the first important issue is demographics. The Canadian economy must prepare for the retirement of the baby boomers. Under current projections, Canada’s working-age population - those 15 to 64 years of age - will start to decline in about 15 years. Given this demographic outlook, there are two points to be made. The first is that we need to continue to lower our ratio of public debt to GDP. This will help to ensure that Canada will be able to support its growing elderly population. The second point is that we will need to make adjustments to help us deal with a labour force that will soon be shrinking in relative terms and, ultimately, in absolute terms as well. What kinds of adjustments? We will need to make sure that the older segment of the working-age population is not discouraged from participating in the labour force. But more importantly, we need to raise productivity if Canadians are to continue to enjoy rising incomes. It will not be easy to get those productivity gains. We will need to see greater investment in new, improved machinery and equipment. We will need to see more and better application of information and communications technology. We will need to ensure that our workers have the skills and receive the training they require to take advantage of productivity-enhancing technology. And we will need to improve business organization and practices, to fully exploit the potential of new technologies, and to minimize any barriers to their application in the workplace. Raising productivity will also require a major effort to ensure that our microeconomic policies facilitate innovation and higher productivity in both the private and public sectors in Canada. In thinking about our macroeconomic policies, we can’t assume that all the shocks are behind us. We have seen the buildup of economic imbalances recently, with large current account surpluses in Asia and a large current account deficit in the United States. And fiscal imbalances are growing in Europe and the United States. So how can the Bank of Canada help to prepare for the challenges ahead? Most importantly, we must stick with the monetary policy framework that we built in the 1990s. That means keeping our commitment to low, stable, and predictable inflation. And it means that our floating exchange rate will continue to be an important part of our monetary policy framework. This framework will continue to help the economy adjust to changing economic circumstances, both at home and abroad. Of course, exchange rates don’t always move as smoothly as desired or expected. Still, let me repeat what I have said many times before: having a floating exchange rate to facilitate economic adjustments is by far the best option for the Canadian economy. Recent Economic Developments Let me now turn to the current economic situation, starting with the outlook for inflation. As we noted in our October Monetary Policy Report, we expect that Canada’s inflation rate will fall over the next few months. The core rate of inflation - a measure that removes the eight most volatile components of the consumer price index - will likely move down close to the bottom of our 1 to 3 per cent inflation-control range early next year, before starting to move back up towards 2 per cent. On the Bank’s latest fixed announcement date last week, we decided to leave our key policy rate unchanged. In doing so, we noted a few developments that have altered our outlook since we published the Monetary Policy Report. Let me review some of them. At the end of November, Statistics Canada released its national accounts data for the third quarter. These data showed that Canada’s economy had grown at an annualized rate of just 1.1 per cent in the third quarter, a rate that was well below expectations. What’s more, there were downward revisions to growth in previous quarters. This meant that, at the end of the third quarter, there was more excess capacity in the Canadian economy than we had anticipated. In the Monetary Policy Report, we said that we expected the economy to close its output gap and return to its level of full capacity by early 2005. Closing the output gap over that period would be consistent with inflation returning to the 2 per cent target by mid-2005. But because we now know that the output gap is larger than we had expected in October, we also know that the economy will have to grow at a faster rate during the fourth quarter and through 2004 to close that output gap by early 2005. While growth earlier this year was disappointing, we are now seeing a number of encouraging signs suggesting that stronger growth will resume, beginning in the current quarter. I will mention three of those signs. First, while the overall growth rate in the third quarter was just 1.1 per cent, it should be noted that this figure was depressed because businesses met demand in large part from inventories. Final domestic demand grew quite strongly - by close to 6 per cent - thanks to healthy household spending and rising business investment. This investment bodes well for higher future production. And, with continuing employment growth, we expect household spending to remain robust. Second, the reduction in inventory investment is probably over. While this adjustment depressed growth in the third quarter, it should not do so in the fourth quarter. In fact, the completion of the inventory correction should contribute to growth in the fourth quarter. Third, Canada’s export sector should receive a boost from rising foreign demand, in particular, from the United States. Remember that the U.S. economy grew at an annualized rate of about 8 per cent in the third quarter, and Canadian exporters should see some benefit from this and from the continuing strong growth expected in the U.S. economy over the months ahead. Rising non-energy commodity prices should also be a boost to the economy. All told, the Canadian economy should be poised for solid growth ahead, beginning in the fourth quarter. We would expect economic growth in this quarter to be well above 4 per cent on an annualized basis. However - and let me stress this - the effect of the recent sharp appreciation of the Canadian dollar is a major uncertainty at this time. It is not clear to what extent the increase in foreign demand I have just mentioned will be offset by the effects of a stronger currency. Nor can we be sure that there is enough monetary stimulus in the economy to support the increases in household spending and business investment that would be required to return the economy to full capacity by early 2005. Some important economic data are expected between now and our next fixed announcement date, on 20 January. These should give us a better sense of how Canada’s export sector is doing, and how household spending went over the holiday season. We will be closely watching all the data ahead for evidence that the economy is growing at a rate solidly above the growth of potential. Conclusion This past year, like the two years before it, was full of “interesting” economic challenges for Canada and the world. It is tempting to hope that next year will be somewhat less “interesting” and bring fewer challenges. But regardless of what next year brings, what is critical is that we keep our eyes on the longer-term horizon and focus on the challenges ahead. These challenges include adapting to shifting demographics, raising productivity, and getting our microeconomic policy framework right. At the Bank of Canada, we remain committed to the sound monetary policy framework that will help us rise to tomorrow’s challenges. And that’s good news for all of us, no matter what the coming years may bring.	bank of canada	2,003	12
Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report Update, Ottawa, 22 January 2004.	David Dodge: Summary of the latest Monetary Policy Report Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report Update, Ottawa, 22 January 2004. * * * Today, we released our Update to the October Monetary Policy Report. The Update reviews economic and financial trends in the context of Canadaâ€™s inflation-control strategy. Three developments have led us to modify our outlook for economic growth and inflation in Canada, since our October Monetary Policy Report. These include: stronger-than-expected world economic activity, the continued sharp depreciation of the U.S. dollar against major world currencies (including the Canadian dollar), and a somewhat larger output gap in Canada at the end of 2003. Weighing these developments and their likely persistence, we lowered our projection of output in Canada over the next year and a half. In this context, we cut policy interest rates to support aggregate demand and thus return inflation to 2 per cent over the medium term. In Canada, economic growth in the period ahead will need to come primarily from private domestic demand, supported by monetary stimulus and by strong business confidence. We now project growth to average about 2 3/4 per cent in 2004, and to pick up to about 3 3/4 per cent in 2005. This would imply that the output gap would not change materially before the end of 2004, but would be substantially closed by the third quarter of 2005. We project that core inflation will fall below 1 1/2 per cent in early 2004, before gradually moving back to the 2 per cent target by the end of 2005. Total CPI inflation should remain below core inflation through 2005 if oil prices ease gradually from their current levels. The main uncertainties in the outlook relate to the adjustment of the Canadian economy to global changes. Canadian monetary policy facilitates the overall adjustment process by helping to sustain aggregate demand in Canada.	bank of canada	2,004	2
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Board of Trade of Metropolitan Montréal, Montréal, 11 February 2004.	David Dodge: Adjusting to a changing economic world Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Board of Trade of Metropolitan Montréal, Montréal, 11 February 2004. * * * Good afternoon, ladies and gentlemen. It’s a pleasure to be with you here in Montréal today. These are turbulent times, not just for business people, but for all Canadians. We have come through a very difficult year, a year filled with surprises that have challenged us all. At times like these, it is easy to focus on the near-term issues and problems. But by doing that, we risk losing sight of the big picture. The Bank of Canada had plenty to say about the near-term outlook in its Monetary Policy Report Update a few weeks ago. So today, I want to talk about the longer-term trends at work in the economy. In doing so, I want to take a quick look back at some of the major economic events of recent decades, and examine how we approached the issues of adjustment at the time. Then, I will discuss the adjustments that are needed now and in the future. In this way, I hope to draw on the lessons learned from the past. I will frame this discussion in terms of structural economic policies, macroeconomic policies, and the role of the exchange rate in facilitating adjustments. Previous adjustment policies I will start by going back to the 1970s. There were at least two forces at play that highlighted the need for economic adjustments. The first was a significant drop in the rate of productivity growth. Canada, like the United States, had become accustomed to productivity rising at a rapid pace during the 1950s and 1960s. With this growth in productivity came steady advances in real incomes. But the trend towards higher productivity slowed abruptly in the early 1970s. At the time, policy-makers, business, and labour assumed that the slowdown was cyclical. It wasn’t. Economists still don’t have a complete explanation for it. But what we now understand more clearly is that the productivity increases of the 1950s and 1960s had a lot to do with the application throughout the economy of earlier advances in general-purpose technology. Businesses took advantage of various technological advances in many diverse fields, enabling them to realize significant productivity gains. When productivity growth slowed in the 1970s, many people assumed that the slowdown was temporary and that rapid growth would resume on its own. This was a mistake. Without solid productivity gains, the economy was unable to deliver the increases in real incomes that everyone had come to expect. This situation was compounded by the second major event of the 1970s: the energy crisis. Unfortunately, we in Canada didn’t recognize the full implications of the energy crisis. We were slow to realize that higher oil prices also meant a reduction in the economy’s production capacity. Canadian policy-makers tried to cushion the impact of the higher energy prices and slower productivity through increased transfers, subsidies, and easier monetary and fiscal policies. For example, the Bank of Canada added to liquidity by expanding the money supply too fast in relation to the slower growth in the economy’s production capacity. In the wake of these structural and macroeconomic policies, inflation rose, and fiscal deficits grew. This slowed the structural-adjustment process in the late 1970s and early 1980s. All of this was made worse by the shared misperceptions about the productivity slowdown. Businesses, households, and governments all thought that economic growth would recover and that real incomes could continue to rise at their previous rate. But without strong productivity growth the economy could no longer satisfy these demands. But that difficult period from 1975 to 1985 taught us a lesson. We learned that structural adjustments are important and inevitable, and that macroeconomic policies have a role to play in making those adjustments work quickly and with less disruption. Canada had the opportunity to apply those lessons in the 1990s. Let me explain how. To begin, recall the state of Canada’s economy as the 1990s began. Although inflation had come down from the very high levels seen in the early 1980s, it was still relatively high by today’s standards. On the fiscal side, the picture was pretty grim and getting worse. Public sector deficits eventually peaked at around 8 per cent of Canada’s GDP, and public debt levels were continuing to mount. Clearly, the situation was not sustainable. Changes were urgently needed. The first major change came in 1991, when the Bank and the Government of Canada agreed on a series of explicit inflation-reduction targets. The agreement called for an inflation target - defined in terms of the annual rate of increase of the consumer price index - that descended gradually to 2 per cent, the midpoint of a 1 to 3 per cent range. The agreement has been extended three times, with the latest one covering the period to the end of 2006. Each time, the midpoint of the target range has been kept at 2 per cent. This framework has worked very well. From the end of 1994 to today, inflation has averaged almost exactly 2 per cent. Moreover, not only has inflation fallen, it has become more stable. Indeed, the trend of inflation - as measured by what we call “core inflation” - has stayed within the target range almost continuously for the past 10 years. More importantly, we found that, after a few years of inflation targeting, the inflation expectations of Canadians fell into line with the 2 per cent target. And expectations have remained close to the target in recent years. Another major adjustment began in the middle of the 1990s. At that time, Canada was facing an unsustainable fiscal situation. Spending had to be put on a viable long-term course, and the ratio of public debt to GDP put on a steady downward track. By the middle of the decade, governments - federal and provincial - had begun to take the painful but necessary steps to balance their books and reduce their debt burdens. This fiscal adjustment helped improve the credibility of Canada’s economic policies and reduced the risk premium that investors demanded on Canadian government bonds. Lower interest rates reduced debt-servicing costs and stimulated economic growth, which brought in more revenues for governments. The federal debt-toGDP ratio has fallen to about 44 per cent, from a peak of close to 70 per cent. The ratio of total government liabilities to GDP has declined from a peak of about 100 per cent to about 80 per cent, according to the OECD. The other major change in the 1990s was the structural adjustments that took place in the public and private sectors. In both cases, these adjustments were enormously helpful, because they made the Canadian economy more flexible. In the public sector, governments moved to reduce distortions in the economy, by eliminating many industrial subsidies, lowering income taxes, and putting the Canada and Quebec Pension Plans on a sustainable basis. Further, the government made changes to its system of unemployment insurance, basing the program more on insurance principles and improving the employability of labour. In the private sector, businesses and employees faced restructuring in the wake of free-trade agreements, as Canada opened up further to international competition. None of this was easy, but it did leave Canada’s economy more flexible, and in a better position to handle economic shocks and, therefore, to grow sustainably. Canada’s floating exchange rate helped facilitate the adjustments that were taking place on these various fronts. It helped by sending signals to businesses about the kinds of adjustments that were needed. Firms that produced traded goods and services, and that were able to take advantage of freetrade agreements and strong foreign demand, saw their profits increase. And because the depreciating Canadian dollar raised the cost of machinery and equipment relative to labour, businesses in expanding sectors of the economy were encouraged to absorb some of the excess labour that had been released by shrinking sectors. The floating exchange rate also helped on the macroeconomic side. The depreciating Canadian dollar in the late 1990s helped to encourage foreign demand, as demand from the government sector was being restrained. So you can see how these three factors converged in the 1990s to lay the groundwork for a stronger economy in the future. A sound macroeconomic policy framework, appropriate structural adjustments, and a floating exchange rate, all did their part to help the economy adjust to the changing circumstances of the 1990s. Economic adjustments in the future That’s a quick look back. Now, I’d like to talk about some of the longer-term forces we can expect to see at work in the economy in the years ahead and the economic adjustments that will likely be necessary. The first point I would make is that we have an opportunity in the next few years to again register solid productivity gains. This time, the information and communications technology sector is providing the general-purpose technologies that can drive sustained gains in productivity and incomes. Of course, the mere presence of technology is not enough to guarantee higher productivity. We also need investment, as well as training and organizational changes and flexibility. In the latter part of the 1990s, Canadians had begun to invest in these productivity-enhancing technologies. After a pause at the beginning of this decade, such investments seem to have resumed. These efforts are particularly important, especially in light of the serious demographic challenges we will face over the next few years. That is my second point: our workforce is aging. Current projections are that the share of the population that is of working age - those aged 15 to 64 - will begin to decline in about 15 years. We will need to take these population shifts into account, and to remove impediments for older workers who wish to remain in the labour force. The third point I would make is that there are powerful forces in the global economy that bear watching. The significant imbalances that we now see in the world’s current- and capital-account flows need to be corrected. Emerging markets, particularly in Asia, are becoming increasingly powerful players in the global economy. All these forces will have an impact on the Canadian economy in the years ahead. Against this backdrop, what kinds of economic adjustments will be needed in the future? Let me suggest a few. First, Canada’s economic structures must continue to adjust to changing circumstances. There will need to be more high-productivity activities in the economy and fewer low-productivity ones. But for significant gains in productivity to resume, governments must ensure that their microeconomic policies encourage flexibility and do not hinder innovation in the public and private sectors. Workers will need to have the training and skills to take advantage of new technologies. And businesses will need to ensure that their organizations and practices allow the potential of new technologies to be fully realized. Second, Canada must keep its fiscal house in order. Canada’s ratio of public debt to GDP will need to decline further. This will free up more resources to help us support our aging population. At the same time, this implies that governments at all levels will be keeping their budgets more or less balanced, if not in surplus. What about monetary policy in the future? In the Bank’s Monetary Policy Report Update last month, we said that the role of monetary policy is to facilitate adjustments by helping to sustain aggregate demand. What does this mean? As always, it means that we will aim to return inflation to its 2 per cent target, by trying to keep the economy operating as close as possible to its full production capacity. That is our constant goal. But it also means that we will be aware of the forces that are driving adjustments in the economy in the years ahead. We know that, with a stronger currency, the economy will have to rely more on domestic demand and less on foreign demand for ongoing, solid growth. We will take this into account as we set monetary policy. This leads me to my last point, which concerns the exchange rate. A floating exchange rate will continue to be an important part of our monetary policy framework, facilitating the necessary adjustments and sending important price signals. Canadian businesses should continue to be guided by price signals, including those being sent by exchange rates. Just as businesses reacted to the signals of a weaker Canadian dollar in the 1990s, they should now respond to the signals of a stronger currency against the U.S. dollar, as well as to the changing exchange rates against other currencies. A stronger Canadian currency is consistent with the adjustments that are going to be needed in our economy, even if the speed of the recent appreciation has made these adjustments more difficult. Because it makes machinery and equipment less expensive relative to labour, a stronger currency is in line with our need to increase productivity, as well as with the future demographic pressures on our labour force. A stronger currency is also consistent with the increase in commodity prices relative to those of manufactured goods and services. And it increases the price of non-tradable goods relative to that of tradable goods. This should encourage the shifting of labour and capital into those sectors that are oriented to meeting domestic demand. We are already seeing signs that Canadian businesses are indeed adjusting to the stronger dollar. Each quarter, the Bank of Canada surveys Canadian firms about the state of their business. Recent surveys show that Canadian firms are reasonably optimistic about the future. Obviously, the appreciation of the Canadian dollar has affected different companies in different ways. In particular, some manufacturers who have not benefited from rising commodity prices have struggled to adjust. But most firms are acting to raise productivity, as well as cutting costs, adjusting supply chains, and hedging their currency exposure, among other efforts. Those businesses that have been helped by the stronger currency are also adjusting, by lowering prices, strengthening their balance sheets, and in some cases, increasing productivity. Information from the Bank’s latest survey can be found on our Web site. Our surveys, as well as those conducted by the Export Development Canada and the Conference Board of Canada, suggest that business investment will increase. I can appreciate that making some of these adjustments is not easy. For many firms and employees, it can be a painful and difficult process. But in today’s world, not adjusting is not an option. Fortunately, thanks to a sound economic policy framework, we have a relatively favourable climate in which to take these necessary steps. Many elements currently support investment: inflation remains low, stable, and predictable, and credit conditions are favourable. Business confidence and balance sheets are strong, and equity markets are performing well. Conclusion Let me close by talking about the lessons we can learn from the past. To me, the key points are clear. Economies must have the flexibility to adjust as circumstances change. This means having the right structural policies in place, as well as appropriate macroeconomic policies. Along with the right economic policies, a floating exchange rate will help the economy make adjustments more smoothly. All of us, whether as economic policy-makers or business people, must be quick to recognize the need to adjust. We ignore economic realities at our own peril. When adjustments are too slow, the economy suffers. When inappropriate policies are followed, the damage can take years to undo. But when the right adjustments are made quickly, the whole economy can benefit. As business people making your own adjustments to future economic challenges, you can count on the Bank of Canada to pursue the appropriate monetary policy to help you get on with the job.	bank of canada	2,004	2
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Mexican Business Coordinating Council, Mexico City, 17 February 2004.	David Dodge: Policies for changing times Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Mexican Business Coordinating Council, Mexico City, 17 February 2004. * * * Good morning. I am glad to have the opportunity to meet with business leaders in Mexico today. I am also glad to have this opportunity to meet with our colleagues at the Banco de México. Our two central banks have had a long and fruitful relationship, one that includes swap facilities, joint research, and close consultations. I believe that public servants and business leaders in Canada and Mexico have a great deal in common and much to learn from one another. Indeed, in many ways, Canada and Mexico are partners. We share common issues and challenges. We both share borders with the United States, the most important export market for each of us. Both Canada and Mexico have recently faced setbacks in cross-border trade with the United States. These stem not only from weaker U.S. domestic demand, but also from specific trade problems and from border-crossing delays associated with tighter security. We have both been affected by the slowdown in the world economy and by global economic imbalances - although the impact of these factors appears to have been somewhat less in Canada than in Mexico over the past three years. And we are both working on the structural adjustments that are necessary to weather shocks and to thrive in a changing environment. Today, I want to focus my remarks on Canada’s adjustment to global economic changes. I will talk about our efforts to adjust to longer-term economic forces and about our challenges in this regard. And I will talk about some of the lessons that we have all learned during the past couple of decades. Policy-makers in both Canada and Mexico have drawn on these lessons to improve our macroeconomic policy frameworks, and thus to better manage and adjust to change. I will conclude with some thoughts about how Canada and Mexico can continue to adjust to the economic changes that face us in the future. The most important lesson that we have all learned is that structural adjustments are key in adapting to change, and that macroeconomic policies have a role to play in making those adjustments with a minimum of economic and social disruption. Past adjustments Canada has experienced two periods in recent decades when significant economic adjustment was required. The first was during the 1970s, when we were hit by a rapid slowdown in productivity growth and by the effects of the oil crisis. Policy-makers in Canada used macroeconomic and microeconomic policies to try to cushion the economy from the impact of those events. As a result, our adjustment was slower and more painful than it needed to be. We ended up with a weak economy, high inflation, and large government budget deficits. The lesson that Canadians learned from this period is that macroeconomic and microeconomic policies must be clearly focused on facilitating adjustment to economic change. By the beginning of the 1990s, it was clear to us that we needed a framework of policies to help with that adjustment, to bring down inflation, and to put our public finances in order. The first major change came in 1991, when the Bank and the Government of Canada agreed on a series of explicit inflation-reduction targets. The agreement called for an inflation target that would gradually reduce the rate of inflation to 2 per cent, the midpoint of a 1 to 3 per cent range. The agreement has been extended three times, with the latest one covering the period to the end of 2006. Each time, the midpoint of the target range has been kept at 2 per cent. This framework has served us very well. Since the end of 1994, inflation has averaged almost exactly 2 per cent. Moreover, not only has inflation fallen, it has become more stable than it was in the 1970s and early 1980s. Just as importantly, we found that inflation expectations quickly fell into line with the 2 per cent target. And expectations have remained close to 2 per cent in recent years. One of the most important consequences of adopting a system of inflation-control targets is that we at the Bank of Canada can now explain more clearly to business, to labour, and to the general public what we are doing and why. One should not underestimate the benefits that arise from having the public understand the policies and actions of its monetary authority. This understanding makes the conduct of monetary policy easier, and gives citizens a measure by which to judge the performance of their central bank. While no single mechanism is perfect in this regard, our experience suggests that the outcomes of monetary policy are better with a clear, well-understood framework. The second major adjustment that we had to make in Canada was to get our fiscal situation under control. In the early 1990s, the combined federal and provincial deficits were running at about 8 per cent of GDP. This was clearly unsustainable. And so between 1993 and 1997, governments in Canada made a determined, and successful, effort to eliminate their deficits. This fiscal adjustment helped improve the credibility of our economic policies and reduced the risk premium on Canadian bonds demanded by investors. Canada’s economy, like that of Mexico and many others, also underwent structural adjustments in the 1990s, in both the public and private sectors. These adjustments were enormously helpful, because they made the Canadian economy more flexible. Governments moved to reduce distortions in the economy by eliminating many industrial subsidies, reducing personal income taxes, and reforming the unemployment insurance system. At the same time, enterprises responded to the challenges of trade liberalization by improving the quality of their products and marketing them aggressively to new North American customers. These adjustments were not easy. But they did leave Canada’s economy in a better position to handle economic shocks and, therefore, to grow on a sustained basis. Canada’s floating exchange rate helped facilitate these structural adjustments. The depreciating Canadian dollar in the late 1990s encouraged foreign demand, which helped to compensate for reduced demand from the government sector. It also helped by sending signals to businesses about the kinds of adjustments that were needed. In sum, a sound macroeconomic policy framework, appropriate structural adjustments, and a floating exchange rate all did their part to help Canada’s economy adjust to the changing circumstances of the 1990s. While these adjustments were difficult, the payoff came quickly. By the end of the decade, Canadians were beginning to see higher real incomes. International forces So that’s a quick backward look. Let’s now consider the ongoing international forces at work in our economies. Both Canada and Mexico are going to need to increase productivity in the face of fierce competition from China and other lower-cost countries. Indeed, it is clear that all countries are going to have to find ways to become more competitive. In Canada, we have an opportunity in the next few years to again realize solid, steady productivity gains, thanks to past investments in information and communications technology. Of course, technology alone is not enough to guarantee higher productivity. To actually realize productivity gains, enterprises must make the necessary investments and organizational changes. And they must train their staff to use technology to its best advantage. Other forces in the world economy bear watching. These include significant imbalances in global current- and capital-account flows. And new players, particularly in Asia, are becoming increasingly powerful in the global economy. As I’ve mentioned, that increases the competitive pressure facing our manufacturers. But it also means new, fast-growing sources of demand, and new opportunities. Adjustments in the future In the face of all of these forces, what kinds of economic adjustments will be needed in the future? Let me speak about the adjustments that we in Canada will have to make. First, our economy will need more high-productivity activities. For significant gains in productivity to resume, governments must ensure that their microeconomic policies encourage flexibility and do not hinder innovation in the public and private sectors. Canada already benefits from an educated and skilled labour force. Nevertheless, workers must continue to have access to the training they need to take advantage of new technologies. And businesses need to ensure that their organizational structure and practices allow them to realize the potential of these new technologies. Second, Canada, like Mexico, must keep its fiscal house in order. As I have said, we have made great strides in reducing our ratio of public debt to GDP. That ratio will need to decline further to give Canada the flexibility to meet the demands of our aging population. Third, we must provide the appropriate microeconomic policies with regard to labour markets, intellectual property law, environment, and foreign investment, among others. Fourth, we must ensure that our social policies strike a balance between facilitating the adjustments that need to be made and supporting those members of our society who are displaced by structural adjustment. Fifth, I believe that it is crucial that Mexico and Canada continue working together, and with our U.S. partners, to make NAFTA even more successful. And the benefits we have seen from NAFTA should strengthen our resolve to see freer trade globally. We need to continue to work towards reduced trade barriers at the Doha round of multilateral trade negotiations. It won’t be easy, but the long-term economic benefits will make our efforts worthwhile. What is the role of monetary policy in all of this? As always, it is to facilitate adjustments by helping to maintain the balance between supply and demand in our economies. For the Bank of Canada, this means that we will aim to maintain inflation near 2 per cent by trying to keep the economy operating as close as possible to its full production capacity. That is our constant goal. But it also means that, at the same time, we will be aware of the longer-term forces that are driving adjustments in our economy. In Canada, we know that, with a stronger currency, the economy will have to rely more on domestic demand and less on foreign demand for ongoing, solid growth. We will take this into account as we set monetary policy. Both Canada and Mexico have, as a critical element of their monetary policy frameworks, a flexible exchange rate. This gives monetary authorities the ability to set monetary policy tailored to our own domestic economic circumstances. A floating Canadian dollar, or floating Mexican peso, facilitates the necessary economic adjustments and sends important price signals to economic participants. Conclusion Let me conclude. For many firms and many employees, we know that adjustment can be painful and difficult. But in today’s world, not adjusting is not an option. Fortunately, in both our countries, we are making these adjustments under relatively favourable conditions. Global demand is strengthening, and credit conditions are good. We have a better knowledge of what we need to do. And we have made important progress in strengthening our macroeconomic frameworks. The challenges that we will face make it even more important that we continue to strengthen our policy frameworks in order to adjust to changing circumstances and to take advantage of potential gains. The faster we are able to adjust, the greater the wealth we can create for our citizens. That is not to say that adjusting will be easy. Indeed, the experience of recent decades proves that it can be difficult, at least over the short term. But if we take the leap, and seize the opportunities that change will bring, our societies will surely benefit.	bank of canada	2,004	2
Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the Senate Banking, Trade and Commerce Committee, Ottawa, 20 April 2004.	David Dodge: Recent review of the Canadian economy Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the Senate Banking, Trade and Commerce Committee, Ottawa, 20 April 2004. * * * Good morning, Mr. Chairman and members of the Committee. As always, we appreciate the opportunity to meet with you twice a year, following the release of our Monetary Policy Report. These meetings help us keep Senators and all Canadians informed about the Bank’s views on the economy and about the goal of monetary policy and the actions we take to achieve it. The Canadian economy continues to adjust to developments in the global economy such as stronger world demand, higher commodity prices, and the realignment of world currencies, including the Canadian dollar. Emerging-market economies, especially China and India, are contributing to intensified competition but are also creating new trading opportunities for Canada. These developments require shifts in activity among sectors and create a need for adjustments by many businesses. Monetary policy is facilitating these adjustments by supporting aggregate demand, with the goal of keeping the economy near its full production potential and inflation on target. When Paul and I appeared before this Committee last October, we told you that economic growth in Canada was weaker than expected and that there was more slack in the economy than we had projected six months earlier. As you know, the Canadian economy was affected by a number of shocks in 2003. Thus, despite a broadening of the global economic recovery and higher commodity prices, it turned out that the economy at the end of the year was operating well below the level that we had projected in our October Report. Preliminary indications are that growth in the first quarter of this year was marginally below 3 per cent. Thus, the Bank’s view is that the economy is still operating significantly below its potential. Our outlook for economic growth and inflation is essentially unchanged from that of the January Monetary Policy Report Update. The economy is expected to grow by about 2 3/4 per cent in 2004, picking up to about 3 3/4 per cent in 2005. This stronger growth is expected to come from private domestic demand, reflecting the current monetary stimulus in the economy and high levels of business and consumer confidence. Such growth would return the economy to close to its production potential by the third quarter of 2005. Core inflation - which removes the most volatile components of the consumer price index and the impact of indirect taxes on the remaining components - should average 1 1/2 per cent over the remainder of this year. As excess supply in the economy diminishes, core inflation is expected to move back to 2 per cent by the end of 2005. The main uncertainty for the outlook continues to relate to how the Canadian economy adjusts to global developments. Overall, the risks to the outlook appear balanced. Mr. Chairman, Paul and I will now be glad to answer the Committee’s questions.	bank of canada	2,004	4
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Conference on Financial Services and Public Policy, Schulich School of Business at York University, Toronto, Ontario, 22 April 2004.	David Dodge: Research in financial services and public policy - filling the gaps Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Conference on Financial Services and Public Policy, Schulich School of Business at York University, Toronto, Ontario, 22 April 2004. * * * Good evening, ladies and gentlemen. It gives me great pleasure to open this important conference on research in financial services and public policy. In his invitation to this event, my former colleague, Fred Gorbet, referred to the need for “highly focused academic research in Canada on the linkages between public policy and financial services.” I certainly concur with this assessment, and so I am happy to be a participant here today. For five years, the research program here at Schulich has helped to support and nurture a Canadian academic community focused on financial services. In doing so, the program has encouraged researchers to fill the gaps in our knowledge and help policy-makers and regulators to do a better job. After five years, it's useful to think back and recall the motivations for establishing this program in the first place. It goes without saying that the economy works better when a country's financial services sector is as sound and as efficient as possible. And the importance of promoting soundness and efficiency was certainly highlighted by the events of the late 1990s. Five years ago, the global economy was emerging from the Asian and Russian financial crises, and the near-collapse of Long-Term Capital Management. During these events, we saw that financial markets are a key channel through which crises can spread. And among the countries most affected, we saw that one common element was a weak banking system. So one clear lesson to be learned was that the strength of a country's financial system is crucial. This is particularly true in times of stress, because a strong financial system gives an economy a better chance of making necessary adjustments, before a stressful economic situation turns into a full-blown crisis. It may be tempting to look at today's relatively benign economic and financial environment and conclude that the urgent need to strengthen financial systems has passed - tempting, but wrong. Now is precisely the time to get the work done, when there is considerable liquidity in the global system, and interest rates and spreads around the world are low. Because, at some point down the road, there will be less liquidity, and interest rates and spreads will be higher. So if we wait, the task will only become more difficult. It may be a cliché to say that we should fix the roof when the sun is shining, but the point is valid. During the past five years, other events have also underlined the importance of the research you are doing here at Schulich. Following the collapse of Enron, and in the wake of other scandals, we have heard a great deal about corporate governance, transparency, and accountability. As businesses and policy-makers address these issues, we all need to understand how current rules are affecting the efficiency and stability of the financial sector, and how any proposed new rules will do so in the future. Regulators must always keep in mind that their actions may have unintended consequences, thus making the solution worse than the problem they were trying to correct. The Bank of Canada has been a source of funding for the research program at Schulich since its inception. It is fair to ask why the Bank cares so much about financial services and public policy research. Our interest stems from our mandate to further the economic and financial welfare of Canada. There are several ways that we do this, and the work that you do here has relevance for all of our roles. The most high-profile way that we promote the economic well-being of Canadians is, of course, through the conduct of monetary policy. We know that the financial sector and financial markets are at the heart of the transmission mechanism for monetary policy. And we know that monetary policy is more effective when markets function well. So it is absolutely critical that the Bank understand the financial sector and the markets as thoroughly as possible. We also promote Canada's economic well-being through our role as lender of last resort. We have a mandate to oversee those payment, clearing, and settlement systems that have the potential to pose systemic risk. And we have a less formal, but still important, role in providing advice to the Department of Finance on financial sector policies. In all of these areas, it is clear that we have a strong interest in promoting sound institutions, efficient financial markets, and well-functioning systems to support them. Of course, financial markets and institutions play a critical role in the economy by serving borrowers and savers, and by bringing about the efficient allocation of credit. But the financial sector itself is an important contributor to economic growth. So policy-makers also have an interest in providing a framework that will allow our financial institutions and markets to compete in an increasingly globalized world. With global standards evolving rapidly, Canada must be at the forefront in terms of efficiency and soundness. One thing that the Bank can do is to help policy-makers and financial service providers have the best available research at their disposal. Indeed, in our most recent medium-term plan, the conduct and promotion of leading-edge research was identified as one of the Bank's strategic priorities. Of course, the Bank does a significant amount of research in-house. We have established an ambitious research program for 2004 and beyond. It includes such topics as how to improve our economic modelling, how regulatory initiatives and frameworks can help or hinder financial markets and institutions, and an investigation into the effects of various types of asymmetric information on capital markets. We are proud of the work that we do. But we recognize that we can't do it all ourselves. There will always be large gaps in our research program. And we recognize that our research, and the research that is being carried out in universities, can be mutually strengthened through collaboration. And so we promote good research by actively collaborating with academics and seeking out partnerships. Finally, we try to inform others of what we are doing by publishing working papers and summarizing our work in our semi-annual Financial System Review. And we post a summary of our research program on the Bank's Web site annually. We also know that good research requires good data. There is a widespread need for better data on the Canadian financial system, and the Bank has begun to seek out data sources through its Financial System Database Project. We know that pulling together more complete sources of data about financial institutions, financial markets, and payment, clearing, and settlement systems, will not be simple. Indeed, it will be a complex and costly project, and one where collaboration with external partners will be necessary, and enormously helpful. If we co-operate and build the databases properly, we can all share in the benefits. This is a priority for the Bank, and I would be happy to hear your suggestions on the best way to proceed with this ambitious project. That is an explanation of why we care about your work. Now let me take the opportunity - given this audience - to expand upon some of the areas where we at the Bank of Canada would like to see more research done. I will organize my remarks by talking about the three areas I have already mentioned: financial institutions; financial markets; and payment, clearing, and settlement systems. Within each area, I will raise a number of questions. What I want to do is to stimulate ideas, in the hope that some of you may be inspired to continue to probe into these issues. Where research is needed Financial Institutions. Over the past 15 years or so, regulators and policy-makers have been working hard to improve the soundness of financial institutions. Clearly, this is important and necessary work. But in carrying it out, we must always strive for a balance. That balance is between maintaining and strengthening the key elements of regulation and supervision that promote appropriate risk management, and the necessity to promote efficiency by keeping compliance costs to a minimum. So the question that can be asked is, How do regulators best encourage good risk management without unduly discouraging risk taking and without stifling innovation? Rather than putting the emphasis on compliance with a vast number of detailed rules, it seems to me that the goal of the regulator should be to encourage financial institutions to identify and measure the true nature of the risks being taken, and to see that methods are being developed to mitigate these risks. Policy-makers and regulators do not want to discourage appropriate risk taking to the point where incentives are created for appropriate risk-taking activities to move outside the regulated financial system. Given the development of a wide range of new financial instruments and the exponential growth in their use, the need to find this regulatory balance is becoming more and more acute. It is certainly true that through these instruments, banks have become better able to manage risk by shifting some risks to others. But as banks do this, the question arises, Where do these risks ultimately reside? And are the bearers of these risks able to manage potential losses in times of economic stress, so that the financial system is ultimately more stable? The evolution in accounting standards also has many implications for financial institutions and markets. Does compliance with some of our accounting rules lead to large swings in reported earnings that do not reflect the true economic state of a firm? If we are to use fair-value accounting, how do we ensure that both assets and liabilities are correctly and equally marked to market? And we need to understand how particular elements of accounting rules can affect the risk-taking behaviour of financial institutions and investors. The issue of the right regulatory balance can also be looked at in relation to questions about the most efficient structure of financial institutions. This relates to the powers of institutions to do business, the types of business lines that can be offered by a single institution, and the corporate structures of institutions. As we approach the quinquennial review of the Bank Act in 2006, now is the time for researchers to be making their contributions to these areas. Financial Markets. Let me now turn to financial markets. This is one area where considerable research has already been done, particularly in equity markets, and we now know more about how markets work than we did in the past. However, markets are constantly evolving, driven by technological and other forces. Given this, policy-makers and regulators should always be asking a basic question, while providing reasonable protection against inappropriate conduct and minimizing systemic risk, are we still allowing sufficient incentives for markets to innovate, develop, and become more efficient? Let me give you some concrete examples. Are there inefficiencies in the way that our markets provide financing for Canadian firms? Specifically, is there something about the structure of our markets that leads non-investment-grade issuers to go abroad for their long-term debt financing? Or are our banks remarkably efficient in providing longer-term capital through their corporate loan business? Or are other instruments, such as income trusts, providing a substitute mechanism? To begin to answer those questions, we need to have answers to even more basic questions, such as, What determines the cost of capital, and how does the cost of capital in Canada compare with that in other countries? Exactly how do Canadian firms access capital? And are there particular market impediments here in Canada that small and medium-sized issuers are facing? Again, we know much more than we used to in these areas, but our knowledge is still far from complete. One particular cost-of-capital issue that we have been investigating is related to the so-called “Canadian discount” - the fact that firms listed only on Canadian exchanges tend to have lower price-to-earnings ratios than comparable U.S. firms or Canadian firms listed on U.S. exchanges. This increases the cost of raising equity capital and may interfere with the ability of Canadian financial markets to provide the most efficient match between issuers and investors. Whether the source of the discount is a matter of perception or something more substantial, we need to understand the forces that are causing it. If policy-makers are to find the best ways to promote market efficiency, they need a better understanding of market microstructure. They need answers to questions such as, How do transparency and liquidity affect the cost of capital? How do different structures affect the optimal rules for transparency and liquidity in each market? Is the Canadian situation unique? And what lessons can be learned from the experiences of other countries? The Bank recently held a workshop on these and related topics, with input from many financial market participants. A summary of this workshop will appear in our next Financial System Review. Market microstructure will continue to be an important area of research at the Bank and, I hope, in the Canadian academic community as well. Payment, Clearing, and Settlement Systems. So far, I've talked about issues related to the architecture of the financial system. But as researchers, it is also important to pay attention to the plumbing - the critical infrastructure that supports the activities of institutions and markets. So let me ask a few questions regarding payment, clearing, and settlement systems. As I mentioned, the Bank of Canada is responsible for the oversight of those systems that have the potential to pose systemic risk. Of course, financial service providers are major participants in these systems. At the Bank, one major research project involves efforts to model payment, clearing, and settlement systems so as to better understand how they work. Further research into the best oversight processes for these systems is also a priority. While the Bank's objective is to see that risks are minimized, we need to do so in ways that do not unduly inhibit the development of even more efficient systems. Do any current practices create unnecessary inefficiencies? What issues are raised by the current drive towards straight-through processing? How can cross-border clearing and settlement be improved, particularly where the ownership of securities and the posting of collateral are involved? Conclusion As you can see, there are still many questions that need to be answered. There are still gaps in our knowledge, and the need to fill these gaps is pressing. You, as academics and researchers, can do your part so that policy-makers, supervisors, and institutions are all better informed and more productive. As I said earlier, Canada's economic health depends on a strong financial services sector. So your work is crucial, not just for the Bank of Canada, but for all Canadians. I hope that I have been able to convince you that there are many research topics that are not only inherently interesting for academics, but relevant for public policy. I look forward to you filling the gaps in our knowledge.	bank of canada	2,004	4
Remarks by Mr David A Dodge, Governor of the Bank of Canada, at the Town Hall Meeting, Ottawa, 18 May 2004.	David A Dodge: The Bank of Canada’s commitments to Canadians Remarks by Mr David A Dodge, Governor of the Bank of Canada, at the Town Hall Meeting, Ottawa, 18 May 2004. * * * Good morning everyone and welcome. Welcome also to those of you joining us by videoconference. Today’s gathering is very important, so I’m glad you have taken the time to attend. Before I begin I want to say hello to the members of the Management Forum and Executive Management Committee who are with us today. These Town Halls are becoming a bit of a springtime tradition. The snow melts and the time comes for us to get together. We take stock of where we are, where we’re going, and how we want to get there. As you know, many institutions, both governmental and private, are currently concerned about governance structures, accountability and rules of behaviour. Of course we focused on these issues a couple of years ago when we established our Compass. And it’s our Compass I’d like to focus on now. It is an amazing document. I think it captures the essence of who we are. And one of the truly great things about it is how it came to be. Creating the Compass was a comprehensive exercise. It was top down, bottom up and side to side. Staff had an opportunity to take part in the consultation, debate, and careful consideration that went into the making of it. Together, we produced a remarkable set of commitments to Canadians, to excellence, and to each other. We really don’t need to worry about producing something new. But it is useful as we get together, to remind ourselves of what it is that we created. Our commitment to Canadians placed our legislated mandate into very concrete terms. Canadians need to have confidence in the value of the money they earn and the quality of the bank notes that they carry around. They need to have confidence in Canada’s financial system. They want to know that the Bank is managing the government’s funds with integrity. And that we are communicating and being accountable for what we do. When we say we are committed to Canadians, we’re saying we’re committed to fostering their confidence in our integrity as a central bank. Our second commitment is to excellence. It reflects the high standards we set for ourselves in our work on behalf of Canadians. It goes hand in hand with the statement we made when we launched the Compass and the Medium Term Plan. Namely: that we are committed to performance that is second to none among the central banks of the world. It was a challenging goal then, and it still is. But we’re getting there. We’re doing outstanding work in monetary policy; I’m very proud of the way we have continued to meet our inflation control targets. In the area of currency we’re producing new bank notes in the Canadian Journey series. The new $100 bill represents the first of three new notes being issued this year; notes that are designed to be secure, durable and well-accepted. Here at the Bank we are fostering an ongoing atmosphere of trust, respect and innovation through our strong system of values. We continue to place a strong emphasis on research and analysis in all aspects of our work. How else is our commitment to excellence in evidence? There are the partnerships we are cultivating both within and outside the Bank. We are communicating clearly and openly. We are nurturing leadership at all levels. And we are cultivating diversity, both of people and of ideas. Together, in all of these ways, we have been achieving excellence. The third commitment we made was to each other. We were clear that we wanted our work environment to be founded on a strong set of values. The first of these is that we articulate our own ideas and listen to those of others. We agreed to share knowledge and experience so that we could all learn from each other. Then, there was a pledge to develop our talent and careers to achieve personal excellence. Your own development, of course, has always rested first and foremost with you. But the Bank has been providing some of the impetus, and helping to create an environment that is conducive to learning and growing and an environment where the two official languages are used interchangeably. “Knowledge sharing” is vital to our organization. I hope that together we can progress further in making the Bank a true knowledge-sharing institution as we complete our medium-term plan. And while the Bank is encouraging you to excel by developing yourself, there is also the recognition of the fact that you have a life outside the Bank. We committed ourselves to working in an environment where each employee is respected. When we respect each other as individuals, then we can have the kind of debates that we need to help us become the best we can be. We can have clashes of ideas secure in the knowledge that there are no winners or losers. Or rather, that we’re all winners, because what we’re doing is exploring all aspects of an issue. And finally, we said we would recognize those who demonstrate our commitments. I encourage you to continue to think about ways that you can recognize people in your areas who live these values. We need to celebrate their successes. We need to share their ideas. That was the direction we laid out. Three strongly stated commitments, and a number of simply stated values intended to help us meet them. I was impressed by the Compass when it was written, and I’ve been impressed by how well we are all living by it. You showed real leadership in making this strong statement about who we are and what we stand for. The Compass serves us well. But as you know, with today’s emphasis on corporate governance and accountability, other organizations, both private and public, are now searching for ways to achieve what we have already achieved. Many of these organizations are setting about doing this by putting in place a set of highly detailed rules to constrain behaviour. But I am sure that a lot of highly detailed rules is not the answer for us. I don’t think we need much more than the Compass. I think, to a large extent, it is a part of us now. And I think the proof of that is that integrity - your integrity - is clearly one of the towering strengths of this institution. So I don’t think we need a lot of new rules to govern our behaviour. And where we do need more explicit guidelines and procedures, I’d like us to tread rather lightly. But I do want to say a couple of words today about two particular areas: disclosure of wrongdoing and conflict of interest. First, let me deal with disclosure of wrongdoing. We have had a policy for some time now, but we on the Executive Management Committee thought it was important that we also have procedures that conform more generally with procedures that the government of Canada is proposing. I encourage you to examine those procedures closely; if you have any questions, please talk to your manager. The second point I wanted to make was regarding our conflict of interest policy. The sign-off we all do here is important. Not because anything wrong is going on, but because our policy helps ensure that we don’t run into these kinds of conflicts. So we do have, as an organisation, a few things in place beyond the Compass. But the Compass is what I always find myself coming back to. Practically everything we need is in there. And it’s a respectful document. It gives each of us the responsibility of exercising good judgment. And more importantly, it says that we trust each other to do so. I’m really proud to be in an institution where we can operate that way. And the fact that we can is something I believe each of you should take pride in. Because, let’s face it, it’s not something that happened by itself. It’s not a coincidence. It was your ideas that shaped the Compass. And it’s no coincidence that the Compass is even more relevant today than when we put it together. So, congratulations not only for creating it, but for living by it.	bank of canada	2,004	6
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Hamilton Chamber of Commerce, Hamilton, Ontario, 16 June 2004.	David Dodge: The changing world economy - what it means for Canada Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Hamilton Chamber of Commerce, Hamilton, Ontario, 16 June 2004. * * * Good afternoon. I am very glad to be in Hamilton today. This city has undergone tremendous change over the past couple of decades, and it’s certainly exciting to see the revitalization efforts taking place here. And now, Hamilton is working to diversify its economic base. It’s obvious that adjusting to change is not a new thing for Hamiltonians. The same is true of the Canadian economy, which must always adjust to changing domestic and world circumstances. During 2003 and so far this year, some of those adjustments may have felt more like overhauls, particularly for some manufacturing firms here in Ontario. One of the most important changes that we have all seen since 2002 has been the realignment of major currencies in the face of global trade imbalances. This has been driven primarily by weakness in the U.S. dollar against other currencies, including our own. A second change has been the weaker demand for Canadian exports in 2002 and 2003. In addition to the exchange rate effects, some of this weakness has been linked to growing competitive pressures arising from the rapid integration of China and, to a lesser extent, India, into the global economy. These countries are becoming increasingly important exporters and importers of a wide range of goods and services. Third, last year, the Canadian economy faced a number of specific domestic shocks, such as SARS, mad-cow disease, floods, fires, and the power blackout in Ontario. All of these developments since 2002 have left us with an economy that is operating below its production potential. I’ll come back to Canada’s specific economic outlook later on. But I’ll spend the bulk of my time today discussing the major changes that are taking place in the global economy, and how Canada is adjusting to this new environment. I will also talk about how the macroeconomic framework we have developed in Canada during the past couple of decades gives us more flexibility to adjust to global economic shocks and to embrace the new opportunities that change brings. The only constant is change We’ve all heard the old saying that the only thing we can be sure of is change. And we have certainly seen sweeping changes in the world economy over the past 20 years. Today, we are seeing significant swings in the balance of economic power, as large emerging markets have opened up to trade. But let’s remember that integrating new regions of the world into the international trade order is not a new phenomenon. Since the early nineteenth century, various countries have emerged at different times as major forces on the international economic scene. After the Second World War, the world trade order, which had broken down in the 1930s, had to be rebuilt. The war-torn countries of Western Europe were slowly reintegrated back into that order. Through the 1950s and 1960s, Japan re-emerged as a major economic power. Then Korea took off in the 1970s, followed by other so-called “Asian tigers” during the 1980s and 1990s. Now, it’s China’s turn. And India is not far behind. What makes the ascent of China and India different from that of other countries is their sheer size. Together, these two countries represent close to 40 per cent of the world’s population. Their combined economies, measured on the basis of purchasing-power parity (which compares economies by equalizing the purchasing power of their currencies for a similar basket of goods and services) add up to more than 85 per cent of the U.S. economy. In fact, by that measure, China’s economy is the second largest in the world, after that of the United States, and India’s is fourth, after Japan’s. Their influence is intensifying the competitive pressure facing producers in other countries, including Canada. But it also means new, fast-growing sources of demand and new opportunities for us. Let’s remember that some of the early emerging-market economies have become important markets for Canadian goods and services. The integration of China and India into the world trade order is taking place as other emerging-market economies, such as Mexico and Brazil, continue to carve out their niches in world markets. Now, I’d like to spend a few minutes discussing the adjustments that all open trading nations must make in this changing environment, and recall some of the lessons that past adjustments have taught us. Benefits of international competition First, let me say a few more words about the competitive environment. Not surprisingly, some perceive the growing competition from China and India as a threat. Companies everywhere are under constant pressure to lower costs, and many of them are finding that China and India are attractive places to establish production facilities and service centres. The loss of certain jobs in the home countries of those companies is a sensitive social and political issue and can contribute to protectionist pressures, especially during periods of relative economic weakness. But as we consider the impact of increased competition from Asia, it is important to remember that economic growth in Asia is lifting hundreds of millions of people out of poverty. That’s an absolute good. And it is a new source of opportunity, creating more demand for goods and services from the industrialized countries and thus providing a boost to global economic growth. Healthy financial systems As our economies have become more open, we have also been reminded of the importance of a solid, efficient financial system. In any country, growing firms need access to credit from a sound, wellfunctioning financial sector, including a healthy banking sector. Countries with strong financial systems are much less likely to trigger or to amplify international financial crises than countries where those systems are weak. With the increasing integration of world markets, it is in everyone’s interest to promote efforts to limit the impact and the spread of financial shocks. Since the Asian and Russian financial crises of 1997-98, countries have worked to improve the transparency and reliability of their domestic financial systems. Mexico, for example, has made tremendous efforts to improve the health of its banking sector, partly by drawing on the sound business practices of large banks from other countries, including Canada. In some countries, however, progress is less evident. And in China, the building of a strong commercial banking sector presents an enormous challenge. But it is not just domestic financial systems that need to be strong and flexible. As the global economic environment evolves, it is important that international financial institutions adjust in response. That is why institutions such as the International Monetary Fund and the World Bank must continue to modernize themselves, to remain relevant in a changing world. While the IMF and the World Bank have evolved somewhat since their creation in 1944, they have changed much less than the global economy they oversee. So it is encouraging that a strategic review of their mandates and operations has begun. This review is a first step towards a much-needed updating of these institutions. Commodity price adjustments I’ve spent some time outlining some of the structural forces at work in the world economy. Now I’d like to talk about some of the adjustments that are being made following the recent sharp rise in global demand. The first adjustment is to higher commodity prices. The rapid growth of some emerging-market economies and the strong recovery in the United States are fuelling demand for raw materials. And that, in turn, is pushing up the prices of these raw materials. Certainly, we have seen the effect of this demand on most commodity prices. Of course, one price increase that we all feel acutely is that of oil. The recent surge in crude oil prices is another example of pressure stemming, at least in part, from strong world demand. This stronger demand has not yet been met by compensating growth in the supply of crude oil - although a recent agreement by OPEC to boost production will help. Nor have we seen substantial efforts by price- sensitive consumers to use less oil and gas. Meanwhile, geopolitical events have contributed to concerns about potential supply disruptions, exacerbating the run-up in oil prices. It is reasonable to expect that oil prices will remain relatively high until some of the geopolitical uncertainty dissipates, world production capacity expands, and further conservation efforts take hold. Higher energy costs mean that it will be more expensive to produce many goods and some services. It is not clear to what extent companies will be able to offset rising costs and limit price increases to consumers. What is clear is that economies need to adjust to these higher costs - and economic policies must support that adjustment. We have learned this from the mistakes made during the oil crisis of the 1970s, when many countries, including Canada, tried to shield their economies from the effects of rapidly rising energy prices. The result was an eventual adjustment that was slower and more painful than it needed to be. A return to more normal world interest rates A second adjustment underway in the global economy is the return to more normal interest rates and somewhat wider spreads on risky investments. After the global economic slowdown of 2000 and the terrorist attacks of 11 September 2001, central banks around the world lowered their policy interest rates to provide the liquidity to help their economies recover and absorb excess capacity. The world economic recovery we are seeing is due, in large part, to accommodative monetary policy - that is, historically low interest rates. Through 2003 and the early part of 2004, interest rates in some countries hit their lowest levels in 50 years, and global credit conditions were very expansionary. But we know from experience that, as growth resumes and economies get closer to their production capacity, inflationary pressures start to build. And so central banks in many countries will have to remove some of the stimulus, and interest rates around the world will have to return to more normal levels. This process has already started, with market rates adjusting in anticipation of future increases in policy interest rates. There is no doubt that over the next year, we will see upward adjustments in policy interest rates around the world. The timing and the magnitude of these adjustments will vary from country to country, according to each one’s economic circumstances. The good news is that all this is happening before economies reach the limits of their production capacity, and before inflation takes off and inflation expectations start to rise. That bodes well for sustained economic growth without the credit crunches or accelerating inflation that occurred in earlier global business cycles. I have painted a reasonably sanguine view of the world economy and its ability to meet challenges. I don’t mean to suggest, however, that there aren’t any economic risks in the adjustments that I have outlined. As you all know, we are again facing heightened geopolitical uncertainties. And there are significant global economic imbalances that must be corrected over time. But, over the past couple of decades, central bankers and governments, as well as corporations and financial institutions, have learned a great deal about managing global risks. And most countries agree on the critical elements and policies necessary to adjust to global economic change. How well is Canada’s economy adjusting? So, just how well is Canada’s economy adjusting? Let me look at some of the important efforts we have made and at the policies that are necessary to help us manage change and seize new opportunities. First, maintaining solid economic growth in Canada requires confidence based on well-managed monetary and fiscal policies. As you know, the Bank of Canada is responsible for monetary policy. You may also recall that in 1991, together with the federal government, we agreed on an anchor for monetary policy. This anchor was an explicit inflation target that would gradually lower the annual rate of consumer price increases to 2 per cent - the midpoint of a range of 1 to 3 per cent. Since then, we have kept inflation around 2 per cent, on average. And inflation expectations have fallen in line with this target. Our inflation-targeting system means that the Bank of Canada lowers rates when we see the trend of inflation heading below 2 per cent. And it also means that we raise rates when it looks as if the trend of inflation will be moving above the target. This symmetric response helps to smooth the ups and downs of the business cycle. In our decision-making process, we must allow for the fact that it takes 18 to 24 months for changes in interest rates to have their full effect on the economy and on inflation. Therefore, we must constantly look ahead to make timely decisions that will help to smooth the business cycle, rather than exacerbate its volatility. Another important benefit is that inflation targets have enabled the Bank to explain more clearly to business, labour, and the public what we are doing and why. Better public understanding of central bank policies and actions makes monetary policy more effective. Canada’s experience shows that monetary policy works best when it goes hand in hand with other sound economic policies. In particular, implementing and maintaining sound fiscal policy at all levels of government is fundamental to good economic performance. This gives a country the credibility and flexibility to manage economic challenges. And it gives citizens confidence that the authorities will manage public finances prudently. I talked earlier about the impact of increased global competition. Canada has clearly felt that impact, and we continue to adjust to meet competitive pressures. Canada has a long history of supporting multilateral trade agreements. Opening up to global competition and to new markets has made us a more innovative and competitive economy. As we see the integration of major new players in the world economy, our firms must continuously adapt, innovate, and improve their efficiency. That means continued investments in research and development, as well as education and training. And, in a changing world economy, our firms must continue to find and to exploit new opportunities. I noted earlier that the booming growth of large economies like China and India means that demand for both energy and non-energy commodities will likely remain strong. And so Canada will need the flexibility to shift resources into the production of those commodities, as demand requires. It is important that our resource sector strives to remain among the world’s most efficient, and that our manufacturing sector continues to innovate. The steps that I have just described will help us meet the long-term challenges that we, as well as other national economies, face. Canada’s economy continues to adjust to global economic developments. Monetary policy has been facilitating these adjustments by supporting aggregate demand, with the goal of keeping the economy near its full production capacity and inflation on target. Canadian economic outlook Before I close, I want to spend a couple of minutes on the Bank’s views about the current economic outlook and inflation in Canada. Growth in the first quarter of this year was 2.4 per cent, below the economy’s estimated potential growth rate of about 3 per cent. This implies that the level of output in the economy is still significantly below its production potential. However, both final domestic demand and exports grew strongly in the first quarter. These indicators, along with more recent data, suggest that growth in the first half of 2004 is likely to be somewhat above 3 per cent. In our April Monetary Policy Report, we said that we expected the economy to grow by about 2 3/4 per cent in 2004 and by about 3 3/4 per cent in 2005. We also said that core inflation - a measure of trend inflation obtained by removing eight volatile components from the consumer price index, as well as the impact of changes in indirect taxes on the remaining components - was expected to average 1 1/2 per cent over the remainder of 2004 and to move back up to 2 per cent by the end of 2005. Information received since the release of our April Report has been generally consistent with expectations about core inflation. But the sharp rise in world oil prices, in response to stronger-than-anticipated global demand for oil and heightened geopolitical uncertainties in the Middle East, means that total CPI inflation over the next several months will be higher than the Bank expected in April. It is important to note that while higher oil prices may push up the total CPI over the next few months, they should not feed through into higher trend inflation, as long as inflation expectations remain anchored around the 2 per cent target. Conclusion To conclude, the world economy has undergone tremendous change in recent years. And we can be sure that there is more to come. While we Canadians can remain confident of our ability to adjust to change, we must not be complacent. We should continue to work at strengthening our macroeconomic framework, enhancing our productivity, and opening up further to trade. That is the best way to ready ourselves for the challenges and opportunities that lie ahead.	bank of canada	2,004	7
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the European Economics and Financial Centre, Paris, France, 24 June 2004.	David Dodge: Cooperation and the conduct of economic policy Remarks by Mr David Dodge, Governor of the Bank of Canada, to the European Economics and Financial Centre, Paris, France, 24 June 2004. * * * Good afternoon, ladies and gentlemen. I am delighted to be here and to have the opportunity to speak at this conference. The theme of this event is “Policy Coordination in an Integrated Global Economy.” It seems as if the idea of policy coordination is making a comeback these days. This is probably because of the growing interconnectedness of the global economy and the series of shocks that have recently reverberated around the world. While globalization has affected different countries to varying degrees, it has brought many benefits to the world economy - including increased trade, broader sources of financing, and more rapid diffusion of technology. But globalization has also left countries more exposed to developments beyond their borders. From a central bank perspective, globalization has made the conduct of monetary policy somewhat more challenging. In order to gauge the prospects for the domestic economy, it is more and more necessary for central bankers to take into account how their economy will be affected by events elsewhere. And of course, central bankers in very large economies must be cognizant of the effects that their actions may have on the global economy and, hence, on their own economy. Canada has had a very open economy for many years. So, not only is it in our interest to ensure that our domestic economic policies are the right ones, it is also in our interest that other countries pursue appropriate policies. As globalization continues, it will increasingly be in everybody’s interest that all countries follow sound economic policies. Given this growing integration of the world economy, it might appear that there is a need for closer international coordination of economic policies. Traditionally, talk of coordination has made people think of more formal arrangements, such as the Plaza and Louvre Accords of the 1980s. Not only did those agreements attempt to influence global exchange rates, they spelled out detailed prescriptions for individual countries in areas such as fiscal and monetary policy. I will argue today that the scope for macroeconomic policy coordination is very limited, although it is vital for policy-makers to co-operate in the sharing of information and views on monetary and fiscal policy. But I will also argue that there are some areas where coordination is required, most particularly in establishing and maintaining rules and standards that will allow global financial markets to function well and global trade to expand. The right economic policies Let me start with macroeconomic policies and information sharing. I’ll begin with a question. If there is no international macroeconomic policy coordination, how can countries determine which policies they should choose to strengthen their domestic economies and thus contribute to global growth? In answering that question, I would say that policy-makers should always look to their own economies first. Promoting policies that encourage sustainable growth and financial stability in their own domestic economy is the best contribution that national authorities can make to the growth and stability of the global economy. But which policies are the right ones? The OECD, among other organizations, has been working on this question for decades. I can recall attending OECD meetings here in the 1980s, when a consensus began to take shape on a set of policies that would provide the strongest base for sustainable economic growth. These policies relate to four basic areas. First, monetary policy should be directed at keeping inflation low and stable. Second, fiscal policy should take a disciplined approach to the public purse. Third, structural policies should encourage economic flexibility. And fourth, countries should work towards trade liberalization. Let me take a few minutes to discuss these areas, beginning with monetary policy. In Canada, as in many other countries, the goal of monetary policy is to maintain the public’s confidence in the future value of money. We do so by working to keep inflation low, stable, and predictable. Over the years, the Bank of Canada, like many other central banks, has struggled to find the right anchor for its monetary policy - an anchor to guide its actions and to give the public a way to measure its performance. Since 1991, our monetary policy anchor has been our system of explicit inflation targeting. Under this system, we aim for a 2 per cent annual rate of consumer price inflation over the medium term. This target is spelled out in a formal agreement between the Bank and the Government of Canada. But the Bank is solely responsible for the implementation of monetary policy. It’s important to note that we conduct our policy symmetrically around the 2 per cent target. We will lower interest rates to stimulate total demand when we see that the trend of inflation is threatening to fall below the target over the next 18 to 24 months. Similarly, we will raise interest rates to dampen demand when we see that the future trend of inflation is poised to rise above the target. In this way, monetary policy acts as the primary tool for stabilizing the economy. Although inflation targeting has a relatively short history, the experience of many countries so far suggests that this approach brings with it important economic benefits. By smoothing the peaks and valleys of the economic cycle as a whole, inflation targeting helps the economy to achieve maximum sustainable growth over the medium term. But if a central bank wants to have the monetary policy independence needed to pursue low and stable domestic inflation, then it has to be prepared to allow the external value of its currency to fluctuate. That independence, which is typically lost under a fixed exchange rate regime, has been a tremendous asset for Canada. Further, given the somewhat sticky nature of both wages and prices, a floating exchange rate can serve as an important economic stabilizer, helping to facilitate the adjustment to shocks and the resolution of global imbalances. It is true that under a floating exchange rate regime, currencies can experience short-term volatility. This volatility can certainly be unnerving. However, in my view, central bankers ought to be extremely cautious about trying to smooth these fluctuations. It is extraordinarily difficult to judge whether sharp currency movements simply represent market “noise” or more fundamental forces. So, there is great potential for policy error when central bankers try to smooth currency volatility. Besides, businesses can take advantage of highly efficient hedging tools available in financial markets to help them deal with short-term currency movements. Let me now turn to fiscal policy. A country should have a medium-term fiscal plan that is appropriate to its particular situation. Citizens and investors need to know that their government will not let debt levels get out of hand. When public debt is controlled, people can have confidence that their governments will not inflate the debt away, impose an overly onerous tax burden in the future, or simply repudiate the debt. In attempting to keep levels of public debt under control, governments should be wary of using “discretionary” fiscal policy to stabilize the economy. Let me be clear that I am talking here about discretionary action and not the use of automatic stabilizers, such as unemployment insurance payments. For one thing, it is very difficult to get the timing of discretionary action correct. For another, as we know from bitter experience around the world, tightening fiscal policy is politically much more difficult than easing it. And so the use of discretionary fiscal policy as an economic stabilizer increases the chances of a country getting into an unsustainable debt situation. Further, the economic evidence suggests that in open economies under a floating exchange rate regime, monetary policy can be a much more effective stabilizer than discretionary fiscal policy. In the 1990s, governments in Canada - both federal and provincial - struggled not only to eliminate budget deficits, but to run surpluses in order to bring down public debt-to-GDP ratios. Given Canada’s demographics, with an aging population and a workforce that is likely to stop growing within 15 years or so, aiming to reduce the debt-to-GDP ratio is an entirely appropriate fiscal anchor. Of course, other countries may have different considerations that shape their medium-term fiscal plans. The importance of information sharing So far, I have argued that formal coordination of macroeconomic policies is unlikely to lead to better economic outcomes than if all countries simply followed the right policies for their own circumstances. In addition, coordination risks amplifying the effects of a mistake in judgment about the state of the global economy. But co-operation in the form of information sharing does play an extremely important role in the development of macroeconomic policy. Let me elaborate. Countries can put an appropriate policy framework in place; but, without accurate and reliable information on the state of other economies, it is difficult to determine what policy actions will deliver optimal results. The Canadian economy provides a clear example. Given Canada’s dependence on international trade, the Bank of Canada needs to thoroughly understand the forces at work in the world economy in order to adopt the appropriate monetary policy stance at home. Otherwise, we risk misjudging the state of total demand in the domestic economy, and that can lead to policy errors. The increasingly interconnected nature of the world economy means that policy-makers in all countries must have a thorough understanding of global economic and financial developments. It is fitting that we should be discussing this topic here, in this building, given the OECD’s long history in economic co-operation. How does this information sharing among countries take place? In addition to OECD meetings, central bankers gather at the Bank for International Settlements every two months. In fact, I will be headed to Basel for such a meeting in a couple of days. One of the most important features of these meetings is our systematic, detailed discussion of the world economic situation. These meetings, as well as the periodic meetings of the International Monetary Fund, the G-7 and G-20, and the Financial Stability Forum, are important opportunities for policy-makers. Not only can we hear directly from our counterparts, but we also have the chance to ask questions about their policies and prospects. And between these meetings, senior officials from finance ministries and central banks talk frequently to each other. This kind of information sharing can also be useful in areas other than macroeconomic policy. I mentioned before that the OECD policy consensus includes the idea that countries should strive for economic flexibility through their structural policies. In particular, that means the creation and maintenance of effective and efficient labour and capital markets. Again, the sharing of information about experiences and best practices can be invaluable in helping authorities design policies and programs that are appropriate to their own economies. Information sharing can also help to reduce uncertainty and to promote economic security by demonstrating the most effective ways to strengthen the rule of law and reduce the risk of abuses. And information sharing is an important part of the effort to combat money laundering and terrorist financing - an effort led by the Financial Action Task Force here in Paris. Where coordination can be helpful So is there any scope for outright policy coordination in a global economy? As I said at the beginning, I would argue that, when it comes to international trade and finance, actual coordination is not only desirable, it is probably necessary to facilitate the expansion of commerce and to promote well-functioning global financial markets. Let me explain, starting with international trade. A moment ago, I said that trade liberalization is a crucial part of an appropriate economic policy framework. But in order to have freer trade worldwide, countries need to come together to draw up and enforce a set of rules governing the exchange of goods and services. In this regard, Canada has been a consistent supporter of the World Trade Organization (WTO) and its earlier incarnations. Unfortunately, in recent years, there has been insufficient international support for strengthening the global trade order, and talks on difficult sectors, such as agriculture, have floundered. Collectively, developed countries still have a considerable way to go in terms of reducing subsidies and liberalizing trade for a number of goods, including agricultural products. In my view, we have a responsibility to do this in order to promote growth in the most impoverished nations. That is why Canada has been pushing for an early resumption of the Doha round. And there are other sectors, such as financial services, where major effort is required. This effort must be made so that the global economy can benefit. It won’t be easy; but, in the long run, it will be worth it. International coordination is also important in efforts to establish a framework to allow financial markets to function efficiently. In recent years, this has been reflected in the drive towards greater transparency. Unless countries develop and implement a clear and coherent way of disseminating relevant information, global financial markets will be unable to function at peak efficiency. This applies to both the public and the private sectors. Following the Asian and Russian crises of 1997-98, the IMF and the World Bank launched the Financial Sector Assessment Program to identify strengths and weaknesses in national financial systems. This effort is backed by Reports on Observance of Standards and Codes, which are conducted by the IMF. These reports can bolster confidence by demonstrating to markets the level of commitment that countries have to boosting their transparency. Other efforts to improve transparency in the wake of Enron and similar scandals include initiatives to improve corporate reporting, accounting, and dissemination of financial market information. These efforts to further domestic transparency will certainly be helpful on their own. But if we coordinate our efforts, we can spread the benefits of transparency and help global financial markets to operate more efficiently. This applies to the development of market codes of conduct, as well as to compliance and enforcement efforts. And it also applies to the development of accounting standards that are universally applicable. It is only through coordination that we will all get the full benefit of improved standards and codes. Unlike macroeconomic policy, where the best collective outcome depends on each country following appropriate domestic policies, when it comes to international trade and global financial markets, the best collective outcome will require strong, coordinated efforts. Conclusion Let me sum up. As globalization continues, it may appear that there is a need for national authorities to coordinate their macroeconomic policies through formal agreements and arrangements. I have argued that this is not the case. I hope that I have convinced you that such coordination is unlikely to be helpful. But I hope that I have also convinced you that information sharing among countries remains extremely important. What is crucial is that national authorities pursue sound domestic policies, while being fully cognizant of what is happening elsewhere in the world. These policies include a well-anchored monetary policy focused on inflation control and a prudent fiscal policy conducted within an appropriate medium-term plan. Such policies should be supplemented by a set of structural policies that foster economic flexibility, as well as by policies that encourage openness to international trade. By strengthening their domestic economies while taking global developments into account, policy-makers will be helping to improve the world economy. Where I think we do need coordination is in the establishment of frameworks that facilitate international commerce and strengthen the global financial system. We do need a coordinated international trade order, and the strengthening of that order remains a worthy goal for us all. We do need a coordinated, transparent framework to support and maintain effective and efficient global capital markets. And we do need to promote the coordination of accounting standards. Finally, let me say that, as we take part in this conference here, at the home of the OECD, economic co-operation remains as important now as it was on the day that organization was founded. The sharing of information among national governments and regulatory bodies is absolutely essential. Co-operation helps policy-makers follow sound domestic economic policies appropriate to their own circumstances while being cognizant of the actions of others. That, in turn, should lead to better global economic performance.	bank of canada	2,004	7
Opening statement by Mr David Dodge, Governor of the Bank of Canada at a press conference following the release of the Monetary Policy Report Update, Ottawa, Ontario, 22 July 2004.	David Dodge: Monetary policy report update Opening statement by Mr David Dodge, Governor of the Bank of Canada at a press conference following the release of the Monetary Policy Report Update, Ottawa, Ontario, 22 July 2004. * * * Today, we released our Update to the April Monetary Policy Report. The Update reviews economic and financial trends in the context of Canada's inflation-control strategy. The Bank's outlook for economic growth and inflation in Canada is little changed from the April Report. Let me start with our outlook for inflation. Higher-than-expected world oil prices mean that total CPI inflation is likely to remain above 2 per cent through the rest of this year, before falling slightly below core inflation in the second half of 2005. Core inflation is projected to remain just above 1.5 per cent for the rest of 2004, before gradually moving back up to the 2 per cent target by the end of 2005. Economic growth in Canada should average about 3 ½ per cent through the remainder of 2004 and in the first half of 2005, before easing to 3 per cent in the second half. This would imply average annual growth of about 2 ¾ per cent in 2004 and 3 ½ per cent in 2005. This profile suggests that the Canadian economy will reach its production capacity by mid-2005. As economies approach their production capacity, monetary stimulus must be removed to avoid a buildup of inflation pressures. In Canada, the timing and magnitude of interest rate increases will depend on the evolving prospects for inflation and for pressures on capacity. Three factors will play an important role in this respect. The first is the assessment of the size of the output gap. The second is the future growth of Canadian imports and exports, which is particularly uncertain because of the ongoing adjustments to global changes and the recent patterns in trade growth. The third is the overall effect on the Canadian economy of movements in the world prices of oil and non-energy commodities. In addition, there continue to be heightened geopolitical concerns. Paul and I will now be happy to take your questions.	bank of canada	2,004	8
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Chamber of Commerce, Calgary, Alberta, 20 September 2004.	David Dodge: Canadian monetary policy in an evolving world economy Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Chamber of Commerce, Calgary, Alberta, 20 September 2004. * * * Good afternoon. I'm glad to be back in Calgary. We at the Bank of Canada welcome these opportunities to get out across the country, to speak to business people, and hear your perspectives on the economy. The feedback we receive from businesses from coast to coast is an important part of our monetary policy deliberations. I know that the staff of our regional office here in Calgary work hard to stay on top of local business conditions on the Prairies, as do our other offices for their regions. I am happy to have the opportunity to meet with the national body of the Chamber of Commerce. I can tell you that my regular contacts with the Ottawa liaison group are very valuable to me. The Bank does look to the Chamber to help us understand how economic developments are unfolding at the industry level. And I particularly want to thank the Chamber for being an ongoing partner in our efforts to smoothly introduce three new high-denomination bank notes this year. This is the second straight year in which we have set up a currency-education kiosk at your annual meeting, to help spread the word about our new bank notes. You can learn about the security features that we have included in our high-denomination notes. And we have materials about our new $20 note that we unveiled last month, and which goes into circulation beginning next Wednesday, 29 September. I should add that I'll be back here in Calgary on 13 October to unveil the new $50 bank note, which goes into circulation beginning in mid-November. During the past year, powerful forces have continued to shape the global economy. Alberta, and indeed all of Canada, have felt the impact of these forces. Of course, the evolution of the global economy is not a short-term event. Some of the forces currently at work have been building for years. Similarly, today's developments may have repercussions, and raise the need for adjustments, for years to come. So today, I want to talk about Canada's economic outlook and the prospects for monetary policy within the context of the evolving world economy. How the monetary policy framework works I will start with a brief review of our monetary policy framework. Let me remind you of the goal of Canadian monetary policy. Experience has taught us that the best contribution the Bank of Canada can make to good economic performance is to keep inflation low, stable, and predictable. By doing so, we can provide the backdrop that best allows our economy to grow in a strong and sustainable way. We aim to keep inflation - as measured by the annual rate of increase in the consumer price index - at 2 per cent. It's important to note that we conduct monetary policy in a symmetric way. This means that we will raise interest rates to dampen total demand when we see that inflation is threatening to rise above our 2 per cent target over the next 18 to 24 months. In the same way, we will lower interest rates to stimulate demand when we see that the trend of inflation is poised to fall below the target. This symmetric approach to monetary policy has delivered an average rate of inflation that has been very close to 2 per cent since inflation targeting was adopted in 1991. It is also important to keep in mind that monetary policy actions take time to have their full effect. The lags are variable, but it typically takes a year and a half to two years for a change in interest rates to have its full impact on the economy and inflation. That is why we say that we need to be forward looking with our monetary policy, and that is why we are always trying to assess the state of the economy 18 to 24 months into the future. Specifically, we try to evaluate the various factors that will affect supply and demand, to help us estimate the future size of the output gap. What do I mean by "output gap?" That term refers to the difference between actual output - what the economy is producing - and potential output - the maximum amount the economy could produce without triggering higher inflation. Another way that we sometimes refer to this concept is to talk about how close the economy is to its production capacity. This idea is important because when economies operate above their capacity - or, as economists like to put it, there is excess demand and a positive output gap - inflationary pressures can build. But when economies operate below capacity - meaning that there is excess supply and a negative output gap - disinflationary pressures can set in. Ideally, we want to see the economy operating close to its capacity, with total demand roughly in balance with total supply. If we achieve this, we can have the best outcome over time - strong, sustainable growth that avoids booms and busts, along with rising employment and low inflation. One major problem is that we cannot directly measure potential output. Further, the economic data that measure actual output are often revised - sometimes significantly so. The challenge for us, then, lies in estimating the size of the output gap, and there is always a significant degree of uncertainty around that estimate. So we look at a number of other economic variables to help us form an opinion about how large the output gap is. You can find out more about these variables on our Web site. They include, among others, indicators of capacity in goods markets, signs of tightness in labour markets, and signals of pressures in the real estate market. Some of these are quantitative, and some are qualitative, based on surveys of businesses conducted by our regional offices. Another indicator is the rate of inflation itself. If core inflation - which strips out eight highly volatile components of the consumer price index - is consistently coming in above or below our expectations, it may lead us to adjust our view about the current size of the output gap. Earlier, I said that when the economy is operating near its capacity, total demand for Canadian goods and services - or what economists like to refer to as "aggregate demand" - is roughly in balance with total supply. Total demand has two components - domestic demand and foreign demand. Assessing foreign demand is difficult, but because it represents such a large share of total output in Canada, we at the Bank spend a great deal of time and effort trying to gauge that demand. Of course, it is nothing new to say that our economy is importantly affected by events abroad. Canada has always relied on international trade. For a long time now, the United States has been the focus of attention in assessing the world economy. But many of today's global economic developments have their origins outside North America, most notably in Asia. Before I talk about their current implications, I would like to take a few minutes to discuss the nature of these developments and their likely implications over the next decade or so. The medium-term implications of global developments Just as Japan and Korea emerged as major players on the global stage in previous decades, China is now quickly becoming an economic powerhouse. And India is not far behind. When you consider that these two countries account for 40 per cent of the world's population, it is not hard to see why they are having such an impact on the global economy. As we look ahead, it is clear that China and India will be major global competitors, not just in labour-intensive industries, but increasingly in skill-intensive industries as well. It's a pattern of development that the world has seen before. Established firms in many industries will feel competitive pressure from China and India, until the large pool of surplus labour in those countries can be absorbed. But at the same time, this process will create income and wealth in China and India and, hence, increase their ability to buy more goods and services from abroad. So, the integration of these countries into the global economy represents both a competitive challenge and a tremendous opportunity for the industrialized world. These emerging markets are just that markets. China is already one of the largest importers in the world and its importance will increase over the next decade. This source of growing demand can provide a much-needed boost to the global economy in general and to the Canadian economy in particular. We have already seen some Canadian commodity producers step in to fill the demand from Asia. Indeed, Statistics Canada recently reported that the value of Canadian exports to China in the first seven months of this year rose by 58 per cent compared with the same period in 2003. There will also be opportunities for Canadian firms to integrate low-cost components into their own production processes, through direct investment or joint ventures. This will be an increasingly important way for Canadian firms to maintain cost competitiveness. Over the medium term, it will be absolutely crucial for all Canadian businesses and governments to continue to take advantage of these opportunities as they arise. At the same time, Canadian businesses and governments need to recognize that these global developments will require adjustments here in Canada. There will be some activities, particularly those that are labour-intensive and lower-value-added, where Canadian firms will not be well placed to compete with lower-cost producers in Asia. The key will be to adjust by shifting resources into expanding, higher-value-added activities, where Canadian firms can exploit the opportunities presented by the changing world economy. By making these adjustments, we will be able to increase productivity and raise our standards of living over the medium term. Of course, it is not just developments in Asia that will require us to make adjustments here in Canada. We will also have to adjust as the U.S. economy reduces the size of its fiscal and current account deficits. But the subject of adjustments to global imbalances is beyond the scope of my remarks today. What I can say, though, is that the Bank of Canada will facilitate whatever adjustments are necessary by keeping inflation low, stable, and predictable. This will help Canadian firms and individuals read market signals more clearly and allow them to make plans with confidence in the future value of their money. Near-term implications of global developments That's a look at the medium term, and it is important for business people and economic policy-makers to always keep an eye on the horizon. But, as you run your business from day to day, and as we at the Bank conduct monetary policy, it is the shorter-term developments that are the greater focus of attention. So, let me spend a few minutes on the near-term outlook for the world economy, and what that outlook implies for foreign demand for Canadian goods and services. As I said before, the emergence of China and India is having an important impact on the Canadian economy through an increase in demand for many of the commodities that we produce. This has caused a run-up in the prices of nickel, potash, and steel, among others. And, in turn, this has boosted the income of many Canadian producers, even after taking into account the effects of the large appreciation of the Canadian dollar that we saw in 2003. Of course, the most high-profile price increase recently has been that of oil. Very rapid growth in Asia has led to unexpected additional demand for oil. For the time being, this unanticipated demand is putting pressure on a market that already had little spare capacity. Over the medium term, oil production will, in all likelihood, increase to meet this additional demand. But it takes time for new production to come on line. Thus, it is not unreasonable to think that oil prices will be higher in the near term than what we might expect them to be over the medium term. Our best judgment at the moment is that high levels of growth in Asia will continue over the next couple of years, and that demand for commodities will continue to grow, although perhaps not quite as rapidly as in the past couple of years. This is based on the not-unreasonable assumption that the Chinese authorities will be able to manage economic growth at a more sustainable pace. While developments in Asia are likely to play a very important role in supporting continued strength in the global economy, developments in the United States will still have the largest impact on the volume of Canada's exports over the short term. As we said in our July Monetary Policy Report Update, recent data point to some slowing of U.S. growth from the red-hot pace of the second half of 2003 and the first quarter of 2004. Higher oil prices appear to be having some restraining effect on U.S. consumer spending, and both consumers and businesses seem to be somewhat less optimistic than they were earlier this year. Nevertheless, we still expect growth to be similar to what we forecast in July - that is, faster than the growth rate of U.S. production capacity. This strong U.S. growth bodes well for continued high levels of Canadian exports, although they are unlikely to continue to grow at the rapid pace of the first half of this year. Consistent with this profile for solid U.S. and global economic growth and with the expectations of financial markets, we continue to assume some upward movement in global policy interest rates to moderate inflation pressures as output levels approach production capacity. Canadaâ€™s economic prospects Let me now turn to Canada, beginning with a quick recap of the first half of 2004. At the start of the year, we said that we did not expect net exports - the difference between what we export and what we import - to make a significant contribution to Canada's economic growth in 2004 or 2005, because of the sharp appreciation of the Canadian dollar last year. We also said that economic growth would have to come primarily from domestic demand in order to eliminate the excess supply that existed at the start of the year and to close the output gap. To facilitate growth in domestic demand, we reduced our key policy interest rate from 2 3/4 per cent to 2 per cent in three steps earlier this year. However, Canada's economic performance in the first half of 2004 turned out somewhat differently from our expectations. The volume of exports grew much more rapidly than we had anticipated. So did imports, but not to the same extent as exports. As a result, net exports made a very significant contribution to growth, and aggregate demand in the first half of the year grew more strongly than we had expected at the beginning of 2004. So the output gap at mid-year was smaller than we had projected. Indeed, the Bank judges that the Canadian economy is now operating close to its production capacity. As we look ahead to the remainder of this year and to 2005, we expect that exports will grow more slowly than in the first half of 2004. But there are lots of uncertainties that cloud the outlook for foreign demand and Canadian growth. These include uncertainty about the western grain crop, the re-opening of the U.S. border to live cattle exports, and auto production, as the "Big Three" automakers face softer markets for their products. Despite these caveats, aggregate demand will likely grow at a rate equal to, or marginally above, the rate of growth of production capacity over the next four quarters. With the economy currently operating close to capacity, we reduced the amount of monetary stimulus in the economy two weeks ago by raising our key policy interest rate to 2 1/4 per cent. Inflation, both total and core, has been volatile in recent months, primarily because of swings in energy prices and because of automobile purchase-incentive programs. But despite this volatility, we continue to project that core inflation will be a bit above 1.5 per cent for the second half of 2004, before gradually moving up to the 2 per cent target in 2005. Looking forward, we will need to continue to reduce monetary stimulus to avoid a buildup of inflationary pressures and to contribute to sustainable, solid economic growth. However, the pace of our actions will depend on our continuing assessment of the evolving prospects for pressures on capacity and inflation. In this context, there are several key factors that the Bank will be watching closely. As always, there is uncertainty about the exact size of the output gap. There is also considerable uncertainty at this time about the future growth rate of both exports and imports, and about the evolution of world prices for energy and non-energy commodities. And we will be watching the impact of geopolitical developments on global confidence and demand. We will update our outlook for the Canadian economy in our next Monetary Policy Report, which will be published on 21 October. Conclusion Let me conclude by going back to my earlier point about the need to adjust to changes in the world economy. We can be certain that the powerful global economic forces I spoke of today will continue to be felt as the world economy continues to evolve. This evolution will lead to challenges that we must face, but it will also lead to opportunities that we must seize. At the Bank of Canada, we will continue to monitor these global forces closely and assess their impact at home and abroad. This will help us contribute to Canada's future economic prospects through low and stable inflation. For Canada to grow and prosper over the long run, Canadian businesses and governments will need to make the right adjustments to the evolving world economy. As leaders in the business community, your job will not be easy. But over the past several years, we have seen ample evidence that you can face challenges and take advantage of opportunities. I am confident that you will continue to do so in the future.	bank of canada	2,004	9
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Ontario Economic Summit, Niagara-on-the-Lake, Ontario, 7 October 2004.	David Dodge: Global economic developments and the implications for Ontario Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Ontario Economic Summit, Niagara-on-the-Lake, Ontario, 7 October 2004. * * * Good afternoon. I am glad to be here, and to participate in this very important summit. It’s not easy to come up with something fresh to say this late in the conference agenda. My topic is “Ontario’s Place in the World,” but, of course, you’ve already spent a day and a half listening to the opinions of smart people who spend a great deal of their time studying this very subject. You’ve discussed at length the forces at play in the world economy, and how they are influencing Canada’s economy and, of course, the economy of Ontario. Unfortunately, I have not been able to attend the entire event, so I have missed hearing many of the interesting speakers and presentations that have gone before. So, to contribute to this discussion about Ontario and its place in the world, I thought that I would begin by giving you a brief synopsis of what I heard this past weekend at the meetings of the G7 and the International Monetary Fund in Washington. I’ll recap what was said about the challenges facing the global economy, both over the next year and further out over the medium term. Then, I will talk about how those themes and their implications relate to the Ontario economy. The global economy in the near term One theme that I heard repeatedly in Washington is that 2004 is turning out to be a better year than many had thought, particularly over the first half of the year. Indeed, the IMF is now projecting global economic growth of 5 per cent in 2004, which would be a marked improvement from the 3.9 per cent rate seen in 2003. Globally, while the United States continues to be an important source of growth, it is encouraging to note the very strong growth in Asia and the improved momentum in Europe. There have been a few factors underpinning this growth, including a still-favourable financing environment, and a general improvement in the banking sector and in private sector balance sheets and profitability. The outlook for consumption and investment in most countries continues to be good. This outlook bodes well for the rest of this year and 2005, even though there was a sense at the meetings that growth over this period will not be quite as strong as we saw in the first half of 2004. The IMF’s own forecast, for example, pegs global growth for 2005 at 4.3 per cent - still above the trend rate, but off a bit from 2004. However, this optimistic outlook came with a clear caveat. The balance of risks for the global economy in 2005 has shifted slightly to the downside. Let me briefly mention some of the risks that were talked about. There was a general sense that the sharp rise in oil prices could become a more significant drag on growth next year, particularly if prices were to stay at current levels. Higher oil prices have cut into the rate of economic growth, but the consensus is that, so far, the overall effects appear to be manageable. Geopolitical events remain a risk to the world economy. As well, we are beginning to see the potential for inflationary pressures in some countries, as economies approach the limits of their production capacity. The challenge for monetary authorities will be to manage the transition from a very low interest-rate environment to one where policy rates are somewhat higher. Medium-term prospects for the global economy Looking beyond 2005, there was a general consensus that economic policy-makers around the world need to move ahead with addressing the problems that the global economy will face. So let me now take a few minutes to discuss what was said about the medium-term challenges for the global economy. In 2006 and beyond, a key concern will be how economies will adjust to the current global economic imbalances. A large U.S. current account deficit has its counterpart in the large current account surpluses in almost every other region of the world, most notably in Asia. At the same time, we have seen a sharp rise in the net foreign liability position of the United States and a massive accumulation of foreign exchange reserves by the Asian countries. Looking forward, the U.S. current account deficit is likely to continue to deteriorate, and current account surpluses in emerging Asia may remain larger than desired for longer than desired. For now, there is no reason to believe that world capital markets cannot manage these imbalances. But, over the longer haul, the magnitude of these current account imbalances cannot continue, and no country can pile up foreign exchange reserves indefinitely. Global adjustment will be needed to restore balance. This global adjustment could take place in several ways and through several channels. Hopefully, these will allow the adjustment to take place in an orderly way. The first channel is through changes in the global pattern of savings and consumption. Domestic savings in the United States could rise - both government and household savings rates can be expected to head up. And foreign consumption could increase, as economies and markets continue to expand. It is worth noting that in North America, household consumption is running well over 60 per cent of GDP. As we look ahead, and take into account the aging population, it is important that savings rates increase in North America. At the same time, household consumption in emerging Asia is only about 40 per cent of that region’s GDP. As Asian incomes rise, there is great potential for household consumption in that region to increase. So these are natural forces that will be working towards the adjustment of these imbalances. The second channel for adjustment will undoubtedly involve changes in real exchange rates; that is, the relative value of currencies taking into account the effects of inflation. Changes in real exchange rates could come about either through movements in relative inflation rates, or movements in nominal exchange rates, or some combination of the two. With respect to nominal exchange rates, the big issue is the need for some effective depreciation of the U.S. dollar against the currencies of emerging Asia. A key element here is China’s fixed exchange rate, and how successful the Chinese authorities will be in meeting their stated goal of moving to a floating currency. In all likelihood, both of these channels of adjustment will play some part in facilitating the correction of global imbalances. As these adjustments take place, two things will be critical to ensuring that real incomes continue to rise worldwide. First, global trade flows must continue unimpeded. That is why we must push for continued progress at the Doha Round of trade negotiations under the World Trade Organization. It is also why we must fight against any outbreak of protectionism. Second, all economies must take steps to enhance their flexibility so that the adjustment doesn’t have to take place through loss of real incomes. Here in Canada, we have to continue to increase the flexibility of our markets for goods and services, for capital, and crucially, for labour. At the same time, all of us leaders of corporations and public sector institutions must work to enhance the productivity of our workplaces. That leads me to the issues that we have to consider here in Ontario. The remainder of my remarks today will deal with these issues. Adjustments in Ontario Now, as I mentioned, I was not able to participate in your earlier discussions about the structure of Ontario’s economy. But, having outlined the forces that the international experts believe will be at work in the years ahead, let me now spend a few minutes talking about the competitive and structural issues that we face here at home in light of these global forces. Experience has taught me that one has to be very careful in trying to predict exactly how structures in an economy are going to evolve. But I think that we can safely predict that the first and most obvious adjustment will be a transformation of manufacturing processes around the world, as low-cost, highly efficient capacity is built in Asia. This means tremendous and continuing competitive pressure on industries that have traditionally been mainstays of the Ontario economy - automobiles and parts, other transportation equipment, and some areas of light manufacturing. Over time, those pressures will increasingly be felt by industries such as steel and heavy manufacturing. There are no signs that these pressures will abate in the years ahead. A second adjustment will be to higher energy costs in the years ahead. This is a major issue for all countries, and poses a problem for Canada and Ontario, which are energy-intensive by world standards. But energy cost increases and supply concerns are not limited to oil and natural gas. The blackout of August 2003 was a spectacular example of the need to have adequate and failsafe electricity supplies. We know that our electricity supplies are often stretched to the limit. And we know that demand in Ontario will continue to grow in the future, and that there is no clear plan to replace the capacity that has been slated for closure. A third adjustment relates to non-energy commodities. Strong demand from the booming economies of Asia is behind the rise in non-energy commodity prices such as nickel and iron ore. In response, we are seeing significant efforts in countries around the world to find new sources for these commodities and to improve their efficiency in extracting them. This province’s commodity producers must take advantage of this healthy environment to boost their own productivity to meet new competitive challenges. Fourth, we are in the process of adjusting to the fact that services, once thought to be non-tradable, are increasingly open to worldwide competition because of changes in technology. Ontario’s serviceproducing industries are facing increased competitive pressure from new suppliers, such as India’s burgeoning information technology and business services industries. All indications are that this pattern will continue, and will be repeated in other service industries. Perhaps the biggest challenge for Ontario’s service sector will be from the continued consolidation within financial services industries around the world. This poses a real competitive challenge to the financial services industry that is so important to the Greater Toronto Area. Indeed, while financial services companies may be concentrated around Toronto, they are important to the whole province the finance, insurance, and leasing sector represents almost 15 per cent of Ontario’s GDP. All these competitive challenges are compelling Ontario’s businesses, politicians and policy-makers to find ways to increase industrial productivity and market efficiency. Let me just stop for a second, because what I’ve said so far may sound overly negative about Ontario’s economic prospects. We need to keep in mind that changes in the global economy are also creating income and wealth in China and India, thus increasing their demand for goods and services from abroad. These emerging markets are just that - markets. This source of growing demand can provide a boost to the global economy in general, and the Ontario economy in particular. Now, in the past two days, you have heard from people who are far more expert than I am about how individual sectors can meet this competition and take advantage of these opportunities. So I’m not going to try to add my own specific policy prescriptions to the debate. But I would like to point out some issues that I believe must receive considerable focus in order to position Ontario to meet the global challenges facing us over the medium term. The first is the need to improve the efficiency of labour markets and the quality of Ontario’s human resources. This is a critical element of Ontario’s ability to meet future competitive challenges. To develop the skilled workers that this province will require to meet its labour demands, Ontario must ensure that its education and training systems are second to none. This applies to early childhood education and development, the provincial school system, and post-secondary education and skills training. And all employers, both public and private, have a responsibility to provide their workers with opportunities to upgrade their skills. Appropriate investment by individuals, by employers, and by governments, will be needed. But even the best-educated and trained workforce will still face inevitable economic adjustment that will lead to displacement and additional burdens on some groups in society. This does not mean that we should shy away from the task. But it does mean that a second area of focus should be to have policies in place that help to smooth the adjustment. These include providing access to training, or helping workers relocate or shift into expanding areas of the economy. The third area would be to improve the efficiency of capital markets and the financial system in Ontario and Canada. We all know that an economy works better when its financial services sector is sound and efficient. A robust and well-functioning financial system is key, so that growing firms have access to credit, and savings can be efficiently recycled to help businesses expand. Now, I am not here with a prescription for what needs to be done in this area. But we must not lose sight of the fact that the financial sector is an important contributor to economic growth in Ontario. An efficient financial sector will continue to be a competitive advantage for this province, both in maintaining efficiency in our own market, and in providing an opportunity to export expertise around the world. So policy-makers have an interest in providing a framework that will allow our financial institutions and markets to compete in an increasingly globalized world. With global standards evolving rapidly, Canada and Ontario must be at the forefront in terms of efficiency and competitiveness. A fourth area of focus is the province’s infrastructure - it needs to be a contributor to industrial efficiency, not an impediment. An important part of this is transportation infrastructure. And this applies not only within the province, but also to the links with our trading partners in other provinces, other parts of North America, and overseas. But it is not just physical infrastructure that is important. We also need the right policy infrastructure in areas such as security, inter-provincial trade, and regulation. For example, as industries increasingly rely on just-in-time delivery, border delays can cause real damage to businesses. That is why it is critical to develop and maintain border crossings that are as safe as these times require, yet open enough to allow the rapid flow of goods and people. The fifth issue would be securing reliable sources of cost-effective energy for the future. Ways must be found to foster the development of new sources of energy and to provide the right incentives for the efficient use of that energy. Clearly, there is a need for an appropriate framework to encourage investment in electricity transmission and generation, including renewable energy and alternative technologies. So those are five critical elements that I see as part of Ontario’s efforts to meet the challenges that lie ahead, and to take advantage of the opportunities presented by growing world markets. It is by no means a comprehensive list. There are many other important issues that I have not discussed. But I have tried to point out five areas that, in my opinion, policy-makers and business leaders cannot ignore. Conclusion We know that the challenges facing our economy will not be easy to meet. We know that tough choices will have to be made to secure an economic framework that enhances Ontario’s efficiency and its flexibility. We know that the burden of adjustment will fall disproportionately on some individuals and groups and that we have a collective responsibility to help with that adjustment. But we also know that Canadians and Ontarians have made tough choices in the past that have proved right. These choices have yielded an economy that is resilient, and capable of competing with the best in the world. That tradition must continue. The choices Ontarians make in the years ahead will determine our ability to meet the challenges thrown at us by this changing world economy, and to seize the opportunities that growth in world markets will bring. This province has tremendous human and natural advantages. I am confident that it also has the will to make the choices that will help Ontario thrive in this new world economy.	bank of canada	2,004	10
Speech by Mr Paul Jenkins, Senior Deputy Governor of the Bank of Canada, to the FMAC/FMA-USA Joint Conference 2004, Toronto, Ontario, 30 September 2004.	Paul Jenkins: Communication - a vital tool in the implementation of monetary policy Speech by Mr Paul Jenkins, Senior Deputy Governor of the Bank of Canada, to the FMAC/FMA-USA Joint Conference 2004, Toronto, Ontario, 30 September 2004. * * * Introduction It is a pleasure to have the opportunity to address this joint conference of financial market professionals from Canada and the United States. At the outset, I want to thank the Financial Markets Association of Canada and the Financial Markets Association of the United States for inviting me to be your conference keynote speaker. The members of these two organizations play an instrumental role in ensuring the efficient functioning of North America’s financial markets and, from a central bank perspective, the efficient transmission of monetary policy. You are, therefore, among the Bank of Canada’s key target audiences. We rely on the effective two-way flow of information between the Bank and financial markets in order to fulfill our mandate efficiently and serve the public interest responsibly. In aiming to do so, our overriding priority is to provide markets with the confidence that the value of money will be preserved through sound monetary policy. Put differently, financial markets embody the views of savers, investors, and borrowers, and the most basic consideration in the formulation of such views is confidence in the future value of money. Many of you, who have worked in financial markets for some years, may well take for granted the evolution in the way monetary policy is conducted. But if Rip Van Winkle had been a monetary policy “wonk” and had awakened from his 20-year sleep today, he would surely be bewildered by the extraordinary changes that have occurred in central banking, especially in the way central banks communicate. The fact is, few aspects of the conduct of monetary policy have changed quite so dramatically as the role of public communications. We have gone from a communication approach that not so long ago had central banks doing little to let people know what they were up to and why, to one that is now progressively transparent and deliberately forthcoming. Indeed, while central banks used to say little and let actions speak for themselves, today it would be accurate to say that words can, and often do, speak louder than actions. Central bank practitioners of monetary policy have become far more preoccupied with communication because communication is so tightly bound to achieving good economic outcomes. As financial market players, you are one of the publics that are most sensitive to this new reality. Bearing all this in mind, I want to focus my remarks today on communication and monetary policy. I will structure my remarks to address three key issues: • first, why communication has become so important in conducting monetary policy; • second, the need for central banks to be strategic in their communication approach; • and third, some practical challenges central banks must manage in implementing their communication strategies. 1. Importance of communication in conducting monetary policy Let me begin, then, with the importance of communication. For the Bank of Canada, communication is a strategic priority in supporting our goal of preserving low, stable, and predictable inflation. Indeed, I would submit that effective communication has become a vital tool in the implementation of monetary policy. Why this emphasis on communication as an important monetary policy tool? There are at least two key reasons: first, experience has shown that communication improves the effectiveness of monetary policy or, put another way, monetary policy is most effective when it is effectively communicated; and second, communication helps central banks to be more accountable. I want to touch on each of these points in turn. Like all public policies, monetary policy benefits from increased public understanding and support. This translates into what I call “legitimacy of policy.” Through clear explanation of why our policy objectives and actions are the right ones, we aim to gain public support for what we are doing. With success on this front, we begin to shape expectations and influence behaviour in ways that support policy outcomes. Central to our effort is clarity of purpose. We at the Bank of Canada have found that a clear statement of our objective - an explicit inflation target - is crucial. With the clear recognition and appreciation of this objective, agents in the economy - consumers, investors, businesses, financial market participants - begin to adjust their behaviour in ways consistent with an expectation that future inflation will be firmly in line with the inflation target. Price, wage, and financial decisions will tend to be consistent with the target. And the net effect will be a more stable macroeconomic environment and greater success in keeping inflation low and stable. The second reason why communications is important is accountability. A clear basis for judging a central bank’s performance is extremely important to its credibility and independence. For the Bank of Canada, the explicit inflation target is that basis for accountability. Put simply, the public can measure our performance by how successful we are in achieving the 2 per cent inflation target. The fact that we have had a pretty good record in this regard has reinforced our credibility and the public’s confidence that we will keep inflation at, or near, the target. But for the Bank to be fully accountable, we must not only communicate the information that the public needs to understand our policy objective and our progress in meeting that objective, but also the challenges that arise in the economic environment and the factors that we take into account in making decisions. Communicating all this information has become one of the Bank’s chief activities. 2. The need to be strategic in our communications To communicate successfully, we need to be strategic. That requires an effective, proactive approach to communications. So we have to identify who our audiences are and what communication vehicles are most effective in reaching them. We aim for effective dialogue with the public, the media, the markets, and other interested and influential constituencies. We want to further their understanding of monetary policy and foster public support for our goals and actions. At the same time, and equally important, we want to increase our understanding of the public’s views. This is clearly a continuous and iterative process. And the old communications principle, “Repeat, Repeat, Repeat,” is entirely appropriate. By repeating our fundamental messages about the framework we use to conduct policy and about our policy goals and why they are important, we are increasing the odds that these messages will take hold in the public consciousness and resonate in shaping behaviour. Through all our communications, we are providing the opportunity for public critique of our economic analysis, by economists, financial market players, journalists and reporters, politicians, and the public more broadly. This is constructive. Engaging the public in the issues is important in broadening awareness and understanding of monetary policy. Let me be a little more specific about this. As I have already noted, expectations play a critical role in the conduct of monetary policy. First and foremost, we want to anchor expectations about future inflation to our 2 per cent target. Financial market expectations about future policy actions are also important to us. Market expectations get reflected in medium- and longer-term interest rates, as well as prices of other financial assets, and these financial prices make up part of the overall financial conditions in the economy. We therefore pay close attention to market expectations, and indeed look to financial markets to get an independent view of the expected future path of interest rates. Bank staff, in our trading room and in our regional offices, are in regular contact with market dealers and investors in key financial centres, including Toronto, Montréal, New York, and elsewhere around the world. We also apply analytic techniques to extract from asset prices the views of market participants about the future path of interest rates. We look at interest rate futures, expectations implicit in the term structure of interest rates, and markets for instruments such as bankers’ acceptances, term repos, and treasury bills. This involves assessment about relevant term, risk, and liquidity premiums. In this way, we keep our finger on the pulse of the market, on its interpretation of our decisions and statements, and on its views as to where policy interest rates are headed. We also stay on top of published economic analyses and commentaries from financial institutions. And we review the surveys of economists’ and market participants’ expectations for interest rates that are published by the major wire services. All of this information, together with other economic and financial analysis, feeds into the Bank’s deliberations leading to our interest rate decisions and then into the messages we communicate about the decision to the public. If the iterative process and the two-way communication that I have just described work as they should, the views of the Bank and the markets should be broadly consistent. And this should help create an environment in which positive economic outcomes are achieved in an efficient manner. The Bank of Canada’s communications strategy is based on reaching our target audiences through a schedule of key publications and communications events throughout the year. This gives us a regular, continuous, and integrated program of communication with the public. It permits us to communicate our evolving views on the economy and the trend of inflation on a regular basis through the course of the year. These communications events include eight scheduled policy interest rate announcements, when we issue a press release, publication of our semi-annual Monetary Policy Report in April and October, Updates to the Report in January and July, frequent speeches by the Governor and other Governing Council members, public appearances before parliamentary committees, press conferences, and other media events and interviews. And a recent initiative has been to publish our regional office Business Outlook Survey, which summarizes business and industry views on their outlook for the economy and inflation. From the Bank’s perspective, we are encouraged by the progress we are making in engaging public interest in economic and monetary policy issues. The quantity and quality of media coverage of the Bank - both electronic and print - has increased markedly in recent years, especially since the adoption of a fixed schedule of regular dates for announcing policy interest rates. The C.D. Howe Institute’s creation of a shadow Monetary Policy Council last year to provide an independent analysis and view on interest rate decisions is making a constructive contribution to public awareness and debate. And the public traffic to the Bank’s Web site has grown enormously, indicating a growing public appetite for our published statements and information. These are encouraging indications that the public is reacting to our communications and, in many cases, providing us with tangible feedback. 3. Some practical challenges to a successful communications strategy Implementing an effective communications strategy for monetary policy in 2004 has some very real challenges. Today, I want to touch on a couple of these: first, how to communicate uncertainty; and second, how to capitalize on new technologies, specifically an effective Web site. (i) How to communicate about an uncertain future After many years of being involved in developing and communicating monetary policy, I have found that dealing with the simple fact that the future is uncertain is one of the most difficult communications challenges a central bank faces. Clearly, financial markets are hypersensitive to anything a central bank says about the future because the markets are looking for indications about where interest rates may be going. This makes talking about the future all the more challenging. Let’s remember, central banks do not have a crystal ball. Economies are always subject to events and shocks that are unforeseen. And the fact that monetary policy operates over a medium-term time frame compounds the communications challenge. How can a central bank best address this communications challenge? I believe that we must be able to tell a coherent narrative - in other words, a story. The story has to explain the logic of central bank decisions, but allow the public and the markets to make their own assessment of future Bank decisions. The story must be set in the context of a clear statement of the objective of policy, a view of the key macroeconomic relationships, especially the inflation process, and an understanding of the tools and the actions used to achieve our policy objective. But the story also has to recognize the forward-looking nature of monetary policy; that is, the considerable time lags between monetary policy actions and their effects. And it has to recognize that the outlook is uncertain and that the future path of interest rates will be linked to developments in the economy. In other words, the outlook is conditional - conditional on assumptions, such as an assumption about the world price of oil, and on views and analysis based on circumstances at a given point in time. This may not be an easy story to tell. But for it to be as clear as possible, the elements have to add up in a way that reflects the monetary policy framework we have adopted to conduct policy. This includes how the exchange rate fits into the framework. Fundamentally, we have to assess the implications of movements in the currency for aggregate demand since, in setting policy, we aim to keep aggregate demand and supply in balance in order to help keep inflation close to our target. Another important aspect of the story is to communicate a sense of the risks and uncertainties facing the economy. If our story does all this, then it will properly convey the key relationships, nuances, and conditional nature of policy. More specifically, what we do, primarily through our Monetary Policy Reports and Updates, is to provide a projection of those key macroeconomic variables - real GDP growth, the output gap, and inflation - that drive monetary policy decisions and give indication to the general direction of policy. We do not provide an interest rate path as part of these projections. Under an inflation-targeting framework, the policy consequences of changing circumstances or unanticipated events fall primarily on interest rates, and thus any projected interest rate path would be an unreliable guide to future policy actions. In other words, our commitment is to the policy objective, not to a particular interest rate path. Our communication focus is therefore on presenting and updating our macroeconomic “base-case” projection consistent with eliminating any output gap - positive or negative - and achieving the 2 per cent inflation target over the policy horizon of roughly 1 1/2 to 2 years. But in order to underscore the conditional nature of the base-case projection, we also discuss the main risks and uncertainties that we see, and we identify those issues that we will be watching closely. Let me offer a specific example from the Bank of Canada’s fairly recent experience. In the spring of 2002, there was evidence that demand pressures in the economy were growing more rapidly than had been anticipated, even though they were not yet showing up in price increases. Based on the evidence at the time, we raised our policy interest rate three times. By the first quarter of 2003, there was further evidence that inflation was above target, suggesting that strong domestic demand was putting pressure on the economy’s production capacity. So we raised our target overnight rate further in March and again in April. At that time, we concluded that the risks to the global economic outlook were more evenly balanced than they were the previous autumn, and we said so. Then the Canadian economy was sideswiped by a number of unanticipated developments, most notably SARS, BSE, and a rapid rise in the value of the Canadian dollar as part of a broad-based weakness in the U.S. dollar. The impact of these developments caused us to alter our outlook for economic activity and inflation in Canada. With inflation pressures easing, we lowered the policy interest rate in July and September to help support domestic demand. Through this period, there was some criticism of the Bank, that we had acted prematurely in raising rates and that, as a result, we had to reverse our decision. The fact of the matter is that conditions did change significantly. So our analysis and outlook changed accordingly, and we communicated the evolving story consistent with our monetary policy framework and its forward-looking nature. Like the baseball umpire says, “there’s strikes and there’s balls, and I calls ‘em as I sees ‘em.” (ii) Communication technologies: capitalizing on a good Web site A second communications challenge that I want to highlight is capitalizing on new technology. By shrinking time and space, new communication technologies have created enormous pressure to provide markets and the public with access to real-time information about monetary policy. Fortunately, these technologies offer the means to help address these pressures. So the Bank of Canada has put a lot of emphasis on developing and maintaining a high-calibre Web site. The Web has become particularly important for monetary policy communication because it helps facilitate equal treatment of target audiences and it enables us to respond more quickly to information needs. Our site gives the general public and more specialized audiences direct and immediate access not only to our releases, publications, speeches, and technical information, but also to more easily understandable information about the Bank and monetary policy. Thus, the Web supports our objective of being proactive in reaching the public, the markets, and specialized audiences with news and information. Last year, we were honoured to be presented with the “Central Bank Website of the Year” award by Central Banking Publications and Lombard Street Research. Nonetheless, we continue to work at improving and expanding the site. (If I might add a plug, our Web site address is bankofcanada.ca; banqueducanada.ca.) Our audio “Webcasts” of speeches and press conferences by the Governor have been highly successful. They provide the instant access that markets and media want, to what the Bank is saying on monetary policy issues, as we say it. They also enable journalists and market participants from anywhere in the world to tune in “in real time.” Our Web site plays an important role in supporting our financial market activities. Dealers and distributors can find up-to-the-minute information on securities auctions and tenders, plus historical yield data and a variety of technical documents. And the site permits much wider distribution of the Bank’s research than was possible in the past. The Web is maturing as a medium, and the Bank will continue to exploit it to communicate more directly and effectively with its target audiences. Economic outlook Now, I want to take a moment to review the economic outlook. As I do this, I will be referring to some of the same terms and concepts that I have identified in my remarks today as important in helping the Bank tell a coherent story about the conduct of monetary policy. Canada’s economic growth in the first half of this year was somewhat stronger than the Bank had been expecting. This was largely as a result of more robust external demand for Canadian goods and services. With domestic demand only slightly weaker than expected, the growth of aggregate demand in the first six months was a little stronger than we had anticipated. Thus, the output gap at mid-year was smaller than we had projected. Indeed, we judge that the economy is now operating close to its production capacity. Inflation, both total and core, has been volatile in recent months, primarily because of swings in energy prices and because of automobile purchase-incentive programs. Despite this volatility, we continue to project that core inflation will gradually move up to the 2 per cent target in 2005. Looking forward, we expect aggregate demand to grow at, or marginally above, the rate of growth of production capacity. With the economy operating close to capacity, monetary stimulus needs to be reduced to avoid a buildup of inflationary pressures and contribute to sustainable, solid economic growth. It is in this context that we raised the target for the overnight rate by 25 basis points on 8 September to 2 1/4 per cent. As we pointed out then, there are uncertainties around the outlook. These uncertainties continue to relate primarily to three factors: the estimated size of the output gap, the future growth of Canadian exports and imports, and the overall effect on the Canadian economy of current and future movements in the world prices of oil and non-energy commodities. In conducting monetary policy, the Bank will continue to pay attention to these factors as we assess the evolving prospects for pressures on capacity and inflation. We will provide a detailed analysis of the outlook for inflation and the economy in our Monetary Policy Report, which will be published on 21 October. That Report will also extend our economic projections into 2006. Conclusion Let me conclude by summarizing my main points. First, communication has become another vital tool in the implementation of monetary policy. Thanks in part to effective communication, Canadians are now more confident that inflation will be kept near the 2 per cent target, and this expectation is feeding into their day-to-day decision-making. Second, central banks need to be strategic in their approach to communications. By communicating in a timely and effective way, we can engage the markets and the public in the issues we face. At the same time, public input helps make monetary policy more effective. And finally, there will continue to be numerous day-to-day challenges in communicating monetary policy. But in addressing these challenges, be they complex ones like the conditionality and forward-looking nature of monetary policy or technical ones like capitalizing on new technology, we are always striving to achieve better, more effective policy. Communications is indeed a vital tool in helping the Bank achieve the goal of low, stable, and predictable inflation. But it is important to remember that low inflation is not an end in itself. Ultimately, it is the means by which monetary policy contributes to Canada’s solid economic performance and to the rising living standards of Canadians.	bank of canada	2,004	10
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Nation Builders Dinner, Famous 5 Foundation, Calgary, 13 October 2004.	David Dodge: The new Canadian $50 banknote Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Nation Builders Dinner, Famous 5 Foundation, Calgary, 13 October 2004. * * * Good evening. I am very glad to be here tonight. This has been an exciting day for the Bank of Canada. This morning, we unveiled a new $50 note that celebrates nation building: shaping the political, legal, and social structures for democracy and equality. As you know, one of the events and themes commemorated on the new $50 bank note is the Persons Case. I am especially pleased to be here tonight, helping to celebrate the 75th anniversary of that historic case, and honouring the Famous Five, who helped to enshrine the rights of all individuals, in Canada and other countries around the world, to participate on equal terms in political life. Like the Persons Case, the new $50 note is about more than the rights of women to participate in public office. This new bank note celebrates the ability of individuals to make a profound difference and to help make Canada a country where rights and freedoms are secure. That is why we have also included on the new note a tribute to Thérèse Casgrain, a pioneer of civil rights in Canada. Through her involvement in provincial, national, and international organizations, Thérèse Casgrain worked to help the disadvantaged, improve the rights of women, and reform society for the benefit of all citizens. In honour of this remarkable Canadian, the Thérèse Casgrain Volunteer Award medallion, pictured on the back of the note, celebrates Canadian volunteers who advance a worthy cause and contribute to the well-being of their fellow citizens. We were honoured to have Renée Casgrain-Nadeau, Thérèse Casgrain’s daughter, help us to unveil the $50 note earlier today. And I’m very glad to see members of the Casgrain family here tonight. Above all, the $50 note celebrates the right of all people to participate fully in society and to enjoy the benefits of living in a culture that protects their individual rights and freedoms. That is why we have included on the $50 note a quote from the Universal Declaration of Human Rights: “All human beings are born free and equal in dignity and rights.” These rights help to shape and advance a democratic society. And it is through a nation’s laws and public institutions that these rights are supported and protected. The Bank of Canada has played an integral role in Canadian society since 1935. We’re just a little younger than the Persons Case - next year, we celebrate the 70th anniversary of our founding. And we’re keenly aware of our place in this country’s civic infrastructure. The Bank was founded at a time when this country was struggling to define itself and to survive the economic and social turmoil of the Great Depression. Let’s remember that, during the 1930s, Canada’s economy shrank by more than that of any nation other than the United States and took longer to recover. The Depression hit especially hard in Western Canada - at its peak, an estimated two-thirds of the people in the rural Prairies were on some form of government relief. During this time, the first elements of Canada’s social welfare system were being created. And new social pressures were altering the economic and political life of the nation. In this environment, the Bank of Canada opened its doors in March 1935, to provide an effective, centralized monetary authority for Canada. Then, as now, our mandated role has been to regulate credit and currency in the best interests of the economic life of the nation and, generally, to promote the economic and financial welfare of Canada. To that end, the Bank’s monetary policy contributes to solid economic performance and rising living standards for Canadians by keeping inflation low, stable, and predictable. We issue bank notes that Canadians can use with confidence that they will be widely accepted. The new $50 is a good example of that. We also promote a safe, sound, and efficient financial system, and provide funds-management services for the Government of Canada. Our work is hardly the stuff that usually gets people excited. No one has erected a statue to celebrate really effective monetary policy. But no civic infrastructure is more important than one that allows all citizens to have confidence in the value of money and in the soundness of their economy. Building a civic infrastructure that promotes social, economic, and political confidence is no easy task. It requires hard work by dedicated individuals. Irene Parlby was such an individual. Her support of the United Farmers of Alberta, and her subsequent political career, began as a struggle to improve the incredibly harsh conditions faced by women on Alberta’s farms. As societies have progressed, and economies have become more open and connected around the world, there has been growing attention paid to the ideas of economic, social, and cultural rights. These are part of a larger body of human rights law that developed following World War II. In 1948, they were enshrined in the Universal Declaration of Human Rights. The Famous Five recognized the importance of economic rights much earlier than that, and worked to put in place laws that extended these rights to women. For example, Louise McKinney, Henrietta Muir Edwards, and Emily Murphy helped to establish the Dower Act in 1917, which granted Alberta women property rights in marriage. And Nellie McClung spent much of her political life fighting for mother’s allowances, better public health services, and improved property rights for married women. Now, in Canada, we have created a society where most of us can take for granted our right to earn a fair wage and provide for our families. But we should not underestimate the importance of macroeconomic policies, frameworks, and institutions that support the standard of living that we enjoy. For example, low, stable, and predictable inflation means that our salaries and our savings aren’t eroded by rising prices, nor will our economy be devastated by deflation as it was in the 1930s. Good monetary policy means that we can plan for the future with confidence. A sound financial system means that we can conduct financial transactions with equal confidence. A secure currency means that we can use cash with confidence that bank notes will be readily accepted, and without fear of being stuck with a counterfeit bill. At the Bank of Canada, we are always mindful of our commitment to Canadians - to contribute to the economic well-being of this country. Part of that commitment is to communicate our objectives openly and effectively and to stand accountable for our actions. The Famous Five and Thérèse Casgrain remind us of the tremendous influence that individuals can have on society. As Louise McKinney said, and I quote, “The purpose of a woman’s life is just the same as the purpose of a man’s life - that she may make the best possible contribution to the generation in which she is living.” We each have a responsibility to contribute to the society in which we live. As a public institution, the Bank of Canada takes this responsibility seriously. We know that by fulfilling our economic role in Canadian society - by giving Canadians confidence in the value of money - we make an important social contribution as well. The Bank of Canada will continue to promote the economic well-being of Canada and Canadians. That is our commitment to you. Tonight, we celebrate the commitment of five individual Canadians to the advancement of human rights in our country. This is something truly worth celebrating, and I thank the Famous 5 Foundation for inviting me to join you on this occasion of the 75th anniversary of the Persons Case.	bank of canada	2,004	10
Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, Ottawa, 21 October 2004.	David Dodge: Summary of the latest Monetary Policy Report Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, Ottawa, 21 October 2004. * * * Today, we released our October Monetary Policy Report. The Report reviews economic and financial trends in the context of Canada’s inflation-control strategy. The Canadian economy has grown faster than was projected in last April’s Monetary Policy Report and the July Update, largely because of a surge in exports. It is now operating near its production capacity and continues to adjust to global economic developments. The Bank’s base-case projection for the period to the end of 2006 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, the Bank projects economic growth 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 to the 2 per cent target by the end of 2005. Given the path suggested by futures prices for crude oil, the Bank expects total CPI inflation will rise to 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. Against this background, the Bank raised its target for the overnight rate to 2.5 per cent on 19 October. The base-case projection assumes further reduction of monetary stimulus over time, to keep the economy near its production potential and to achieve the inflation target. The pace of interest rate increases will depend on the Bank’s continuing assessment of the prospects for factors that affect pressures on capacity and, hence, inflation. There are significant risks and uncertainties around this base-case projection, related to the adjustment to changes in the global economy, including changes in commodity prices and exchange rates. The risks surrounding global economic prospects relate primarily to the evolution of oil prices, the pace of expansion in China, the way in which current account imbalances in the United States and East Asia will be resolved, and geopolitical developments.	bank of canada	2,004	10
Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the House of Commons Finance Committee, Ottawa, 26 October 2004.	David Dodge: Economic and financial trends in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the House of Commons Finance Committee, Ottawa, 26 October 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 Members of Parliament 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. Since we last met, we are pleased to have issued Canada’s new $20 bank note with enhanced security features. The new note began circulating on 29 September. Last Thursday, we released our October Monetary Policy Report, which reviews economic and financial trends in the context of Canada’s inflation-control strategy. When Paul and I appeared before this Committee last April, we told you that the economy was judged to be operating significantly below its potential. That is no longer the case, because the Canadian economy has grown faster than was projected in last April’s Monetary Policy Report and the July Update. This stronger growth was largely due to a surge in exports. The economy is now operating near its production capacity and continues to adjust to global economic developments. The Bank’s base-case projection for the period to the end of 2006 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, the Bank projects economic growth 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 to the 2 per cent target by the end of 2005. That is the same projection that we made last April. However, given the path suggested by futures prices for crude oil, the Bank expects total CPI inflation will rise to 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. Against this background, the Bank raised its target for the overnight rate to 2.5 per cent on 19 October. The base-case projection assumes further reduction of monetary stimulus over time, to keep the economy near its production potential and to achieve the inflation target. I want to emphasize that the pace of interest rate increases will depend on the Bank’s continuing assessment of the prospects for factors that affect pressures on capacity and, hence, inflation. There are significant risks and uncertainties around this base-case projection, related to the adjustment to changes in the global economy, including changes in commodity prices and exchange rates. The risks surrounding global economic prospects relate primarily to the evolution of oil prices, the pace of expansion in China, the way in which current account imbalances in the United States and East Asia will be resolved, and geopolitical developments.	bank of canada	2,004	11
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.	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 for factors that affect pressures on capacity and, hence, on inflation. Paul and I have just returned from last weekend’s meeting of the G-20 in Berlin. The issues we discussed there line up very closely with those issues we identified and analyzed in our Report commodity prices, realignment of currencies, global imbalances, and the growing presence of emerging-market economies such as China and India. While we remain broadly comfortable with the global growth scenario we outlined in our Report, discussions this weekend and at other recent international meetings suggest a slight moderation in global growth prospects, despite the fact that both spot and futures prices for oil have declined somewhat during the past month. Since the October Report, one of the most significant developments has been a further depreciation of about 5 per cent in the value of the U.S. dollar against other major floating currencies, including the Canadian dollar. If current exchange rates were to be sustained - and if all other economic and financial factors were to remain unchanged - this would have a dampening effect on aggregate demand for Canadian goods and services. Since monetary policy aims to keep aggregate demand and supply in balance in order to keep inflation close to our target, we need to assess the implications of movements in the currency for aggregate demand and the context in which they occur - that is, the changes in other economic and financial factors. In conclusion, I want to stress that the Bank assesses the full set of information before each of its fixed announcement dates, and we will do so again before our 7 December announcement. Mr. Chairman, Paul and I now will be happy to answer your questions.	bank of canada	2,004	11
Notes for remarks by Mr David Dodge, Governor of the Bank of Canada, on behalf of the Canadian Minister of Finance, Mr Ralph Goodale, to the German-Canadian Business Club of Berlin-Brandenburg-Association of Berlin Merchants and Industrialists, Berlin, 22 November 2004.	David Dodge: The strength and resiliency of the Canadian economy Notes for remarks by Mr David Dodge, Governor of the Bank of Canada, on behalf of the Canadian Minister of Finance, Mr Ralph Goodale, to the German-Canadian Business Club of Berlin-Brandenburg-Association of Berlin Merchants and Industrialists, Berlin, 22 November 2004. * * * It is an honour to be with you today. As you may know, this is the second time that I have visited Berlin. In June 2003, I had the honour to speak at this group’s founding ceremony in my role as the Governor of the Bank of Canada on the need, based on Canada’s experience, for a solid economic policy during uncertain times. I have very fond memories of this visit and I am pleased to see so many familiar faces today. Since that time you have made great efforts to promote strong German-Canadian trade relations and build a better understanding of the economic and social conditions in both of our countries. Today I would like to speak to you on behalf of Canada’s Minister of Finance, Ralph Goodale, who sincerely regrets not being able to be with you today. In his Economic and Fiscal Update November 16, Minister Goodale described the remarkable strength and resiliency of the Canadian economy following numerous shocks in 2003, including SARS, a single, isolated case of “mad cow” disease and the strong appreciation of the Canadian dollar. Canada weathered this period of economic slowdown, and has recovered from relatively weak growth of two per cent in 2003. In fact, Canada saw growth of 3.4 per cent in the first half of the year - much stronger than expected. Private sector forecasters now expect growth of three per cent for all of 2004, and 3.2 per cent growth in 2005. In the Bank of Canada’s recent Monetary Policy Report, the Bank projects economic growth of 2.9 per cent in 2005 and 3.2 per cent in 2006. The origins of this success can be found in policies that began a decade ago. In 1993 Canada had the second-worst government debt-to-GDP ratio among G-7 countries. It had high unemployment. It had low productivity growth. Federal debt servicing costs were absorbing 38 cents of every dollar of government revenue. This situation was clearly unsustainable, and many difficult and unpopular decisions had to be taken to clean up public sector balance sheets during the 1990s. In 1994 the Government launched a series of expenditure reductions which, by 1997, had reduced program spending by almost 20 per cent. In 1996, action was taken to introduce major reforms to our nation’s public pension plan, to put it on a sound financial footing. Taking these actions was very difficult. So, what was essential during this time was clearly communicating to Canadians the steps that had to be taken to get our fiscal house in order, and the ominous consequences of not doing so. Fortunately, Canadians understood that you can’t forever consume more than you produce. They displayed the innate good sense necessary to make short-term sacrifices for the long-term interests of their families. As a result, Canadians transformed a vicious circle of rising deficits and debt into a virtuous circle of balanced budgets and surpluses, and falling debt. Reducing, and ultimately elimating, the deficit in the 1990s helped Canada’s international credibility and led to a reduction in the risk premium demanded by investors. This fiscal improvement allowed for lower interest rates, and made easier the implementation of monetary policy. Not only did lower interest rates reduce debt-servicing costs, they also stimulated economic growth, which brought in more revenues for the government. The extra revenues and lower debt-servicing costs, in turn, led to an even better fiscal position. The results have been striking. Canada has been among the G-7 leaders in economic growth since 2000. Canada is the only G-7 country expected to post a total government sector surplus this year and next. As a result of this reduction in the federal debt, public debt charges as a share of revenues have fallen from 38 per cent to just over 19 per cent - the lowest level since the 1970s. The federal debt-to-GDP ratio has fallen from a peak of 68 per cent to 41 per cent last year. And the Government has set the objective to reduce that to 25 per cent within 10 years. Business confidence is also high, and investment is increasing. The main point here is that, in the end, tough choices pay off. While the initial work of fiscal consolidation is certainly difficult, it pays dividends later on. Now that Canada is in the midst of this virtuous circle, the Government has the means to invest in key priority areas, while at the same continuing to meet its fiscal targets. One of these priority areas is health care. In September, the federal government and Canadian provinces and territories announced a 10-year, $41 billion heath accord that would focus on streamlining health care delivery, training more health professionals, investing in better equipment, and enhancing research and innovation. The Government is also focused on the delivery of other key commitments to Canadians, including: • High-quality early childhood development; • Predictable and long-term funding to municipalities for critical infrastructure needs; • Meaningful action on the disparities that impede opportunities for Aboriginal Canadians; and • Meeting the imperatives of national defence and national security. As Minister Goodale said in his Economic and Fiscal Update presentation, meeting these priorities will require ongoing fiscal discipline. It will also require attention to improving productivity. But given the current high ratio of employment to population, and given that Canada’s population will soon begin to age rapidly, we will have to rely increasingly on productivity to raise living standards in the future. To increase productivity, we Canadians need to invest in human capital, physical capital and innovation - the three drivers of productivity growth. The key will be to adapt to change through policies that promote flexibility. That’s why Canada is investing in the skills and knowledge of our people, and is creating a competitive environment through lower taxes that encourage investment in physical capital and reward the efforts of entrepreneurs. These flexibility-enhancing policies, along with lower barriers to trade, smart regulation and openness to international investment, are the building blocks of Canada’s modern and prosperous economy. Collaboration between Canada and Germany is part of this effort to encourage international investment. As one example, our two countries have a long-standing relationship in science and technology. The driving force behind this relationship is the Bilateral S&T Cooperation Agreement, signed in 1971. And there is the very successful partnership between the National Research Council of Canada (NRC) and the Helmholtz Association of German National Research Centres. The Canadian Embassy in Berlin deserves real credit for encouraging this flourishing collaboration, and promoting technology-oriented partnerships. Such cooperation is critical in an increasingly connected global economy. So, too, are forward-looking initiatives such as the Trade and Investment Enhancement Agreement between Canada and the EU, which would allow qualified workers to move much more easily between the EU and Canada and would enhance the ability of our financial sectors to seize investment opportunities. Once concluded, this Agreement would present Germany, Europe and Canada with a unique opportunity to make our economies more global, more efficient and more prosperous. Now let’s turn to a different issue. As you know, G-20 Finance Ministers and Central Bank Governors met in Berlin over the weekend. Among the themes of our discussions were the importance of promoting flexibility in national economies to help adjustment to changing circumstances, and the need for reductions of global imbalances. The importance of a sound domestic and international financial system to facilitate the trade, savings and investment necessary to bring about a reduction of these imbalances was also discussed. So let me conclude these remarks this morning with a few thoughts on the importance of international monetary arrangements to facilitate the reduction of imbalances. Most major industrialized countries and a large number of emerging market countries are operating with flexible exchange rates. The notable exceptions are China and a number of countries in Southeast Asia which, either explicitly or implicitly, tie their currencies to the yuan, which is in turn pegged to the U.S. dollar. With two systems operating, not everyone is playing by the same “set of rules,” and imbalances are building. The concern is two-fold: • First, the sense that some countries are not playing by the rules could give rise to protectionism, with potentially very serious negative consequences for the global trading system. • And second, a disproportionate burden of adjustment to changing economic circumstances is being borne by those of us with flexible exchange regimes, including Canada and Europe. So there is a real need, going forward, to think hard about these international monetary arrangements. Of course, there is much more to the resolution of global imbalances than just exchange rate regimes. There are issues of savings and investment flows and of promoting strong economic growth worldwide, through strong domestic demand in each country. But the issue of international monetary arrangements deserves critical attention and debate, as we look out over the medium- and longer-term to the challenges facing the global economy. To conclude, I hope these remarks give you a good perspective on the fiscal health of the Canadian economy and on some of the bilateral initiatives between our two countries. As well, I hope that I have given you some food for thought on international monetary arrangements. Thank you for your attention. Let’s now turn to hear your views.	bank of canada	2,004	11
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Empire Club of Canada and the Canadian Club of Toronto, Toronto, 9 December 2004	David Dodge: Financial system efficiency - a Canadian imperative Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Empire Club of Canada and the Canadian Club of Toronto, Toronto, 9 December 2004. * * * Good afternoon. It is a privilege for me to address this joint meeting of the Empire and Canadian clubs, and I thank you for the opportunity to do so. I am particularly pleased to speak to you today because this is a bit of a red-letter day on the Bank of Canada’s calendar. Today, we released the latest edition of our semi-annual Financial System Review (FSR). This publication, which is only a couple of years old, examines issues that relate to Canada’s financial system. Each edition of the FSR takes a look at recent developments and trends in the financial system, as well as issues that have an impact on its efficiency, safety, and soundness. This is because the overall role of the Bank in the financial system area is to promote its safety, soundness, and efficiency. Today’s edition contains a number of articles that focus on the promotion of financial system efficiency and stability. And it is the issue of financial system efficiency that I will talk about today. I will begin with a brief discussion of how the Bank of Canada contributes to the efficiency of the financial system at the macroeconomic level. Then, I will spend most of my time discussing how we can improve efficiency in Canadian financial institutions and markets; that is, the microeconomic aspects of efficiency. But before I do that, I should start by defining what I mean by “financial system” and “efficiency.” Then, I will explain why it is so critically important for Canada to improve in this area. When I talk about the “financial system,” I am referring to financial institutions and markets, the infrastructure, laws, and regulations that govern and support their operations, and the macroeconomic framework within which they operate. My message for you is that improving the efficiency of Canada’s financial system is imperative. But what is an efficient financial system? In economic terms, an efficient financial system is one that helps to allocate scarce economic resources to the most productive uses, in a cost-effective way. The ultimate goal is to have Canada’s financial institutions and markets match investors and their savings with appropriate, productive investments. Put more directly, if Canadians want sustainable economic growth and prosperity, our financial system must function as efficiently as possible. Let me explain why efficiency is so important. With an efficient system, investors can get the highest risk-adjusted returns on their investments and borrowers can minimize the costs of raising capital. Inefficiencies can drive a wedge between what borrowers pay and what investors receive. I’ll give you some examples of how inefficiencies can interfere with the saving and investment process that is so crucial to economic growth. If adequate information isn’t available, potential investors can’t tell whether a particular investment fits with their tolerance for risk. If financing costs are too high because of inefficiencies, borrowers won’t be able to secure the funds they need to expand. If competition isn’t encouraged, the various players in the financial system won’t have the right incentives to innovate. This is why it’s so critical for the financial system to work efficiently. Efficiency and the Bank of Canada I would now like to spend a few minutes on the Bank of Canada’s role in promoting an efficient financial system. In order to have such a system, we need above all a supportive framework of macroeconomic policies that minimize uncertainty and enhance confidence about the future value of money. This includes prudent fiscal policies, which are the responsibility of ministers of finance. It also includes effective monetary policy, which is the Bank of Canada’s responsibility. We achieve effective monetary policy through our system of inflation targeting. One of the key benefits of this regime is that inflation expectations have become well anchored on the 2 per cent target, not just in the short term, but also in the long term. As a result, borrowers now pay a much smaller 1/4 premium to compensate investors for inflation risk. This is particularly important at the long end of the yield curve. Reduced uncertainty has led to lower costs for borrowers and to a more efficient allocation of resources. The promotion of a safe and sound financial system that reduces uncertainties and systemic risk can also contribute to efficiency. We work in partnership with federal and provincial agencies, regulators, and market participants in this area, in order to actively foster the safety and soundness of the financial system. We also have a number of unique responsibilities. It is our role, for example, to oversee those payment, clearing, and settlement systems that could pose systemic risk. These systems have been designed to provide certainty that large-value payments or securities transactions will settle in real time. In addition, they have been designed to operate using a relatively small amount of liquidity compared with systems in other countries. This frees up resources that can be put to more productive use elsewhere. The Bank of Canada is also the “lender of last resort” - the ultimate provider of liquidity to the financial system. Indeed, we’ve just concluded a review of that role, and the details can be found in the FSR that we released today. There is also an international element to our efforts. The Bank of Canada works with partners in other countries on initiatives to strengthen the international financial system. The goal is to minimize the risk of a financial crisis in one part of the world spreading across borders. But that’s a topic for a whole other speech. So to summarize, Canada’s macroeconomic and prudential policies generally do the job they are supposed to do in supporting efficiency. But let me be clear - we are not complacent; we are always looking for ways to improve. Continuous improvement is essential. Efficiency in financial institutions and markets Now, I want to talk more specifically about the microeconomic aspects of efficiency in financial institutions and markets, including the promotion of competition and the provision of an appropriate legal and regulatory framework. Competition drives innovation and efficiency gains. And an appropriate legal and regulatory framework gives all investors fair access to necessary information, while minimizing the costs of raising capital. The evidence shows that Canada’s financial institutions and markets have generally been efficient when compared with those in other countries. But over the past decade, markets and financial institutions elsewhere have become - and are becoming - more efficient. To stay competitive in this environment, Canada’s financial system must also constantly increase its efficiency. If we don’t make this effort, the Canadian economy will suffer. The status quo won’t cut it. So what should our priorities be? I’ll talk about financial institutions first and then about financial markets. Efficiency and financial institutions In terms of financial institutions, a quick look backward may show us the way forward. I want to go back 40 years, to 1964, and recall the Royal Commission on Banking and Finance, otherwise known as the Porter Commission. The Porter Commission was well ahead of its time, with groundbreaking analysis and policy recommendations. In the post-World War II environment, where extensive government controls on the economy were still thought desirable, Porter came out strongly in favour of greater competition, freer markets, and effective regulation that served to enhance efficiency. In the wake of the Porter Commission, Canada revised its financial legislation in some crucial ways. Canadian banks responded to the new competitive environment by innovating and enhancing efficiency. Canadian institutions became world leaders, as financial institutions in many other countries were still operating under more restrictive and less-efficient regulatory regimes. Over the next three decades, Canada continued to lead the world. Successive revisions of legislation covering financial institutions encouraged greater cross-pillar competition in some areas, leading to lower costs and improved efficiency. But over the past decade, other countries have caught up and are forging ahead. During this time, two trends changed the global environment for financial institutions. First, with the expansion of world trade, national markets became truly global. Financial institutions had to find ways to provide enhanced services to customers worldwide. Second, other countries - particularly the United States and the United Kingdom - began to align their regulatory frameworks with the 2/4 competitive philosophy of the Porter Commission. The regulatory barriers that had held back competition, both geographically and among different types of institutions, began to fall rapidly. Out of this more open and competitive environment came consolidation - not just among institutions but across pillars and jurisdictions. As a result, foreign institutions were better placed to exploit new technologies in order to enhance efficiency, and to offer new instruments and combinations of services to their clients. These two trends have led to great benefits for consumers worldwide, and they are continuing. In these circumstances, Canada faces a difficult policy challenge. How can we enhance our policy framework to provide greater incentives for innovation by encouraging competition while, at the same time, giving our institutions the scope to improve efficiency? This is the challenge for Canadians in considering mergers, both within and across pillars, and the removal of barriers to foreign competition. The questions about the best ways to enhance competition - to balance incentives for efficiency with other legitimate public policy concerns - are complex. And I don’t have simple answers. But efficiency must be at the heart of the debate. Because, in the end, an efficient financial system is key for the future - not just of the institutions, but of the Canadian economy as a whole. Financial market efficiency Let me now turn to financial markets. When it comes to the competitiveness of global financial markets, size, depth, and liquidity do matter. So Canadian financial markets - whether equity, fixed-income, derivatives, or foreign-exchange - have an inherent disadvantage compared with those in New York or London. To compensate, Canadian financial markets have to be relatively even more efficient. So what can Canada do to improve the efficiency of its markets? One area that has received a lot of attention, not just in Canada but in many other countries, is securities regulation. The key issue is to reduce what economists call “information asymmetries” by as much as is practical. What that means is that our regulatory framework should aim - in general - at having market prices reflect all relevant information, and that all parties to a transaction should have fair access to that information. We can enhance efficiency by reducing information asymmetries up to the point where the cost of additional compliance would outweigh the benefits. Following events such as Enron, Parmalat, and Livent, it became clear that investors were not always receiving sufficient and accurate information. Corporate scandals prompted many an investor to say: “There oughta be a law!” - a law to make publicly traded companies disclose all information. But in the rush to write laws and regulations, too much attention has been paid to detailed rules that govern how companies disclose information, rather than focusing on what they disclose. We have seen a large increase in the costs of providing information - particularly in the United States - without commensurate progress towards improving the relevance of the information being disclosed. The concept of relevant disclosure is particularly important for a country like Canada, where public companies range in size from the very small to the large and multinational. The precise nature of what constitutes relevant information differs depending on the size and complexity of the firm. Corporate disclosure regulations should recognize this. For large, complex firms, more complex rules are required in order for investors to receive appropriate information. But for smaller firms, less-complex disclosure regulations - and lower costs of compliance - may result in the best cost-benefit balance. The Canadian Securities Administrators recognized this point in putting forward new proposals for guidelines for corporate governance that are based on a firm’s size. There is another consideration, and that is the need for some companies to have access to global capital markets. Firms that want to list on international exchanges will have to follow the disclosure rules that apply in those markets. And large Canadian firms that want to raise capital abroad need regulations here that are recognized as meeting international standards. But smaller, less-complex firms - which make up the vast majority of publicly listed companies in Canada - may not want to raise capital abroad. So it may not make sense for Canadian regulators to force these smaller firms to comply with the kinds of detailed rules that would be appropriate for large firms. Let me be clear. The principles at the heart of Canada’s regulatory framework must be as good as, or better than, those of any other country. But keep in mind that companies considered to be mid-sized in terms of capitalization in Canada would be regarded as micro-capitalized by international standards. Historically, Canada’s public markets have done very well in funding these smaller companies 3/4 efficiently. This should continue in the future. So it is clear to me that our regulatory framework should take into account differing levels of size and complexity when establishing rules for disclosure. The rule requiring CEOs to sign-off on their financial statements is a case in point. The principle behind the rule is to try to make sure that investors have sufficient and accurate information. Holding the CEO accountable is a good way to go about this. The principle can work equally well for large and small firms. But we need to be careful. For very large and complex organizations, setting out some detailed rules in terms of procedures may be helpful. However, we do not need a whole raft of complex rules that tell the CEOs of smaller firms what procedures they must follow before they can put their signatures on their financial statements. We need to be careful not to write rules that govern only the inputs that come before the CEO sign-off. Rather, we need to focus on getting the output right, so that the document that the CEO signs actually gives investors sufficient and accurate information. Efficiency dictates that Canada should have uniform securities laws and regulations, based on principles that apply to everyone. Some have taken this idea further and advocated for a single, pan-Canadian securities regulator. I’m not here today to weigh in on that debate. But I do want to stress that, whatever the structure of the regulator, we must strive for efficiency in regulation - the best regulation, at the lowest cost. Now let me talk briefly about another important information issue, and that is the issue of price transparency in markets. Here, I am referring to timely, public disclosure of transaction details, such as price and volume. It is not difficult to see how this information leads to better resource allocation. The appropriate level of transparency may vary from market to market. Generally, the more liquid the market, the higher the level of transparency it can support. However, the world is moving to greater transparency in all markets through the spread of technology. The Bank of Canada is conducting research and working with market participants and regulators on ways to increase transparency in Canadian markets, with due regard for liquidity, equitable access, and fair play. Together with price transparency, these are the ingredients that help to create efficient, well-functioning markets. It is important that we get transparency and regulation right. But we also need to devote the appropriate time and effort to making the most of whatever rules we write, including existing ones. This means focusing on a range of smaller initiatives that can enhance efficiency. For example, provincial and territorial legislatures need to make the Uniform Securities Transfer Act a priority. Such an act would provide a sounder legal basis for the holding and transfer of rights in securities that are held in book-entry form, and would replace the current patchwork of legal rules in this area. Another initiative is the Canadian Capital Markets Association’s focus on trade-matching to support progress towards straight-through processing. There’s one more area where it is absolutely critical for Canada to continue to improve, and that is enforcement. There is a widely held perception that Canadian authorities aren’t tough enough in punishing fraud and enforcing insider-trading and other rules. That’s why it is encouraging to see that steps to toughen enforcement are being taken, by provincial securities commissions, by the Investment Dealers Association, by law-enforcement agencies, and by the federal government. These kinds of steps to improve enforcement must continue. Conclusion Let me conclude. To improve the economic and financial welfare of Canadians, we need an efficient financial system. The Bank of Canada has been contributing to this goal by enhancing Canadians’ confidence about the value of their money and by reducing risks to the safety and stability of the financial system. Our Financial System Review is part of this effort. But the effort must extend far beyond the central bank. I’ve raised some issues today that I think are critical to enhancing the efficiency of our financial system. None of these issues are new. They have been studied and analyzed thoroughly. But while Canada has been studying and analyzing, the rest of the world has been acting. It’s time for us to act, too. We have to get on with the job of improving efficiency. The future health of our economy and the prosperity of Canadians depend on it. 4/4	bank of canada	2,004	12
Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report Update, Ottawa, 27 January 2005.	David Dodge: Summary of the latest Monetary Policy Report Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report Update, Ottawa, 27 January 2005. * * * Today, we released the Update to our October Monetary Policy Report. The Update reviews economic and financial trends in the context of Canadaâ€™s inflation-control strategy. The outlook for the Canadian economy continues to be shaped by global developments, including the realignment of world currencies. The near-term outlook for the global economy is a touch weaker than projected in the October Report, but more solidly based because of somewhat lower oil prices and greater confidence in the momentum of the U.S. economy. We expect the Canadian economy to operate a little further below its full production capacity in 2005 than was anticipated at the time of the last Report, largely reflecting the dampening effects on aggregate demand of the recent appreciation of the Canadian dollar. For 2006, we project growth to pick up to slightly more than 3 per cent, consistent with returning the economy to its production capacity in the second half of the year, and returning core inflation to 2 per cent around the end of 2006. In line with this revised outlook, the pace of reduction in monetary stimulus is likely to be slower than that envisioned in the October Report. There are both upside and downside risks around the outlook, which continue to relate to the adjustment to global developments. As circumstances change, we always need to be ready to re-assess the policy implications.	bank of canada	2,005	2
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Vancouver Board of Trade, Vancouver, 17 February 2005.	David Dodge: Monetary policy and exchange rate movements Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Vancouver Board of Trade, Vancouver, 17 February 2005. * * * Good afternoon. It is always a pleasure for me to return to Vancouver, a city I called home for a year. And now that I live in Ottawa, I can tell you that it is particularly nice to get the chance to come here in the middle of February. Every year, the Canadian Press surveys news directors and editors to select the top business story of the year. In 2004, they picked the rise of the Canadian dollar. That was not a surprising choice. The dollar's appreciation drew a lot of attention from the media, from business people, from individual Canadians, and indeed, from the Bank of Canada. Changes in the external value of the dollar are one of the key factors that we scrutinize and work hard to understand. We watched the dollar closely as it depreciated during the 1990s, as it fell to an all-time low against the U.S. dollar in early 2002, and as it rose by roughly 25 per cent between January 2003 and January of this year. With the rapid appreciation of our dollar has come an increase in public commentary about the currency - its effects on the Canadian economy in general, and the Bank of Canada's monetary policy in particular. There has been no shortage of stories broadcast or articles written. At the Bank, we welcome this increased interest. Canadians should discuss important economic issues that affect their daily lives. However, some of this commentary has oversimplified how movements in the exchange rate affect the Canadian economy and monetary policy. I don't mean this as a criticism. The relationship between the exchange rate, the economy, and monetary policy is complex. So today, I want to talk about the various factors that influence the exchange rate, examine how these factors affect the Canadian economy, and lay out how the Bank takes them into account as we conduct monetary policy. In doing so, I will elaborate on the contents of a technical box in our latest Monetary Policy Report Update, published on 27 January. The exchange rate in an inflation-targeting framework Let me begin with a brief review of Canada's monetary policy framework. At the heart of our monetary policy is the idea that the best contribution the Bank can make to the Canadian economy is to keep inflation low, stable, and predictable. By aiming to keep the annual rate of inflation at the 2 per cent midpoint of a 1 to 3 per cent target range over the medium term, we lay the groundwork for the economy to grow in a strong and sustainable way. To keep inflation low and stable, we aim to maintain a rough balance between demand and supply in the economy. When aggregate, or total, demand exceeds aggregate supply, the economy will push against its capacity limits - and inflationary pressures will tend to build over time. If we see that inflation is threatening to rise above target over the next 18 to 24 months, the Bank will tighten monetary policy to dampen demand. Similarly, if there is too little aggregate demand relative to supply, the economy will operate below its capacity. If this gap between aggregate demand and supply were to persist, the projected trend of inflation would fall below target. The Bank would then ease monetary policy to stimulate demand and close the gap. That's why it is important for us to understand how developments in the Canadian and world economies affect the balance between demand and supply in Canada. Now let's bring the exchange rate into the picture. To understand the effect of exchange rate movements, we need to understand why exchange rates are moving, and how these movements affect the balance between demand and supply. Exchange rate movements tell us something about economic developments that may be having a direct impact on Canadian aggregate demand. And the movements themselves have their own impact on aggregate demand, by changing relative prices for Canadian goods and services and by shifting demand between domestic- and foreign-produced products. The challenge for the Bank is to evaluate these movements, together with other data, and set a course for monetary policy that works to keep demand and supply in balance and inflation low and stable. Two types of exchange rate movement With this general framework in mind, let me now talk in more detail about the forces that can influence the exchange rate. Here, I want to emphasize a key point: From the Bank's point of view, the causes of a movement in the exchange rate are just as important as the movement itself. I will spend the balance of my time today explaining why this is so. For monetary policy purposes, there are two basic types of exchange rate movement - and no, I don't mean "up" and "down." I mean movements in the Canadian dollar that directly reflect changes in the demand for Canadian goods and services, and those that do not. Consider the first type of movement, which I'll call Type One. Growing world demand for Canadian goods or higher world prices for Canadian products both prompt a direct increase in aggregate demand in Canada. And both tend to cause an appreciation of the Canadian dollar. Put simply, when demand for our goods and services increases, our currency tends to appreciate. Conversely, when demand for our goods and services decreases, our currency tends to depreciate. But not all exchange rate movements are Type One. Some movements, let's call them Type Two, reflect the rebalancing of portfolios in financial markets, which may have nothing to do with current demand for Canadian goods and services.1 One example of a Type Two movement would be a flight to so-called "safe havens" during an international financial crisis. Another example is a movement that relates to expectations of what might be necessary to resolve global imbalances. I'll say a bit more about this later on. But for now, let me just stress the key point about Type Two exchange rate movements. While they are more difficult to describe, their defining feature is that they do not reflect current changes in demand for our goods and services. It's important for us at the Bank to try to distinguish between exchange rate movements that reflect changes in demand for our goods and services and those that do not. That's because these movements have different implications for aggregate demand and, hence, for monetary policy. This is a complicated issue, all the more so because both types of currency movement sometimes occur at the same time. So I want to spend some time talking about these two different types of exchange rate movement. I'll give you some real examples and explain their different implications for monetary policy. Let me start with Type One. I've already noted that when global demand for Canada's goods and services rises, the demand for our dollar also increases, so it tends to appreciate. Similarly, when global demand for Canada's goods and services falls, so will the demand for our currency, which then tends to depreciate. But the exchange rate, by reacting to these changes in demand, also acts as a shock absorber. For example, when global demand for our goods and services weakens, and our dollar depreciates in response, the lower dollar pulls down the relative prices of Canadian goods and services, making them more attractive. And, of course, the opposite happens when global demand rises for Canadian goods and services; the increase in demand is dampened by the associated appreciation of our dollar. Let me give you an example from here in British Columbia. In 1997 and 1998, the world economy was dealing with the effects of economic crises in Asia, Russia, and other emerging markets. In this environment, global demand for the primary commodities that Canada produces was very weak. That weakness resulted in falling prices for many commodities, including some of the raw materials produced in British Columbia or shipped through its ports. At that time, there was a sharp depreciation of the currencies of countries that export raw materials - Canada, Australia, and New Zealand - while the U.S. dollar appreciated. While there were other forces driving the exchange rate at that time, the drop in global demand for raw materials was a direct, negative shock to Canadian aggregate demand, and this shock led to a depreciation of the Canadian dollar. The lower dollar, in turn, helped to offset the shock by making other Canadian exports more attractive to global markets, and by making foreign products and services less attractive to Canadians. This is not to suggest that all Type Two movements in the exchange rate originate in the capital account of the balance of payments and are driven by investment flows. Although most of the examples described later in the text are based on shifting investor expectations and on the rebalancing of portfolios, other Type Two movements are possible and can be driven by non-financial factors. Similarly, while most of the discussion in this text focuses on aggregate demand and the effects of exchange rate movements on net export sales, aggregate supply considerations can also be important and can exert a significant influence on exchange rates. My focus here on demand considerations reflects their greater relevance in the current economic context. Over the past two years, we have seen this movement work in the opposite direction. In 2003 and most of 2004, both the demand for, and prices of, Canadian products rose. Once again, there were other factors at work on the exchange rate during this time. But this direct, positive shock to Canadian aggregate demand led to increased demand for our currency and an appreciation of the Canadian dollar. The stronger Canadian dollar, in turn, increased the relative price of Canadian goods compared with foreign products, and helped to restore the balance between demand and supply. In these two instances, the flexible exchange rate helped to absorb positive and negative shocks to our economy. That's the first type of exchange rate movement. Let's now turn to Type Two. You may wonder: if this second type doesn't reflect changes in demand for Canadian goods and services, what does it reflect? What are the forces behind this type of movement? Quite often, it reflects changes in foreign demand for Canadian financial assets or changes in Canadian demand for foreign financial assets.2 For example, if investors develop a greater appetite to hold Canadian equities or bonds, this drives up the demand for our currency, which then tends to appreciate. The reverse also holds true. A shift in investor sentiment away from our bonds and equities reduces the demand for the Canadian dollar, and it tends to depreciate. But let's remember that these changes in demand for equities and bonds are not related to current changes in aggregate demand for goods and services produced in Canada. The fact that these movements are not related to changes in aggregate demand is the essential difference between a Type One and a Type Two currency movement. A textbook example of a Type Two currency movement occurred during the Mexican Peso Crisis of 1994-95. As a result of the Mexican situation, investors became less comfortable with holding the financial assets of countries with governments that were heavily in debt - and this included Canada at the time. As a result, investors sold the financial assets of those countries and sought the relative safety of investments in the United States. This was one of the factors behind the sharp depreciation of the Canadian dollar during this period. Let me give you another example of an exchange rate change that is not driven by a change in Canadian aggregate demand. The period near the end of the 1990s saw investors become increasingly optimistic - some have said irrationally exuberant - about the prospects for the U.S. economy. The associated financial flows into the United States helped to drive up the U.S. dollar over this period - at the expense of other currencies, including the Canadian and Australian dollars, the euro, and the yen. This optimistic view about the U.S. economy, combined with the decline in commodity prices that I mentioned earlier, helped push down the value of the Canadian dollar from 71 cents (US) in March 1998, to about 62 cents (US) in January 2002. Of course, the process also works in the other direction. During the past two years, investors have become more concerned about the large and growing U.S. current account deficit - which has arisen out of that country's large fiscal deficit and its very low level of private savings. While the United States saves too little, Asian countries are saving too much, and this situation cannot be sustained indefinitely. More domestic demand in Asia and some other countries, and more savings in the United States, are needed to help restore global economic balance. Against this backdrop, market participants have come to the view that further depreciation of the U.S. dollar will be needed to help resolve these imbalances. The earlier "irrational exuberance" about the prospects for the U.S. economy has been cooled by an increased focus on the risks facing that economy. And so we have seen the U.S. dollar fall against many major currencies, including the Canadian dollar. Let me stress the relevant feature that is common across all Type Two movements. These movements do not reflect a change in the aggregate demand for our goods and services. However, the exchange rate movements, by having the usual effect on relative prices, still lead to changes in Canada's net exports and, thus, in Canadian aggregate demand. The implications for monetary policy At this point, it might be tempting to say, "So what?" After all, Canadians looking to head south for a winter break probably don't care what is causing the exchange rate to move. They only want to know I am referring here to a change in demand for Canadian assets that does not involve a change in investment in physical capital in Canada. how many U.S. dollars or Mexican pesos they can buy with their hard-earned Canadian dollars. But it is important for us at the Bank, and for those who follow our actions, to understand what is causing the exchange rate to move. This is because the monetary policy implications of a currency movement depend on its cause, and on what other forces might be at work in the economy. Let's look at examples of the two types of exchange rate movement that result in a stronger Canadian dollar. In Type One, we start with an increase in foreign demand for our goods and services and, hence, an increase in aggregate demand. The Canadian dollar strengthens in response, increasing the relative price of Canadian goods. This increase offsets some of the higher foreign demand by encouraging imports and dampening exports. In other words, the appreciation of the Canadian dollar works to dampen the initial increase in aggregate demand. To the extent that the dampening effect on aggregate demand exactly offsets the direct increase in demand, there would be no need for a monetary policy response. A Type Two appreciation is a different story. Consider the example where the U.S. dollar weakens, driven by market concerns about global imbalances. In this case, there is no initial increase in Canadian aggregate demand. But the stronger Canadian dollar still raises the relative prices of domestic products and leads to a decline in net exports. The overall effect on Canadian aggregate demand is clearly negative. And this decrease in demand - if it persisted - would likely lead to undesirable downward pressure on inflation. All other things being equal, this would require monetary policy to be more stimulative than it otherwise would have been. I hope that this helps to clarify why these two different types of exchange rate movement have different implications for monetary policy. However, I don't want anyone to think that we at the Bank have a mechanical or formulaic approach to dealing with exchange rate movements. The truth is exactly the opposite. Analyzing foreign exchange movements and determining the appropriate monetary policy response is a complicated business. Consider the sharp appreciation of the Canadian dollar against the U.S. dollar over the past couple of years. Which type of movement drove this appreciation? How much of this movement was related to stronger demand for Canadian goods and services, and how much was related to widespread weakness in the U.S. dollar? As we noted in our Monetary Policy Report Update last month, both types of exchange rate movement seem to have been at play over the past year. However, their relative importance appears to have shifted over this period. And that made it difficult to determine the appropriate monetary policy response. Looking at the economic data at the beginning of 2004, we saw that net exports had made a significant negative contribution to Canadian economic growth in 2003. We were concerned that, on balance, much of the exchange rate appreciation in 2003 was of the Type Two variety. This assessment was one of the factors that led the Bank to lower interest rates in early 2004. However, by late last summer and early last autumn, we had seen strong commodity prices and strong world demand. And net exports had made a solid, positive contribution to Canadian growth in the first half of 2004 - a typical Type One effect. With our economy approaching its capacity limits, we raised interest rates in order to reduce the amount of monetary stimulus in the economy. But towards the end of 2004, the balance of Type One and Type Two forces appeared to shift again, with Type Two dominating. The U.S. dollar weakened against all the major floating currencies, and the Canadian dollar rose to a 13-year high of about 85 1/2 cents (US). This occurred despite the fact that world commodity prices had declined somewhat and the outlook for the global economy had weakened. The Bank's target overnight rate was therefore left unchanged at the fixed announcement dates in December 2004 and January 2005. Each monetary policy decision that we make is complicated by uncertainty about the persistence of exchange rate changes and about the length of time it takes for both exchange rate and monetary policy movements to influence the economy. This has been one of the Bank's major challenges in the recent conduct of monetary policy. It's one thing to observe a movement in the exchange rate. It's quite another to determine its implications for aggregate demand and, hence, for monetary policy. We continue to struggle with the same complications today as we chart a path for monetary policy. Canadian interest rates remain low by historical standards. Eventually, this considerable monetary stimulus will have to be reduced; that is, at some point, interest rates will have to rise. But as I said, the second type of exchange rate movement appears to have gained relative importance in recent months, which means that aggregate demand in Canada will be weaker than we had expected last autumn. That is why in our recent Update we slightly lowered our growth projection for 2005, to 2.8 per cent from 2.9 per cent. And it is why we said in the Update that: "â€¦the pace of reduction in monetary stimulus is likely to be slower than envisioned in the October Report." By slowing the pace at which we will reduce monetary stimulus, we will continue to provide support for domestic demand to offset the additional drag we expect from net exports. Conclusion Let me conclude by reminding you of what I said at the beginning of my remarks today. The relationship between the exchange rate, the economy, and monetary policy is complex. And the effects of movements in the currency are spread out over time. You can't look at one day's or one week's performance of the Canadian dollar and pinpoint the reason behind the movement. There is no precise way to measure the relative importance of the two types of movement that I have described, or their likely persistence. So, in setting monetary policy, we at the Bank use an analytical framework based on historical evidence, assess a lot of current data and, even then, we must apply a lot of judgment to our analysis. And the analysis and the judgment can change over time as new information becomes available. Ultimately, the Bank of Canada's commitment to Canadians about monetary policy boils down to this: We will continue to work at maintaining a rough balance between demand and supply in the economy, in order to keep inflation low, stable, and predictable. And as we pursue this objective, we will continue to explain the reasons behind our policy actions, and our view of the outlook for inflation and for economic growth in Canada.	bank of canada	2,005	2
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the National Association for Business Economics, Washington DC, 21 March 2005.	David Dodge: Inflation targeting - a Canadian perspective Remarks by Mr David Dodge, Governor of the Bank of Canada, to the National Association for Business Economics, Washington DC, 21 March 2005. * * * Good afternoon. Three years ago, when I last addressed this group, I spoke about the conduct of monetary policy in the presence of economic shocks. In those remarks, I made passing reference to the Bank of Canada's inflation-targeting framework. Today, I am happy to accept your invitation to return and talk in more depth about how we use inflation targeting as our monetary policy anchor. The invitation is timely, given that the Bank of Canada's inflation-targeting agreement with the Canadian government is up for renewal next year. At the Bank, we are always reflecting on our framework, deciding what works well and what we can improve. Against that backdrop, we have watched with interest the debate taking place here in the United States - inside and outside the Federal Reserve - about whether that institution should join the ranks of inflation-targeting central banks. As part of that debate, the minutes of the February FOMC meeting show that my colleagues at the Fed had a discussion about the merits of inflation targeting last month. According to the minutes, arguments were made both for and against the adoption of an explicit inflation target. Those in favour spoke of how such a target can anchor inflation expectations, add clarity to monetary policy decision making, and help with communications. Those opposed said that the benefits of adopting a target were unlikely to be large, that adopting a target might bias or constrain policy, and that it might appear - and I stress the word "appear" - to be inconsistent with the Fed's dual mandate to promote price stability and maximum employment. Before I proceed with my remarks today, I want to make it absolutely clear that my purpose here is not to weigh in on the debate within the Federal Reserve. I would not presume to tell the Fed what it should or should not do. Rather, I want to talk about the Canadian experience with inflation targets. However, in doing so, I will address some of the arguments raised at the FOMC meeting that I just mentioned. I will begin by discussing the Bank of Canada's legislated mandate, and how inflation targeting helps us to meet the objectives of that mandate. I will then talk about some of the choices that we have made to establish and refine our particular framework. I'll discuss some of the benefits that we can attribute - at least in part - to inflation targeting. And I will conclude by touching on some of the issues still facing us as we look to the future. Our Mandate and Objectives Let me start with the Bank of Canada's legislated mandate. It is interesting to compare our mandate with the one spelled out in the Federal Reserve Act, given that the nature of the Fed's mandate is often cited as one reason why it should not adopt an explicit inflation target. The pieces of legislation that govern the Bank and the Fed do contain some clear differences. But in terms of the conduct of monetary policy, it is the similarities that are more striking. Our mandate is broadly set out in the preamble to the Bank of Canada Act. The preamble was drafted in 1934 and, of note, has not been substantively amended over the past 70 years. The preamble calls on us to "regulate credit and currency in the best interest of the nation." It goes on to say that the Bank should mitigate "fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada." By comparison, the most recent revision of the Federal Reserve Act calls on the Fed to maintain growth of credit and the money supply "commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." The Fed's mandate is a bit more specific than ours in that it states directly that monetary policy should aim at having the U.S. economy operate at full capacity. But the main point is that both central banks have references in their mandates to production, prices, and employment. Indeed, a key goal for all central banks is to conduct monetary policy so as to provide favourable conditions for maximum, sustainable long-run growth, while recognizing that monetary policy alone is not sufficient to bring about that growth. So the question is, What is the best way to operate monetary policy in order to provide the conditions for sustainable growth, bearing in mind the words in our mandate: "so far as may be possible within the scope of monetary action"? Over the years, central banks have tried various frameworks in attempting to answer this question. First, central banks tried fixing exchange rates to gold; most later tried fixing their exchange rates to those of other countries. Some central banks tried to target credit or the growth of monetary aggregates, while many relied solely on their own judgment. All of these frameworks have had their problems, which I won't go into today. But over time, what has become clear is that the best way for monetary policy to promote sustainable economic growth is to anchor expectations about the future purchasing power of money. What we have learned from the bitter experience of many countries - including Canada and the United States is that when monetary policy chases short-term goals, mistakes are made, uncertainty is increased, and fluctuations in economic activity are aggravated. Focusing on domestic price stability - however that term is defined - is the best contribution monetary policy can make to economic stabilization and sustainable long-term growth. Indeed, as my predecessor Gordon Thiessen put it, "Focusing on price stability helps us to guard against the sort of systematic [policy] errors that often occurred when we tried to aim directly at output and employment."1 At the end of the 1980s, the Bank of Canada faced the question of how to pursue price stability in a way that would allow it to accomplish three things: first, help to anchor expectations about the future purchasing power of money; second, give the Bank a guide for the conduct of policy; and third, help us to explain to markets, politicians, and the Canadian public what we are doing and what actions they could expect from their central bank. By 1991, the Bank and the Government of Canada had agreed that inflation targeting was the right framework for pursuing this objective. We considered targeting inflation as the best way to achieve high, sustainable growth of output and employment. To be clear, inflation targeting is not an end in itself. Rather, it is the best means of fulfilling our commitment to promote the economic and financial welfare of Canada. The Canadian Version of Inflation Targeting Let me now say a few words about some of the particular choices we have made over the years to shape our inflation-targeting framework. A central bank that wants to target inflation and run an independent monetary policy must allow its currency to float. As you know, a monetary authority cannot control both the domestic and external values of its currency. We have one instrument, so we can have only one target. Thus, with inflation as our target, we naturally operate with a floating currency. Once the Bank and the government agreed on the concept of inflation targeting, we needed to make some choices to put the concept into practice. Our goal of price stability came to be defined as low and stable inflation. Like many other central banks, we chose a target for the annual increase in the consumer price index (CPI). Initially, our focus was on inflation reduction. So it was announced that the target would decline gradually - from the 3 per cent midpoint of a 2 to 4 per cent target range at the end of 1992 to the 2 per cent midpoint of a 1 to 3 per cent range by the end of 1995. The target has remained there since. Let me take you through some of the key decisions that we made in 1991, and the rationale behind our choices, as we set out the details of our framework. First of all, why did we choose the CPI as our target? The key reasons were that it is widely understood and is the measure of inflation most familiar to Canadians. Choosing a well-known indicator as a target makes it easier to explain our actions and to be accountable to Canadians. However, movements in the prices of particularly volatile components of the CPI can cause the index to fluctuate sharply. So we use a measure of core inflation as an operational guide. This measure strips out the most volatile components and the effect of changes in indirect taxes on the rest of the index, giving us a better understanding of the trend of inflation. G. Thiessen, "Can a Bank Change? The Evolution of Monetary Policy at the Bank of Canada 1935-2000," The Thiessen Lectures, (Ottawa: Bank of Canada, 2001), p. 79. Second, why have a range? While we emphasize the 2 per cent target, we have a range - as many central banks do - because monetary policy operates with long and variable lags. If we tried to target inflation too precisely we could have "instrument instability;" in other words, we would be adjusting our policy interest rate sharply and frequently, which would lead to greater instability in the economy. Further, measured inflation itself can be volatile as specific prices adjust. But to be clear, the range does not represent a zone of indifference - we do aim to achieve the 2 per cent target. Third, given that we must always be forward looking as we conduct policy, what time frame would we choose to achieve our target? From the beginning, we said that if a demand shock pushed inflation away from the target, we would conduct policy so as to return inflation to target over a period of 18 to 24 months. This is because our research suggests that it takes 12 to 18 months for changes in interest rates to have most of their impact on output, and 18 to 24 months to have most of their impact on prices. Of course, there is always uncertainty about the lags involved, and I'll have more to say about this later on. To be sure, there will always be times when there are large swings in relative prices in the economy energy prices being a good example. Under inflation targeting, the objective is not to try to offset or stifle these relative price movements. Our experience has been that with a clear inflation target and with well-anchored expectations, these types of relative price shocks have only a one-off effect on the price level, and do not feed into ongoing inflation. Before I leave this section, I want to emphasize two points about our inflation-targeting framework. The first is that we operate in a symmetric way, and we make it clear to everyone that we do so. By this, I mean that we worry just as much about inflation falling below target as we do about it rising above target. This is a tremendously important point. When the demand for goods and services pushes the Canadian economy against the limits of its capacity, and inflation is poised to rise above target, the Bank will raise interest rates to cool off the economy. Just as importantly, when the economy is operating below its production capacity, and inflation is poised to fall below target, the Bank will lower interest rates to stimulate growth. Whatever the direction of the demand shock, the Bank of Canada will respond appropriately. This symmetry is our answer to the charge that central banks target inflation at the expense of growth. On the contrary, paying close attention to signs of deviation from our target promotes timely action in response to both positive and negative demand shocks. This is how we can keep the economy operating near its full capacity and thus keep inflation low, stable, and predictable. The second point I want to stress is that having an inflation target as an anchor is very helpful in terms of the Bank's accountability. If inflation persistently deviates from the target, we are committed to explaining the reasons why this is so, what we will do to return it to target, and how long we expect the process to take. Our Experience with Inflation Targeting Now let me turn to our experience with inflation targeting. Just as Canada was a pioneer at having a floating exchange rate, we were also among the very first to adopt inflation targeting. And as in other countries that have done so, the result has been unambiguously positive. Indeed, as Claudio Borio put it, "no country embracing inflation targeting has regretted doing so."2 Back in 1991, Canada had several compelling reasons for moving to inflation targeting. Compared with today, inflation was still relatively high. Further, the Bank of Canada and the federal government wanted to minimize the possibility of a wage-price spiral developing in the wake of the introduction of the Goods and Services Tax. We recognized the importance of having both the general public and financial markets understand our actions. And as inflationary pressures built towards the end of the 1980s, we saw that the lack of a monetary anchor was leading to rising inflation expectations. As we look at Canada's record since 1991, in terms of inflation and economic growth, I can tell you that all of the benefits we had hoped would come from inflation targeting have, in fact, materialized. We expected that inflation would become more stable under a targeting framework - and it did so, sooner than we had anticipated. We expected that our credibility would increase and that inflation C. Borio, "Wrap-up Discussion." The Future of Inflation Targeting, (Sydney: Reserve Bank of Australia, 2004): p. 278. expectations would become well anchored under targeting - and this also happened. Indeed, shortterm expectations quickly became anchored to our target, although longer-term expectations took a bit more time to fall in line. Together with marked improvements in Canada's fiscal position in the mid1990s, our excellent track record on inflation added to our credibility. Private sector forecasts for inflation in Canada now average close to the 2 per cent target far into the future. We expected that setting out a clear paradigm for operating under inflation targeting would bring benefits - and it did. Internally, focusing on inflation brought increased discipline and clarity to our monetary policy deliberations. But more importantly, being transparent about our operational paradigm has allowed markets and analysts to better predict how we will react to different economic outcomes. Financial markets and analysts now pay more attention to their own evaluations of the prospects for the economy and inflation in assessing the future path of our policy interest rate. Appropriately, they do not have to rely on the wording of our communications for guidance. Empirical evidence shows that inflation targeting has been an unqualified success for Canada. Inflation has averaged very close to 2 per cent and has remained within the target range since we adopted our targets, with rare exceptions that were due mainly to large swings in the prices of oil or other commodities. Further, there is evidence that inflation targeting has been successful as a macroeconomic stabilizer, helping to smooth the peaks and valleys of the business cycle. Our symmetric approach to inflation targeting is crucial in this regard. Because we guard against both inflationary and deflationary pressures, businesses and individuals can make long-range economic plans with increased confidence. Scarce economic resources are no longer wasted trying to hedge against the threat of runaway inflation. And because our paradigm makes it clear that we guard against deflationary pressures, Canada has avoided any serious threat of deflation. Throughout all the shocks we have experienced, Canadian inflation expectations have remained remarkably well anchored on the 2 per cent target. At the time that we were considering the adoption of inflation targeting, we heard many of the same arguments against such a framework that we hear today in the United States. Some argued that inflation targeting could constrain our ability to act, or would take away our ability to apply our own judgment in the conduct of policy. Our experience has shown these concerns to be groundless. Let me illustrate with a couple of recent examples. In the immediate aftermath of the 9/11 terrorist attacks, we lowered interest rates quickly and decisively to underpin confidence, which could have been profoundly shaken by the attacks. When a major loss of confidence did not materialize over the next few months, we were able to reverse course and withdraw some of that monetary stimulus. Our inflation-targeting framework did not restrict our ability to act. Indeed, because our paradigm is clear, financial markets were able to understand why we made these rapid rate adjustments. Another example is our reaction to the continuing realignment of world currencies over the past two years. The Canadian economy has had to adjust to sharp movements, not just in the external value of our dollar, but also in the foreign demand for many of our goods and services. Inflation targeting gives the Bank an important guideline for dealing with the currency appreciation, allowing us to maintain our focus on macroeconomic stabilization at a time when various sectors of the economy are dealing with the exchange rate shock. Our paradigm has given us the flexibility to apply judgment in the face of considerable uncertainty over this period. The Future of Inflation Targeting Before I close, let me say a few words about the future of inflation targeting in Canada. As I noted at the beginning, our current agreement with the federal government is up for renewal in 2006. So it is useful to think about those elements of our framework that we would not want to change, and other areas where changes might be considered. From the central bank's point of view, the basic arrangement of aiming inflation at the 2 per cent midpoint of a 1 to 3 per cent target range has served us well, along with the use of the CPI as our target. The CPI may not be a perfect indicator of inflation, but it is the most readily recognized and understood measure, and so likely represents our best option for targeting. However, given the volatility inherent in the index, the Bank has emphasized a core inflation measure for operational purposes. I would expect that these elements of our framework will remain in place. But good public policy demands that we continue to do the necessary research to confirm that these remain the best options. Also, the Bank of Canada will continue to recognize the importance of communications and transparency to the conduct of monetary policy. Inflation targeting is a helpful tool for anchoring expectations, but its effectiveness is greatly enhanced when a central bank communicates well. And a symmetric approach to inflation targeting allows the bank to make a convincing case for its policy actions, even during difficult economic conditions. But I don't want to suggest that there aren't questions to be answered as we go forward. One question facing us now is whether 18 to 24 months is the appropriate time horizon for monetary policy to bring inflation back to target after various types of shocks. One type of shock that we have to consider is a major movement in asset prices. Do these types of movements in asset prices contain any information about future inflation beyond our typical policy horizon? And if so, what should we do about it? This is not to suggest in any way that we should try to target asset prices. Rather, the question is whether it would ever be appropriate to lengthen the time horizon for returning inflation to target. A similar question applies to exchange rate shocks. Globalization appears to have altered the way in which economies adjust to movements in exchange rates. This applies both to the adjustment of real economic activity to the shock, as well as the direct pass-through of exchange rate movements to prices. This raises the question of whether 18 to 24 months is too short a time horizon for monetary policy to deal with exchange rate shocks. On the other hand, the reduction in the persistence of inflation that we have seen under inflation targeting would suggest that it may instead be more appropriate to shorten the policy horizon. Given the success to date of handling shocks within an 18 to 24-month horizon, we should not change our framework lightly. But we need to think hard about the appropriate time horizon in dealing with various shocks as inflation targeting evolves in the future. Conclusion Let me close by emphasizing a few key points. There is no doubt in my mind that inflation targeting is the right monetary policy framework for Canada. Through our symmetric approach of keeping inflation low, stable, and predictable, we have laid the groundwork for solid, sustainable growth in output and employment. In doing so, we fulfill our commitment to "promote the economic and financial welfare of Canada," as spelled out in the Bank of Canada Act. With inflation targeting, our policy is more focused, our communications are clearer, and Canada's inflation expectations are more solidly anchored. During a period when consumer price inflation is low and appears to be stable, it may be tempting to some to conclude that an inflation anchor is unnecessary. In my opinion, to reach this conclusion would be a huge mistake. On the contrary, it is particularly important at this time, in the face of large terms-of-trade movements and other shocks, that central banks have an anchor to keep monetary policy focused. From my perspective, inflation targeting is the best anchor we've seen. Of course, I'm not saying that inflation targeting is the end of monetary policy history. And, I love a good debate. So I hope that my remarks today may have helped to add some context to the ongoing discussions here in the United States. And I can tell you that we in Canada will continue to watch, with great interest, as the debate unfolds.	bank of canada	2,005	3
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Humber College Institute of Technology and Advanced Learning, Toronto, 30 March 2005.	David Dodge: Canada’s competitiveness - the importance of investing in skills Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Humber College Institute of Technology and Advanced Learning, Toronto, 30 March 2005. * * * Thank you, Michael, and good evening. I am honoured to be here with you to kick off this lecture series. Once again, I want to thank Humber College and the Canadian Foundation for Economic Education for this opportunity. It’s a bit daunting to try to deliver a lecture this late in the evening. But the subject that I want to discuss tonight is one that should be of interest to all of us - the importance of investing in skills to improve productivity growth. As most of you know, this lecture series was announced by the CFEE at a dinner here in Toronto in November 2003. At the conclusion of my speech that evening, I said that, in an increasingly complex and competitive world, furthering our national economic welfare will depend importantly on the quality of our labour force. I also said that improving skills will require concerted efforts from all of us who are involved directly or indirectly in education: parents, educators, employers, community organizations, and policy-makers. It is this shared responsibility that I would like to emphasize this evening. I will begin with a brief discussion about some of the factors influencing Canada’s productivity performance. Then, I will review some of the larger forces at work on the world economy and their implications as we strive to improve productivity. Finally, with these forces in mind, I will offer a few thoughts on how we can best develop Canada’s human resources. What drives productivity growth? Productivity plays a critical role when it comes to our national standard of living. Productivity growth is the main element that contributes to continued improvements in real incomes and overall prosperity. Rising productivity lets businesses pay higher wages, while keeping costs down, employment high, and profits coming in. That’s why economists like me spend a lot of time thinking about ways to improve the productivity of our economy. There are several factors that help to raise labour productivity - by which I mean the amount of goods and services produced per worker per hour. These factors include the education, training, and experience of the workers and the amount and type of equipment available to them. Productivity can also be raised through technological innovation, and through changes in organizational and management practices. All of these key determinants of productivity influence how "smartly" human and capital resources are used. And these determinants are, in turn, influenced by broader factors such as competition, openness to foreign trade and investment, macroeconomic policies, and the efficiency of financial markets. We all recognize that improving productivity is the key component to raising the standard of living of Canadians. From 1996 to 2002, output per hour worked grew at just over 2 per cent, on average, a little faster than our undistinguished performance of the previous quarter century. This provided some reason for optimism. But over the past two years - while economists, business leaders, and policy-makers have talked about the need to raise productivity - output per hour has been essentially flat. While we’re talking the talk on productivity, we are not doing a good job of walking the walk. We have to do better. And over the next decade or two, we will be working to improve this country’s productivity amid significant global economic change. This evening, I’ll focus on three important and ongoing elements of this change: technological innovation, globalization, and demographic shifts. Then I’ll discuss the implications of these trends for skills development. Technological change Let me start with technological change. It’s difficult to untangle and measure the individual components that contribute to productivity growth. But we do know that one of the most important factors in recent years has been the adoption of new technologies. Key among these has been information and communication technology, or ICT. It is by no means the only area where transformative technological advances have been made, but it is the one on which I will focus tonight, for two reasons: first, because ICT offers a useful example of the sweep and the impact of technological change; and second, because it relates to the other two broad trends that I will discuss this evening. The productivity potential of new technology is only realized when companies and institutions reorganize their business and management practices to integrate the new technology. Our lacklustre productivity record suggests that Canadian firms and public sector institutions are moving too slowly to adopt these new technologies and business practices. Let us also remember that technology not only creates opportunities to change work within a firm, it also creates opportunities to change the nature of transactions across firms. Technological innovation lowers transactions costs and facilitates productivity improvements through increased specialization. Specialized firms can build expertise by developing specific skills and then trading that expertise with other firms that offer complementary advantages. Globalization Technological change is hastening the second trend that I want to discuss tonight - and that is globalization. Travelling or shipping goods around the world now takes hours, not days. Information and ideas are available simultaneously to anyone who has access to the Internet. Wireless technology has brought telecommunication to places where phone lines cannot reach. In short, technological advances have allowed markets to expand as never before. In many ways, technology is the enabler of many of the trends leading to globalization, by slashing the costs and the time it takes to reach across borders and continents. Today, we’re all shopping in the same global village market. Consumers and businesses around the world have become the target customers of Canadian firms. At the same time, our firms are exposed to new sources of competition and new pressures to innovate. Perhaps the most preoccupying element of this trend towards globalization is the emergence of China as an economic powerhouse. And India is not far behind. When you consider that China and India account for 40 per cent of the world’s population - and that their economies are growing at annual rates of 9 and 7 per cent, respectively - it is not hard to see why they have such an impact on the global economy. China and India are now major global competitors in labour-intensive industries. Increasingly, they’re also flexing their muscles in skill-intensive industries. Asia’s highly efficient production capacity is prompting a transformation of manufacturing and distribution processes around the world. And the skills-based software industry in India is transforming that sector globally. So we’re seeing tremendous competitive pressure on industries that are the traditional mainstays of the Canadian economy in general and of Ontario in particular - such as automobiles and parts, steel, and other manufacturing industries. We’re also seeing competitive pressures transform Canada’s high-tech sector, which has only recently emerged as an engine of growth. But the income and wealth created in China and India are increasing the ability of these countries to buy goods and services from abroad. So, their integration into the global economy represents both a competitive challenge and a tremendous opportunity. These emerging markets are just that - markets. China is already one of the world’s largest importers. This growing demand can provide a real boost to the Canadian economy, if we gear up to meet the challenge. So, how do we meet those challenges? One way is to integrate low-cost components from other regions of the world into our own production processes, through direct investment or joint ventures. This can help to keep costs down and free up our resources to concentrate on those areas where we have a competitive advantage. Second, we can focus on activities that embrace and facilitate technological advances. I’m thinking of activities such as industrial design, marketing, customization, packaging, and high-quality, individualized service. Humber College and similar institutions are helping to develop and maintain the skilled labour force that Canada needs to be a global player in these activities. At the same time, we can’t ignore the fact that refocusing activity will likely mean job displacement in certain sectors. There will be some activities, particularly those that are labour-intensive and lower-value-added, where Canadian firms will not be well placed to compete with lower-cost producers in Asia. Adjustment will require shifting resources into expanding, higher-value-added activities where Canadian firms can exploit the new opportunities presented by the changing world economy. By making these adjustments, we will be able to increase productivity and raise our standard of living over time. Demographic trends The third significant trend that Canada and other industrialized countries face is the aging of our populations. Right now, about one Canadian in eight is aged 65 years or older. By 2026, that ratio will be one in five. So, we can expect reduced growth in the labour force and a smaller, older workforce in proportion to our population. And let’s remember that this aging of the workforce is taking place as Canada is shifting to a knowledge-based economy. Technology-intensive employers require increased emphasis on retraining and on continuous learning for all workers, including older ones. Studies have shown that older workers participate less than younger ones in job-related education and training. And those workers with less education or low literacy levels find it particularly difficult to adjust to the knowledgebased economy. They are at a higher risk of being laid off and have greater difficulty in finding new work. The good news is that we still have time to prepare for the demographic shift. We have several factors working in our favour. First, technological change and increased use of ICT mean that participation in the labour force can be more flexible - through teleworking, part-time work, job-sharing, off-site consulting, and other innovations. Second, older Canadians are, on average, healthier than in previous generations, and could stay in the labour force longer. Third, the nature of many jobs has changed. There are more skills-based jobs, but they are often less physically intensive and therefore can be done by older workers. Fourth, since the baby boomers are better educated than the current cohort of retiring workers, they may find it easier to adapt to changing work environments. All of these factors mean that the aging of our population over the next two decades need not have as serious an effect on economic growth as some fear. But we will need to increase productivity and to prepare our workforce and our economy for the demographic realities ahead. A focus on skilled labour This leads naturally to the subject that I will discuss in the remainder of my remarks tonight. These three global trends - technological change, globalization, and demographic shifts - must be central to our thinking as we prepare our workforce and our economy for the challenges that we face. So, in light of these trends, how do we best develop our labour force to boost our productivity? As I said at the beginning, the key to achieving these goals lies in coordinated effort. Skills development is a shared responsibility of business, academic institutions, the public sector, workers, and students. We need a system of incentives for continuous learning and upgrading of skills, and an infrastructure that delivers the training. This has always been important. But, as I mentioned earlier, it will be particularly important in the next two decades, as labour force growth in Canada slows. This system of incentives must benefit both workers and firms. If companies don’t see the payoff from training and skills development for their workers, they won’t make the investments. If workers don’t see what’s in it for them, they won’t devote the time and energy to improve their skills. The first step to improving skills is to build an excellent infrastructure for early childhood development, feeding into a school system that effectively teaches basic skills. For Canada to generate productivity gains in a world market that’s embracing technological change, provincial education systems must continue to boost literacy and numeracy rates among students. There’s no longer such a thing as an unskilled job. The workers of today and tomorrow need to know how to learn, so that they can continuously improve their skills after they leave school. If we find more innovative ways to keep students engaged in their education, they will leave school with the enthusiasm they need to continue learning throughout their career. For some students, especially boys, school can feel like incarceration. One reason why drop-out rates are high is that some students don’t see the connection between what they’re being taught in school and what they want to do when they leave school. In order to be motivated to learn math, language, or science, students need to understand that this knowledge is relevant to the careers they want - that these courses are the foundation on which they will build their skills and interests. No one who learns a musical instrument practices scales so that they can be really good at playing scales. They practice scales so that they can play the songs they like. And students need to see first-hand the opportunities that will open up for them by studying hard and staying in school. Colleges, and the industries that support them, play a key role in providing that motivation, through programs that give high school students a first-hand look at the career options ahead. The flip side of the aging population that I discussed a minute ago is relatively smaller cohorts of young people. But that doesn’t mean that we can stop focusing on the problems we face in preparing these young people for the workforce. Indeed, the fact that we have smaller cohorts means that we must do better - we can’t afford to squander the potential of these young people. Once they have finished high school, they need to learn the skills that will help them to become productive workers in the expanding sectors of the economy. I’m in the right place to be talking about this, because Humber College has an exemplary record of training in areas such as design, merchandising, high-end services, and product innovation. Of course, it will always be critical that Canada stay on the leading edge of advanced research and theory. But pure research always needs to be complemented by the ability to commercialize, customize, and market the products that result. Service industries will also require increasing numbers of skilled workers. Older people buy relatively more services as a percentage of their overall consumption. The health care sector, for example, will require more medical technicians, therapists, nurse practitioners, and home care workers to meet growing demand. And as our population ages, the demand for leisure and travel services is increasing. The hospitality and tourism sectors can differentiate Canada from other destinations by delivering the exemplary service that only well-trained workers can provide. In order to learn relevant skills, students should be trained to use the latest tools and production methods employed by the sector for which they’re training. This means innovative partnerships between educational institutions and industry, to give students access to equipment and methods that are actually being used by leading-edge businesses. It means embracing the classic notion of apprenticeship to help make education and training as efficient and as relevant as possible. One more word on apprenticeships. We need to focus on creating a new generation of skilled craftspeople to replace the generation that is retiring. This is not a new problem. I was writing papers about it in the early 1970s, and it still hasn’t been resolved. Existing shortages in some skilled trades are likely to worsen, particularly in those trades where Canada used to rely on imported skills to meet domestic demand. The time to train this new generation is now, so that they can gain from the experience of the older generation while learning the latest techniques. I’ve spoken at length about our education system. But, as we improve the training of young workers, demographics will demand that we also make better use of older workers over the next couple of decades. And that requires continued and innovative on-the-job training. Employers may be reluctant to invest in training older individuals because of the shorter period in which to recoup training costs and because of a perception that older workers are less "trainable." These are misperceptions. First, because of rapidly changing technology, the payoff period for any training has become shorter and the need for the continuous upgrading of skills greater. Second, research suggests that successful training depends on the design of the training program, not on the age of the trainee. We should help older workers to continue to get the skills they need to remain in the workforce - should they wish to do so. I’ve said that improving the skills of Canada’s workers is a shared responsibility. So let me say a word about the role of the public sector. Boosting productivity requires microeconomic policies that encourage innovation in Canada’s private and public sectors. As I mentioned earlier, sometimes this innovation results in the displacement of workers. Public policy should assist those workers to upgrade their skills - not just when they lose their jobs, but during their entire working life. That requires the right mix of policy incentives for individuals and employers to continue to invest in training. And it must be a continuing process, not just a remedial one. Conclusion Ladies and gentlemen, I don’t for a minute believe that these are easy tasks. But the more flexible and efficient we can make our labour force, the better prepared we will be to improve our productivity and to increase the real incomes of Canadians in the years ahead. So let me conclude with a challenge. I began my remarks by talking about the importance of productivity in our efforts to assure rising incomes and economic well-being. And just as we need to improve the productivity of our factories and enterprises, we also need to improve the productivity of our training and education system. So I challenge Humber College and other educational institutions to constantly evaluate and improve the methods they are using to develop the skills of Canada’s workforce. And I challenge subsequent lecturers in this series to come up with new ideas to help them achieve this goal. Creating the world’s most innovative framework for education and training is not a simple task. But it’s an extraordinarily important one. Because the more innovative we can be in skills development, the more innovative we will be as a nation. And that is the best way to promote sustained, long-term economic prosperity for Canadians.	bank of canada	2,005	4
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Association of New York, New York, 15 April 2005.	David Dodge: How Canada is adjusting to global economic forces Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Association of New York, New York, 15 April 2005. * * * The Bank of Canada has been examining the issue of how the Canadian economy adjusts movements in the exchange rate for a long time. Canada's economy is very open, so we always need to understand how exchange rate movements are affecting real economic activity and, in turn, what the implications are for monetary policy. And with a 25 per cent appreciation of the Canadian dollar over the past couple of years, this has been a major preoccupation. Of course, there's much more to the story than just the exchange rate. Powerful forces have been shaping the global economy. These include the emergence of the economic powerhouses of China and India, and large and growing financial imbalances in the United States and Asia. As a result, we have seen large movements in relative prices, and not just the realignment of exchange rates. We have seen firming prices for non-energy commodities, rising oil prices, flat or falling prices for many consumer goods, and dramatic reductions in the prices of communications services and computer equipment. Today, I want to talk about the kinds of adjustments that the Canadian economy is making to these forces. I will start with a brief review of how our monetary policy operates, and how it helps with the adjustment process. I'll spend a few minutes talking about how the Bank takes exchange rate movements into account as we conduct monetary policy. Then, I will discuss the ways in which the real economy is adjusting to movements in the exchange rate and other global forces. Finally, I will recap the projections for the Canadian economy contained in the Monetary Policy Report. How monetary policy helps the economy adjust Let me begin with a few words about our monetary policy framework. The Bank of Canada Act calls on us to "mitigate fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada." We do this by trying to foster an environment of low, stable, and predictable inflation. In particular, we aim to keep the annual rate of consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent target range. This is the best contribution that we can make to achieving high, sustainable growth of output and employment. To be clear, inflation targeting is not an end in itself. Rather, it is the best means of fulfilling our commitment to promote the economic and financial welfare of Canadians. We pursue this objective by trying to keep the economy operating at full capacity; that is, we aim for a balance between total demand and supply in the economy. When the demand for goods and services pushes the Canadian economy against the limits of its capacity, and inflation is poised to rise above the target, the Bank will raise interest rates to cool off the economy. And when the economy is operating below its production capacity, and inflation is poised to fall below the target, the Bank will lower interest rates to stimulate growth. So by maintaining low and stable inflation, monetary policy promotes greater stability in economic output. A flexible exchange rate is an important part of our monetary policy framework. I hasten to add that we do not have a target or preferred level for the Canadian dollar. I'll come back to the topic of the exchange rate in just a moment. But first, let me talk about how our monetary policy helps the economy to adjust to the powerful economic forces we see today. To begin with, low and stable inflation allows businesses and consumers to better read price signals in markets, which helps them to make better long-term decisions in the face of major economic developments. A second way that monetary policy helps with the adjustment process comes from our strategy of keeping total supply and demand in balance. In these circumstances, economic resources that are released by shrinking sectors where demand is weak can be absorbed by expanding sectors where demand is strong. Of course, adjustment is never simple or without pain, especially at the personal level. But from a macroeconomic point of view, adjustment can take place with less social and economic cost when inflation expectations are well anchored and the economy is operating close to its potential. Having a floating exchange rate is a third way in which our monetary policy framework helps with the adjustment process. Let me explain how. Changes in global demand for a country's goods and services tend to bring about movements in that country's currency. The resulting exchange rate movements help to keep balance in the economy by offsetting the impact of the change in demand. For example, rising global demand for Canadian goods and services tends to lead to a stronger Canadian dollar. The stronger currency, in turn, tends to restrain exports and to encourage imports. By restraining the demand for Canadian-produced goods and services, the floating exchange rate helps to keep total supply and demand in balance. Similarly, when there is falling global demand for Canadian-produced goods and services, the floating exchange rate will encourage demand for these goods and services, again helping to keep total supply and demand in balance. Exchange rate movements and monetary policy This brings me to my next subject, which is how we at the Bank of Canada view movements in the exchange rate. As I said earlier, we do not have a target or a preferred level for the Canadian dollar. But this does not mean that the value of the currency is unimportant, far from it. The exchange rate is something that we at the Bank are always watching closely; looking for the valuable information that helps us to better interpret and predict the strength of total demand for Canadian goods and services. The way that we take the exchange rate into account as we conduct monetary policy is complicated. This is because the exchange rate can move for different reasons. Sometimes, movements in the exchange rate reflect changes in the demand for a country's goods and services. But sometimes, they do not. This distinction is important, because the two types of movements have different implications for demand in the economy and, hence, for monetary policy. Indeed, the reason behind a movement in the Canadian dollar can be just as important for monetary policy as the movement itself. Let me take a couple of minutes to explain. First, consider the type of currency movement that reflects changes in foreign demand. In 2003 and much of 2004, we saw a strong increase in the value of the Canadian dollar. This reflected, at least in part, the strong demand for Canadian exports, and a sharp rise in the global prices of many of these exports, particularly commodities. The stronger Canadian dollar, in turn, encouraged imports and discouraged exports. This is an example of how the appreciation of the Canadian dollar can work to dampen an initial increase in aggregate demand. Were this dampening effect on aggregate demand to exactly offset the initial, direct increase in demand, all other things being equal, there would be no need for a monetary policy response. Now, consider the other type of exchange rate movement, which does not reflect changes in demand for a country's goods and services. Instead, it can reflect changes in foreign demand for that country's financial assets, or changes in domestic demand for foreign financial assets. For example, during the past two years, investors have become more concerned about the large and growing U.S. current account deficit which, according to the Bureau of Economic Analysis, hit a remarkable US$666 billion, or 5.6% of GDP, in 2004. And so we have seen the U.S. dollar depreciate against many major currencies, including the Canadian dollar. In this example, the stronger Canadian dollar leads to a decline in net exports, just as in the previous example. But in the absence of an initial increase in demand to be offset, the overall effect on Canadian aggregate demand would clearly be negative. And this decrease in demand - if it were to persist - would generate downward pressure on Canadian prices and employment that could push inflation below our target. All other things being equal, this would require monetary policy to be more stimulative than it otherwise would have been. To be clear, I don't want you to think that we at the Bank have a mechanical or formulaic approach to dealing with exchange rate movements. The truth is exactly the opposite. Analyzing foreign exchange movements and determining the appropriate monetary policy response is a complicated business. When we look at the movement of the Canadian dollar against the U.S. dollar over the past couple of years, it is clear that the upward movement during this period has been driven by both stronger demand for Canadian goods and services, and by widespread weakness in the U.S. dollar. But there have been times during this period when the first factor appears to have been the strongest influence, and at other times, it appears that the second factor dominated. How businesses are adjusting Now that I have talked about how the Bank of Canada deals with exchange rate movements, let me turn to how the real economy is adjusting to global economic developments, and to the large relative price movements associated with them. It is interesting to compare the experience of the past two years with that in the period from 1997 to 2002. From the beginning of 1997 to the end of 2001, falling commodity prices led to a decline of more than 6 per cent in Canada's terms of trade - the ratio of the prices Canadians receive for their exports to the prices Canadians pay for their imports. At the same time, "irrational exuberance" about the prospects for the U.S. economy led to heavy financial flows into the United States, and this helped to drive up the value of the U.S. dollar relative to other currencies. The Canadian dollar fell from just under 75 cents US in early 1997 to a low of 61.8 cents US in January 2002, before ending the year at about 63.4 cents US. During this time, the cost of labour relative to capital goods declined in Canada because most capital goods are imported and priced in U.S. dollars, while labour is paid in Canadian dollars. Businesses reacted appropriately to these price signals by increasing their production of services and of those manufactured goods that require relatively more labour and less machinery and equipment. What we have seen over the past couple of years is, in many ways, a mirror image of the 1997-2002 period. Commodity prices have risen, and our terms of trade improved by more than 16 per cent from the fourth quarter of 2001 to the fourth quarter of 2004. The cost of labour has increased relative to the cost of capital goods. Again, Canadian firms are responding to the price signals. We are currently seeing large increases in investment spending in oil and gas extraction, other mining activity, and wood-product manufacturing. Firms have been motivated both by high prices for their products and by the expectation that these high prices will persist. We are also seeing rising investment spending in sectors with low exposure to international trade, such as electric power generation, finance and insurance, and information and cultural industries. In these cases, firms are reacting to recent substantial gains in Canadian domestic demand. For both of these groups, a crucial point to note is that a large part of the planned investment is motivated by the desire to increase production capacity. But the story is somewhat different for those sectors that are highly exposed to international trade, but where the prices of their products are not rising. Here, I am referring to sectors such as auto parts, textiles, and clothing manufacturing. Firms in these sectors are feeling the pressure of the higher Canadian dollar, and are also facing increased competition from places such as China and India. The good news is that there is evidence that many of these firms are making adjustments in the face of adversity. Investment spending for these firms is being channelled toward increasing productivity and reducing costs, not increasing capacity. Because much of the productivity-enhancing machinery and equipment is produced abroad and priced in U.S. dollars, the appreciation of the Canadian dollar has lowered the cost of this machinery and equipment relative to that of labour. Other firms are using different strategies to adjust to the stronger Canadian dollar and to increased competition from abroad. A growing number of firms are looking to cut costs by importing more inputs. Others are phasing out production of goods and services with low profit margins and concentrating on those that yield higher returns. And of course, all of these adjustments have implications for the Canadian labour market. Overall job growth has been strong, but there have been important sectoral differences. We have seen job gains in commodity-producing sectors and in those that have low exposure to foreign competition. However, employment has fallen in a number of manufacturing sectors. This reflects, at least partly, the fact that some firms are now substituting capital for labour in order to reduce costs, which is the opposite of the situation we saw in the late 1990s and at the beginning of this decade. Canadian economic prospects Before I conclude, let me quickly review the projections for the Canadian economy that we set out in our Monetary Policy Report yesterday. The global economy has been unfolding largely as expected, and the prospects for continued robust growth are quite favourable, especially over the near term. The outlook for the Canadian economy through to the end of 2006 is essentially unchanged from that in our January Monetary Policy Report Update. Our base-case projection calls for annualized growth of about 2 1/2 per cent in the first half of 2005 and 3 per cent in the second half. Growth of about 3 1/2 per cent is expected through the four quarters of 2006, consistent with closing the output gap in the second half of next year. To express it in annual average terms, growth in 2005 is projected to be about 2 1/2 per cent, down slightly from the January Update, while the projection for 2006 is little changed at about 3 1/4 per cent. With the economy expected to return to full production capacity in the second half of 2006, core inflation should move back to 2 per cent around the end of next year. Based on the scenario implied by oil-price futures, total CPI inflation is expected to remain above the 2 per cent target for some time, before moving slightly below 2 per cent in the second half of 2006. In line with this outlook, a reduction of monetary stimulus will be required over time. However, I want to stress again that the Bank is not committed to any particular interest rate path or timetable. Conclusion Let me conclude. As I noted at the beginning, there are powerful global economic forces at work, and economies everywhere need to make adjustments. In Canada, businesses are, indeed, making adjustments to meet these challenges and to take advantage of emerging opportunities. At the Bank of Canada, we will continue to monitor these global forces closely and to assess their impact. We will continue to conduct monetary policy with the aim of keeping inflation close to target, and thus keeping the economy operating at full potential. In this way, we will do our part to facilitate the adjustments that Canadian businesses are making to changes in the global economy.	bank of canada	2,005	4
Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, Ottawa, 14 April 2005.	David Dodge: Summary of the latest Monetary Policy Report Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, Ottawa, 14 April 2005. * * * This morning, we released our April Monetary Policy Report. In the report, we said that the global economy has been unfolding largely as expected, and the outlook for the Canadian economy is essentially unchanged from that in January's Monetary Policy Report Update. There is increasing evidence that the Canadian economy is adjusting to major global developments, including the realignment of currencies and higher commodity prices. The Bank expects Canada's economy to grow by about 2 1/2 per cent in 2005 and 3 1/4 per cent in 2006, with growth this year and next coming primarily from strength in domestic demand. To continue to support aggregate demand, we decided to leave the target for the overnight rate unchanged at 2.5 per cent on 12 April. The Bank continues to judge that the economy is operating slightly below its production capacity, and we expect that it will move back to full capacity in the second half of 2006. Core inflation is expected to return to 2 per cent around the end of 2006. Based on the scenario implied by oil-price futures, total CPI inflation is projected to remain slightly above 2 per cent this year, and to move slightly below 2 per cent in the second half of 2006. In line with this outlook for growth and inflation, a reduction of monetary stimulus will be required over time. This outlook is subject to both upside and downside risks and to uncertainties. The risks include the pace of expansion in Asia and the prices of oil and non-energy commodities. A further risk relates to the resolution of global current account imbalances. Should these imbalances persist, the risk of a disorderly correction would grow over time. Most of the uncertainties with respect to the Canadian outlook relate to how the economy is adjusting to the relative price changes associated with major global developments. Monetary policy continues to facilitate the adjustment process by aiming to keep inflation at the 2 per cent target and the economy operating near its production capacity.	bank of canada	2,005	4
Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the House of Commons Finance Committee, Ottawa, 19 April 2005.	David Dodge: Recent review of the Canadian economy Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the House of Commons Finance Committee, Ottawa, 19 April 2005. * * * 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 Members of Parliament 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. Last Thursday, we released our April Monetary Policy Report. In the report, we said that the global economy has been unfolding largely as expected, and the outlook for the Canadian economy is essentially unchanged from that in January’s Monetary Policy Report Update. The Canadian economy continues to adjust to global economic developments. This was also an important theme last October when Paul and I appeared before this Committee. These developments include the realignment of currencies in response to global imbalances, the higher prices of both energy and non-energy commodities, and growing competition from emerging-market economies. In Canada, we are seeing more evidence of sectoral adjustments to these global developments. Many Canadian commodity-producing sectors are expanding. However, firms in some other sectors that are exposed to international trade are facing pressure from the appreciation of the Canadian dollar and from foreign competition. On balance, net exports have been a drag on the economy. But with robust domestic demand, some sectors - such as retail, wholesale, and housing - have been growing strongly. The Bank expects Canada’s economy to grow by about 2 1/2 per cent in 2005 and 3 1/4 per cent in 2006, with growth this year and next coming primarily from strength in domestic demand. To continue to support aggregate demand, we decided to leave the target for the overnight rate unchanged at 2.5 per cent on 12 April. The Bank continues to judge that the economy is operating slightly below its production capacity, and we expect that it will move back to full capacity in the second half of 2006. Core inflation is projected to return to 2 per cent around the end of 2006. Based on the scenario implied by oil-price futures, total CPI inflation is expected to remain slightly above 2 per cent this year, and to move slightly below 2 per cent in the second half of 2006. In line with this outlook for growth and inflation, a reduction of monetary stimulus will be required over time. This outlook is subject to both upside and downside risks and to uncertainties. The risks include the pace of expansion in Asia and the prices of oil and non-energy commodities. A further risk relates to the resolution of global current account imbalances. Should these imbalances persist, the risk of a disorderly correction would grow over time. Most of the uncertainties with respect to the Canadian outlook relate to how the economy is adjusting to the relative price changes associated with major global developments. Monetary policy continues to facilitate the adjustment process by aiming to keep inflation at the 2 per cent target and the economy operating near its production capacity. Mr. Chairman, Paul and I now will be happy to answer the committee’s questions.	bank of canada	2,005	4
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Humber College Institute of Technology and Advanced Learning, Toronto, 30 March 2005.	David Dodge: Canada’s competitiveness - the importance of investing in skills Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Humber College Institute of Technology and Advanced Learning, Toronto, 30 March 2005. * * * Thank you, Michael, and good evening. I am honoured to be here with you to kick off this lecture series. Once again, I want to thank Humber College and the Canadian Foundation for Economic Education for this opportunity. It’s a bit daunting to try to deliver a lecture this late in the evening. But the subject that I want to discuss tonight is one that should be of interest to all of us - the importance of investing in skills to improve productivity growth. As most of you know, this lecture series was announced by the CFEE at a dinner here in Toronto in November 2003. At the conclusion of my speech that evening, I said that, in an increasingly complex and competitive world, furthering our national economic welfare will depend importantly on the quality of our labour force. I also said that improving skills will require concerted efforts from all of us who are involved directly or indirectly in education: parents, educators, employers, community organizations, and policy-makers. It is this shared responsibility that I would like to emphasize this evening. I will begin with a brief discussion about some of the factors influencing Canada’s productivity performance. Then, I will review some of the larger forces at work on the world economy and their implications as we strive to improve productivity. Finally, with these forces in mind, I will offer a few thoughts on how we can best develop Canada’s human resources. What drives productivity growth? Productivity plays a critical role when it comes to our national standard of living. Productivity growth is the main element that contributes to continued improvements in real incomes and overall prosperity. Rising productivity lets businesses pay higher wages, while keeping costs down, employment high, and profits coming in. That’s why economists like me spend a lot of time thinking about ways to improve the productivity of our economy. There are several factors that help to raise labour productivity - by which I mean the amount of goods and services produced per worker per hour. These factors include the education, training, and experience of the workers and the amount and type of equipment available to them. Productivity can also be raised through technological innovation, and through changes in organizational and management practices. All of these key determinants of productivity influence how "smartly" human and capital resources are used. And these determinants are, in turn, influenced by broader factors such as competition, openness to foreign trade and investment, macroeconomic policies, and the efficiency of financial markets. We all recognize that improving productivity is the key component to raising the standard of living of Canadians. From 1996 to 2002, output per hour worked grew at just over 2 per cent, on average, a little faster than our undistinguished performance of the previous quarter century. This provided some reason for optimism. But over the past two years - while economists, business leaders, and policy-makers have talked about the need to raise productivity - output per hour has been essentially flat. While we’re talking the talk on productivity, we are not doing a good job of walking the walk. We have to do better. And over the next decade or two, we will be working to improve this country’s productivity amid significant global economic change. This evening, I’ll focus on three important and ongoing elements of this change: technological innovation, globalization, and demographic shifts. Then I’ll discuss the implications of these trends for skills development. Technological change Let me start with technological change. It’s difficult to untangle and measure the individual components that contribute to productivity growth. But we do know that one of the most important factors in recent years has been the adoption of new technologies. Key among these has been information and communication technology, or ICT. It is by no means the only area where transformative technological advances have been made, but it is the one on which I will focus tonight, for two reasons: first, because ICT offers a useful example of the sweep and the impact of technological change; and second, because it relates to the other two broad trends that I will discuss this evening. The productivity potential of new technology is only realized when companies and institutions reorganize their business and management practices to integrate the new technology. Our lacklustre productivity record suggests that Canadian firms and public sector institutions are moving too slowly to adopt these new technologies and business practices. Let us also remember that technology not only creates opportunities to change work within a firm, it also creates opportunities to change the nature of transactions across firms. Technological innovation lowers transactions costs and facilitates productivity improvements through increased specialization. Specialized firms can build expertise by developing specific skills and then trading that expertise with other firms that offer complementary advantages. Globalization Technological change is hastening the second trend that I want to discuss tonight - and that is globalization. Travelling or shipping goods around the world now takes hours, not days. Information and ideas are available simultaneously to anyone who has access to the Internet. Wireless technology has brought telecommunication to places where phone lines cannot reach. In short, technological advances have allowed markets to expand as never before. In many ways, technology is the enabler of many of the trends leading to globalization, by slashing the costs and the time it takes to reach across borders and continents. Today, we’re all shopping in the same global village market. Consumers and businesses around the world have become the target customers of Canadian firms. At the same time, our firms are exposed to new sources of competition and new pressures to innovate. Perhaps the most preoccupying element of this trend towards globalization is the emergence of China as an economic powerhouse. And India is not far behind. When you consider that China and India account for 40 per cent of the world’s population - and that their economies are growing at annual rates of 9 and 7 per cent, respectively - it is not hard to see why they have such an impact on the global economy. China and India are now major global competitors in labour-intensive industries. Increasingly, they’re also flexing their muscles in skill-intensive industries. Asia’s highly efficient production capacity is prompting a transformation of manufacturing and distribution processes around the world. And the skills-based software industry in India is transforming that sector globally. So we’re seeing tremendous competitive pressure on industries that are the traditional mainstays of the Canadian economy in general and of Ontario in particular - such as automobiles and parts, steel, and other manufacturing industries. We’re also seeing competitive pressures transform Canada’s high-tech sector, which has only recently emerged as an engine of growth. But the income and wealth created in China and India are increasing the ability of these countries to buy goods and services from abroad. So, their integration into the global economy represents both a competitive challenge and a tremendous opportunity. These emerging markets are just that - markets. China is already one of the world’s largest importers. This growing demand can provide a real boost to the Canadian economy, if we gear up to meet the challenge. So, how do we meet those challenges? One way is to integrate low-cost components from other regions of the world into our own production processes, through direct investment or joint ventures. This can help to keep costs down and free up our resources to concentrate on those areas where we have a competitive advantage. Second, we can focus on activities that embrace and facilitate technological advances. I’m thinking of activities such as industrial design, marketing, customization, packaging, and high-quality, individualized service. Humber College and similar institutions are helping to develop and maintain the skilled labour force that Canada needs to be a global player in these activities. At the same time, we can’t ignore the fact that refocusing activity will likely mean job displacement in certain sectors. There will be some activities, particularly those that are labour-intensive and lower-value-added, where Canadian firms will not be well placed to compete with lower-cost producers in Asia. Adjustment will require shifting resources into expanding, higher-value-added activities where Canadian firms can exploit the new opportunities presented by the changing world economy. By making these adjustments, we will be able to increase productivity and raise our standard of living over time. Demographic trends The third significant trend that Canada and other industrialized countries face is the aging of our populations. Right now, about one Canadian in eight is aged 65 years or older. By 2026, that ratio will be one in five. So, we can expect reduced growth in the labour force and a smaller, older workforce in proportion to our population. And let’s remember that this aging of the workforce is taking place as Canada is shifting to a knowledge-based economy. Technology-intensive employers require increased emphasis on retraining and on continuous learning for all workers, including older ones. Studies have shown that older workers participate less than younger ones in job-related education and training. And those workers with less education or low literacy levels find it particularly difficult to adjust to the knowledgebased economy. They are at a higher risk of being laid off and have greater difficulty in finding new work. The good news is that we still have time to prepare for the demographic shift. We have several factors working in our favour. First, technological change and increased use of ICT mean that participation in the labour force can be more flexible - through teleworking, part-time work, job-sharing, off-site consulting, and other innovations. Second, older Canadians are, on average, healthier than in previous generations, and could stay in the labour force longer. Third, the nature of many jobs has changed. There are more skills-based jobs, but they are often less physically intensive and therefore can be done by older workers. Fourth, since the baby boomers are better educated than the current cohort of retiring workers, they may find it easier to adapt to changing work environments. All of these factors mean that the aging of our population over the next two decades need not have as serious an effect on economic growth as some fear. But we will need to increase productivity and to prepare our workforce and our economy for the demographic realities ahead. A focus on skilled labour This leads naturally to the subject that I will discuss in the remainder of my remarks tonight. These three global trends - technological change, globalization, and demographic shifts - must be central to our thinking as we prepare our workforce and our economy for the challenges that we face. So, in light of these trends, how do we best develop our labour force to boost our productivity? As I said at the beginning, the key to achieving these goals lies in coordinated effort. Skills development is a shared responsibility of business, academic institutions, the public sector, workers, and students. We need a system of incentives for continuous learning and upgrading of skills, and an infrastructure that delivers the training. This has always been important. But, as I mentioned earlier, it will be particularly important in the next two decades, as labour force growth in Canada slows. This system of incentives must benefit both workers and firms. If companies don’t see the payoff from training and skills development for their workers, they won’t make the investments. If workers don’t see what’s in it for them, they won’t devote the time and energy to improve their skills. The first step to improving skills is to build an excellent infrastructure for early childhood development, feeding into a school system that effectively teaches basic skills. For Canada to generate productivity gains in a world market that’s embracing technological change, provincial education systems must continue to boost literacy and numeracy rates among students. There’s no longer such a thing as an unskilled job. The workers of today and tomorrow need to know how to learn, so that they can continuously improve their skills after they leave school. If we find more innovative ways to keep students engaged in their education, they will leave school with the enthusiasm they need to continue learning throughout their career. For some students, especially boys, school can feel like incarceration. One reason why drop-out rates are high is that some students don’t see the connection between what they’re being taught in school and what they want to do when they leave school. In order to be motivated to learn math, language, or science, students need to understand that this knowledge is relevant to the careers they want - that these courses are the foundation on which they will build their skills and interests. No one who learns a musical instrument practices scales so that they can be really good at playing scales. They practice scales so that they can play the songs they like. And students need to see first-hand the opportunities that will open up for them by studying hard and staying in school. Colleges, and the industries that support them, play a key role in providing that motivation, through programs that give high school students a first-hand look at the career options ahead. The flip side of the aging population that I discussed a minute ago is relatively smaller cohorts of young people. But that doesn’t mean that we can stop focusing on the problems we face in preparing these young people for the workforce. Indeed, the fact that we have smaller cohorts means that we must do better - we can’t afford to squander the potential of these young people. Once they have finished high school, they need to learn the skills that will help them to become productive workers in the expanding sectors of the economy. I’m in the right place to be talking about this, because Humber College has an exemplary record of training in areas such as design, merchandising, high-end services, and product innovation. Of course, it will always be critical that Canada stay on the leading edge of advanced research and theory. But pure research always needs to be complemented by the ability to commercialize, customize, and market the products that result. Service industries will also require increasing numbers of skilled workers. Older people buy relatively more services as a percentage of their overall consumption. The health care sector, for example, will require more medical technicians, therapists, nurse practitioners, and home care workers to meet growing demand. And as our population ages, the demand for leisure and travel services is increasing. The hospitality and tourism sectors can differentiate Canada from other destinations by delivering the exemplary service that only well-trained workers can provide. In order to learn relevant skills, students should be trained to use the latest tools and production methods employed by the sector for which they’re training. This means innovative partnerships between educational institutions and industry, to give students access to equipment and methods that are actually being used by leading-edge businesses. It means embracing the classic notion of apprenticeship to help make education and training as efficient and as relevant as possible. One more word on apprenticeships. We need to focus on creating a new generation of skilled craftspeople to replace the generation that is retiring. This is not a new problem. I was writing papers about it in the early 1970s, and it still hasn’t been resolved. Existing shortages in some skilled trades are likely to worsen, particularly in those trades where Canada used to rely on imported skills to meet domestic demand. The time to train this new generation is now, so that they can gain from the experience of the older generation while learning the latest techniques. I’ve spoken at length about our education system. But, as we improve the training of young workers, demographics will demand that we also make better use of older workers over the next couple of decades. And that requires continued and innovative on-the-job training. Employers may be reluctant to invest in training older individuals because of the shorter period in which to recoup training costs and because of a perception that older workers are less "trainable." These are misperceptions. First, because of rapidly changing technology, the payoff period for any training has become shorter and the need for the continuous upgrading of skills greater. Second, research suggests that successful training depends on the design of the training program, not on the age of the trainee. We should help older workers to continue to get the skills they need to remain in the workforce - should they wish to do so. I’ve said that improving the skills of Canada’s workers is a shared responsibility. So let me say a word about the role of the public sector. Boosting productivity requires microeconomic policies that encourage innovation in Canada’s private and public sectors. As I mentioned earlier, sometimes this innovation results in the displacement of workers. Public policy should assist those workers to upgrade their skills - not just when they lose their jobs, but during their entire working life. That requires the right mix of policy incentives for individuals and employers to continue to invest in training. And it must be a continuing process, not just a remedial one. Conclusion Ladies and gentlemen, I don’t for a minute believe that these are easy tasks. But the more flexible and efficient we can make our labour force, the better prepared we will be to improve our productivity and to increase the real incomes of Canadians in the years ahead. So let me conclude with a challenge. I began my remarks by talking about the importance of productivity in our efforts to assure rising incomes and economic well-being. And just as we need to improve the productivity of our factories and enterprises, we also need to improve the productivity of our training and education system. So I challenge Humber College and other educational institutions to constantly evaluate and improve the methods they are using to develop the skills of Canada’s workforce. And I challenge subsequent lecturers in this series to come up with new ideas to help them achieve this goal. Creating the world’s most innovative framework for education and training is not a simple task. But it’s an extraordinarily important one. Because the more innovative we can be in skills development, the more innovative we will be as a nation. And that is the best way to promote sustained, long-term economic prosperity for Canadians.	bank of canada	2,005	5
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Ottawa Chamber of Commerce, Ottawa, 6 May 2005.	David Dodge: The Canadian economy - adjusting to global economic forces Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Ottawa Chamber of Commerce, Ottawa, 6 May 2005. * * * Good morning. It's a pleasure to be here. I'm always glad to deliver a speech in Ottawa and to get a chance to play before the hometown crowd. But the opportunity is especially welcome this year, because this is an anniversary year for both the City of Ottawa and the Bank of Canada. The year 2005 marks the 150th anniversary of the establishment of Ottawa as a city. On 1 January 1855, the logging community of Bytown was formally incorporated as a city and adopted Ottawa as its new name. This year is also the 70th anniversary of the Bank of Canada. The Bank opened its doors on 11 March 1935. Both the City of Ottawa and the Bank of Canada have evolved and grown since their early days. But at the Bank, one thing that has not changed is our commitment to promoting the economic and financial welfare of Canada. Our work at the Bank of Canada breaks down into four main functions. Let me briefly review them. First, the Bank issues and distributes Canada's paper currency and protects it from counterfeiting. Last year we issued new $100, $50, and $20 bank notes with enhanced security features. We are adding these security features to an upgraded $10 note, which will begin circulating on 18 May. The Bank of Canada's second function is to act as the federal government's banker, managing government funds and the public debt. Third, the Bank promotes the safety and efficiency of Canada's financial system. It provides banking services to commercial banks and oversees the systems that financial institutions use to transfer funds and settle their accounts. Finally, the Bank of Canada conducts monetary policy in order to preserve the confidence of Canadians in the value of their money by controlling inflation. In this way, we contribute to the long-term stability and strength of the Canadian economy. I will spend most of my time this morning discussing this last function - monetary policy. The Bank of Canada Act calls on us to "mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada." We do this by trying to keep inflation low, stable, and predictable. Specifically, we aim to keep the annual rate of consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent target range. We pursue this objective by trying to keep the economy operating at full capacity; that is, we aim for a balance between total demand and supply in the economy. Simply speaking, if the demand for goods and services is pushing the Canadian economy against the limits of its capacity, and if inflation is poised to rise above the target, the Bank would raise its official policy interest rate. This, in turn, would push up other interest rates and help to cool off the economy. Conversely, if the economy is operating below its production capacity, and inflation is poised to fall below the target, the Bank would lower its target rate, to help bring down interest rates and stimulate growth. So, by maintaining low and stable inflation, monetary policy promotes greater stability in economic output, too. A flexible exchange rate is a critical part of our monetary policy framework. We do not have a target or preferred exchange rate for the Canadian dollar. But it is an important relative price in our economy. A floating currency helps us to achieve our inflation target and can act as a shock absorber to cushion our economy from external shocks. How monetary policy helps the economy adjust Now, let me say a few words about the economic environment in which we're conducting monetary policy. There are powerful forces at work in the global economy, including growing competition from emerging-market economies, such as China and India, and large and growing financial imbalances in the United States and Asia. The growth of emerging-market economies is driving up demand for commodities, and that is pushing up world prices for oil and many non-energy commodities. Meanwhile, productivity improvements in some countries and a competitive world environment are lowering the prices for some consumer goods, communications services, and computer equipment. All of these forces are causing significant movement in the exchange rates of key currencies. They have also contributed to the sharp appreciation of the Canadian dollar against the U.S. dollar over the past couple of years. Some of the adjustments we're now seeing in the Canadian economy are in direct response to these forces. Our monetary policy is helping these adjustments by aiming to support continued high levels of domestic demand. In our most recent Monetary Policy Report, released in April, we projected that domestic demand will grow by almost 4 per cent in 2005. This will offset softer foreign demand and the weaker contribution that exports are making to economic growth this year. This is important in the context of the Ottawa region, and I'll return to that in a moment. I mentioned earlier that monetary policy works to control inflation. Low and stable inflation allows businesses and consumers to better read price signals in markets, which helps them to make better long-term decisions in the face of major economic developments. These signals prompt sectors that are shrinking because of weak demand to release resources that can be absorbed by expanding sectors, where demand is strong. Of course, adjustment is never simple or without pain. Individuals may have to retrain or relocate, and expanding businesses may require time to put the necessary capital equipment in place. But from a macroeconomic point of view, adjustment can take place with less social and economic cost when inflation expectations are well anchored, the economy is operating close to its potential, and a floating exchange rate is helping to absorb external shocks. How businesses are adjusting Let's now explore ways in which Canada's economy is responding to global economic developments. Over the past couple of years, commodity prices have risen dramatically. Our terms of trade - that is, the ratio of the prices that Canadians receive for their exports to the prices that Canadians pay for their imports - have improved by more than 16 per cent since late 2001. In response to these higher prices and stronger demand, we've seen stronger investment spending in oil and gas extraction, mining activity, and wood-product manufacturing. We are also seeing rising investment spending in sectors with low exposure to international trade, such as electric power generation, finance and insurance, and information and cultural industries. In these cases, firms are reacting to strong growth in Canadian domestic demand. I should add that the increased activity in the construction sector reflects increases in both domestic and foreign demand. But there are other sectors that are highly exposed to international trade where the prices of products are not rising. Here, I am referring to goods-producing sectors such as auto parts, textiles, and clothing manufacturing, as well as service sectors such as tourism. Firms in these industries are feeling the pressure of the higher Canadian dollar, and they are also facing increased competition from other regions of the world. The good news is that many Canadian firms are making adjustments. Investment spending is being channelled towards increased specialization, higher productivity, and lower costs. In the goods-producing sector, where much of the productivity-enhancing machinery and equipment is produced abroad and priced in U.S. dollars, the stronger Canadian dollar has substantially lowered the cost of this machinery and equipment and has encouraged firms to buy tools that boost their productivity. In the services sector, stiffer competition is encouraging firms to increase their specialization and offer more value-added, customized services. Other adjustments are also taking place. A growing number of firms are looking to cut costs by importing more inputs. We've certainly seen this type of adjustment taking place among the manufacturers of telecommunications equipment. Other firms are phasing out the production of goods and services with low profit margins and concentrating on those that yield higher returns. Monetary policy is working to support this adjustment process by maintaining strong growth in domestic demand. Low interest rates help encourage consumer and business spending to keep the economy operating close to its production potential. This is important nationally, but strong consumer and business demand will be particularly important to Ottawa this year and next, as growth in the public administration sector is likely to slow. While we at the Bank don't conduct detailed analysis at the municipal level, our general analysis suggests that growth in manufacturing can be expected to moderate, as the higher Canadian dollar dampens demand for made-in-Canada products - including technology products from Ottawa. Like the tourism industry nationally, Ottawa's tourism and hospitality sector is also facing increased competitive pressure from the higher Canadian dollar. On the other hand, continued strong business and consumer demand can be expected to provide support for Ottawa's business services, software, and retail sectors. Financial system efficiency Before I conclude, let me say a few words about the financial system and the Bank of Canada's role in promoting its efficiency. As I have said before, an efficient financial system is critical to maintaining Canada's international competitiveness and long-term economic health. An efficient financial system is one that helps to allocate scarce economic resources to the most productive uses, in a cost-effective way. The ultimate goal is to have Canada's financial institutions and markets match investors and their savings with appropriate, productive investments. In other speeches, I have talked about ways to encourage competition, transparency, and efficiency in Canada's financial markets and institutions. I won't review these discussions today, but I do want to repeat that it is critical that Canada makes headway on these issues. If Canadians want sustainable economic growth and prosperity, our financial system must function as efficiently as possible. One initiative in this area is benefiting from the attention of Jim Watson, Minister of Consumer and Business Services, and the Government of Ontario, and that is the Uniform Securities Transfer Act. The efficiency of our financial markets would be improved if provincial and territorial governments would proceed with legislation to replace the current patchwork of legal rules in this area and to provide a sounder legal basis for the holding and transfer of rights in securities that are held in book-entry form. This is just one example of encouraging initiatives that are under way. At the Bank of Canada, we will continue to contribute to these efforts by conducting research and promoting discussion on ways to improve the functioning of our financial institutions and markets and to enhance the safety and soundness of Canada's financial system. We share this research with regulators, market participants, and the public. Our Financial System Review, published twice a year, is part of that effort. Conclusion Let me now conclude. As I noted at the beginning, there are powerful global economic forces at work, and economies everywhere need to adjust. Businesses in Ottawa, and in the rest of Canada, are making adjustments to meet these challenges and to take advantage of emerging opportunities. At the Bank of Canada, we will continue to monitor these global forces closely and to assess their impact. We will continue to conduct monetary policy with the aim of keeping inflation close to our target and the economy operating at its full potential. We will maintain our efforts to promote a safe and efficient financial system. And, as always, we will work to enhance the confidence of Canadians in the value of their money and the stability of their economy. In this way, we will do our part to facilitate the adjustments that the Canadian economy is making to changes in the global economy.	bank of canada	2,005	5
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Economics Association, Hamilton, Ontario, 27 May 2005.	David Dodge: 70 years of central banking in Canada Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Economics Association, Hamilton, Ontario, 27 May 2005. * * * It gives me great pleasure to be here today with you, and to chair this special conference session celebrating the 70th anniversary of the Bank of Canada. The Bank opened its doors on 11 March 1935, at the height of the Great Depression, and immediately faced enormous challenges. In meeting those challenges, the new Bank of Canada drew on the experience of other, established central banks. It received valuable guidance in functions such as the issuance of bank notes, managing foreign exchange reserves, and promoting financial stability. However, such guidance did not prove to be much of an advantage in what has become the main function of the Bank of Canada - monetary policy. Up to the time that the Bank was founded, monetary policy had been subject to the tight discipline of the gold standard - a topic that Angela Redish has explored in her work. That discipline severely limited the authorities' room to manoeuvre. The notion that countries, acting through their central banks, might actually try to stabilize macroeconomic activity within their borders is a relatively new one. As a consequence, over the past 70 years, the Bank of Canada and other central banks have had to learn by doing - by experimenting and gradually refining the art and science of monetary policy implementation. We have received a great deal of help in this effort from the academic community, including the people here today. But it has not been an easy exercise - nor is it finished. Monetary policy is still very much a work in progress. The evolution of monetary policy Let me now briefly review some of the significant changes in monetary policy that have taken place over the past 70 years. The Preamble to the Bank of Canada Act states that the Bank should: â€¦mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada. Seventy years later, this is still an accurate description of our goal. However, the Act does not provide any practical guidance as to how this objective should be pursued. Through the late 1930s and the early post-war period, the main concern of the central bank was to try to eliminate, and then to avoid a return to, the deflation and high unemployment of the Depression years. The government shared this preoccupation, as evidenced by the 1945 federal White Paper on Employment and Income. Things started to change in the late 1950s and early 1960s, when economists led authorities to believe that there was a permanent trade-off between a little bit more inflation and a little bit less unemployment. All authorities had to do, it was believed, was pick their preferred point on a downward-sloping Phillips curve. But the bitter inflationary experiences of the 1970s and a belated recognition that the Phillips curve might be vertical in the longer run - if not slightly upward sloping eventually led to an increased focus on price stability as the goal for monetary policy. We began to appreciate what Olivier Blanchard calls the "divine coincidence" - that is, the realization that aggregate demand-supply equilibrium and price stability are complementary objectives. We've realized that a low, stable, and predictable inflation rate is probably the best contribution a central bank can make to the economic welfare of the nation. Since inflation was viewed as being "everywhere and always a monetary phenomenon," monetary aggregates were used as intermediate targets. But eventually, they proved to be an ineffective anchor. As Gerald Bouey said, we didn't abandon monetary aggregates, they abandoned us. And so, at the beginning of the 1990s, in the search for a new policy anchor, central banks started to focus directly on inflation, either through implicit or explicit inflation targets. Monetary policy transmission and policy effectiveness The instruments that we have used for the transmission of monetary policy have also changed over the years. In the first 35 years of the Bank's existence, we relied on a "belt and braces" approach to policy execution, in the belief that credit was fungible and that every possible financial avenue had to be covered. The result was a complex mix of primary and secondary liquidity requirements, interest rate ceilings, quantitative limits, outright restrictions and prohibitions, foreign exchange market intervention, and when all else failed - a healthy dose of moral suasion. Attempts to describe the conduct of monetary policy turned into a bewildering stream of arcane details that left listeners confused or - it was sometimes hoped - in awe of the economic alchemists who plied this mysterious craft. This started to change in the 1960s, particularly following the Royal Commission on Banking and Finance in 1964, chaired by Chief Justice of Ontario Dana Porter. It would be hard to overestimate the impact of this analysis, and the sea change in official thinking that was initiated by the Porter Commission. The Commission's revolutionary analysis threw out the old reliance on extensive control over the financial system. As a result, Canadian officials were among the first to understand that reserve requirements and various other controls are actually inimical to the efficient operation of the financial system. The government gradually abandoned these controls in its regulation of financial institutions, and so did the Bank in its implementation of monetary policy. Today, the Bank simply announces its target overnight rate, and the market does the rest - a form of virtual, yet effective, control, back-stopped by the Bank's ability to borrow and lend near-infinite amounts of liquidity. After decades of research, and trial and error, we have reduced the conduct of monetary policy to its essential elements - perhaps a form of alchemy, after all! From there, the next logical step was to make the conduct of monetary policy more transparent and accountable. In the past, central banking had often been cloaked in deliberate secrecy, relying on the element of surprise for its presumed effectiveness. Governance and accountability were not considered important. Communications and reporting were limited to an annual report and a few public addresses. Now, following on the work of John Chant - albeit with a significant lag - we have a clear, highly transparent paradigm for the conduct of monetary policy, and the Bank can be held accountable for its performance. Effective communication is an essential part of that transparency. Monetary policy and a flexible exchange rate Finally, let me talk about the role of the exchange rate in monetary policy. Canada moved to a flexible exchange rate in 1950 and again in 1970 - well before most other countries. Although this gave Canada monetary policy independence, a flexible exchange rate alone does not provide a "coherent monetary order," as David Laidler has noted. The monetary policy framework still requires a nominal anchor to help guide decisions and expectations. As I've said before, the Bank searched for that anchor throughout the 1970s and the 1980s. The outcome of that search was our eventual adoption of inflation targets in 1991. And this anchor has exceeded our most optimistic expectations. Looking ahead This isn't to say that we have reached the end of monetary policy history. The Bank of Canada and other central banks are constantly looking for improvements. The inflation-targeting framework that the Bank and the government put in place 14 years ago has performed well. It is up for renewal in 2006, and we are now in the process of assessing both its past performance and possible refinements for the future. As in the past, we are drawing on the work of researchers both outside and inside the Bank. A long tradition of successful modelling and analysis underlies our work, going back to people such as John Helliwell, who put the Bank on the frontier of macro-modelling in the late 1960s with initiatives like RDX. This research and external networking continues and was evident in the conference that the Bank hosted last month on "Issues in Inflation Targeting." As we move forward and add to the Bank's proud history, it is always useful to look back. Special occasions, such as this 70th anniversary, are valuable opportunities to reflect on the work of those who have preceded us. I look forward to the presentations of our four distinguished panellists - John Chant, John Helliwell, David Laidler, and Angela Redish - all of whom have served as special advisers to the Bank. I want to thank them for the contribution they made while at the Bank, and for their continued efforts in advancing the practice of monetary policy in Canada. They will each speak for about 15 minutes. After that, I will open up the proceedings for questions and comments.	bank of canada	2,005	5
Remarks by Mr David Dodge, Governor of the Bank of Canada, at the Conférence de Montréal, Montreal, 30 May 2005.	David Dodge: Reflections on the international economic and monetary order Remarks by Mr David Dodge, Governor of the Bank of Canada, at the Conférence de Montréal, Montreal, 30 May 2005. * * * Today, I want to talk about an issue that is central to the prospects for the world economy - the management of large, global economic imbalances that have become the subject of increasing concern among market participants and policy-makers around the world. I am referring, of course, to the persistent and growing current account deficit in the United States that is mirrored by large current account surpluses elsewhere, especially in Asia. Up to now, world capital markets have been managing these imbalances in a reasonably smooth way. In the short term, it is reasonable to expect that they will continue to do so. But over the medium term, imbalances of this magnitude are not sustainable. At some point, they will have to be resolved. Why? For one thing, a country's external indebtedness cannot keep growing indefinitely as a share of its GDP. Eventually, investors will begin to balk at increasing their exposure to that country, even if it is a reserve-currency country, such as the United States. For another thing, the buildup of foreign exchange reserves by Asian countries will, eventually, feed into domestic monetary expansion and lead to higher inflation. These imbalances will ultimately be resolved, either in an orderly, or in an abrupt, disorderly way. The question is, are current economic policies and today's international monetary order likely to facilitate an orderly resolution of the imbalances? If not, what changes are needed to reduce the risk of an abrupt, disorderly adjustment? The origins of global imbalances Before we discuss solutions and prescriptions, let me talk briefly about the nature and origins of the current global imbalances. In essence, these imbalances reflect the international financial flows associated with saving-investment mismatches. Specifically, over the past decade or so, we have seen many countries outside the United States increase their saving by a very large amount, while at the same time, the United States has reduced its saving and has become increasingly reliant on foreign borrowing. The origins of the increased saving outside the United States are many and varied. Following the Asian crisis of 1997-98, many countries in that region built up large foreign exchange reserves to guard against having to rely on international assistance in any future crisis. Even countries that avoided the worst effects of the Asian crisis - China, for example - increased their net savings by building up reserves. But more importantly, policies to encourage export-led growth in many Asian economies have exacerbated the situation. Some countries have actively tried to prevent an appreciation of their currencies by intervening in the foreign exchange market. In doing so, not only are they increasing the imbalances, they are also seen by some to be securing an unfair trade advantage and shifting the burden of global adjustment onto others. Of course, savings have also increased outside Asia. In Germany, for example, two factors have led to a large increase in saving in recent years: the conclusion of the reconstruction effort following the 1989 reunification and efforts to fix the German public pension system. Certain oil-exporting countries, including Russia, have also started to generate large net savings. And some developing economies, such as Brazil, have moved from being rather large net borrowers to being net savers today. Inside the United States, there has been a sharp decrease in national saving. The high expected returns in equity markets in the late 1990s led to large capital flows into the United States. The significant capital gains - first on equities in the late 1990s and then on housing in this decade - led to a net decline in household saving out of current income. Furthermore, the low interest rates after 2001, and importantly, the shift in the U.S. fiscal position after 2000, have contributed to growing net dissaving in the United States. As a result, the U.S. current account deficit - which represents the amount of net dissaving going on in the United States - now stands at about 6 per cent of GDP. Why global imbalances are a problem So you might ask, why should policy-makers worry about the resolution of these imbalances? After all, there should be a process that works through world financial markets to allow savers in one country to lend to borrowers in another. Such a process supports higher global growth, since countries with surplus savings can invest them in countries that do not save enough internally. Within national borders, regional savings-investment imbalances emerge all the time. And we don't normally worry about them because there are effective market-based mechanisms in place that work to resolve them. Relative wages and prices change, as do relative returns on capital. This causes a movement in the real exchange rate between regions, which then provides an equilibrating mechanism. The ability of labour to move within a country helps to promote an orderly adjustment process. But there are reasons to worry about imbalances in a global context. To begin with, market-based means of resolving international imbalances are somewhat less effective and potentially more disruptive. This is because there is less labour mobility across international borders, and so larger movements in relative wages and prices are needed in order for them to act as an equilibrating mechanism. Further, certain national and international policies, as well as interventions in the foreign exchange market, have been inhibiting the necessary relative wage and price movements. Indeed, some of these policies are making the situation worse. And so the concern is that the longer these imbalances remain unresolved, the greater the chances that the ultimate resolution will be disorderly. Equally troubling, there is a greater chance of protectionist measures that can seriously damage the global economy. Policy impediments to resolving imbalances Let's look a bit more closely at some of the key impediments to the resolution of imbalances. Some of these impediments are national policies, while others relate to the international monetary order. Let me talk about national policies first. Many of these impediments have been identified in discussions at the G-7 over the past couple of years. It is clear that, to date, there has not been enough progress on structural reforms. This lack of progress is somewhat frustrating, given that there is a reasonable consensus on what should be done domestically in all countries. First, microeconomic policies should allow markets for both goods and labour to function as well as possible and with a maximum degree of flexibility. Almost every country, including Canada, talks a good line about this, but action has been rather slow everywhere. Second, strong policies must encourage the creation and maintenance of a sound financial system that can efficiently allocate domestic and foreign savings. Progress here, although slow, is taking place. The work of the Financial Stability Forum, and the contributions in this area from the Bank for International Settlements, have been helpful. But much remains to be done. Third, all countries must pursue fiscal policies aimed at producing a sustainable public debt-to-GDP ratio. Where structural fiscal balance is absent, it should be achieved; where it is present, it should be maintained. There are some real problems on this front in the United States, in Europe, in Japan, and in some developing countries. A multiple-front approach like this, that works to remove the impediments arising from existing national policies, would certainly go a long way towards allowing market-based mechanisms to resolve global imbalances in an orderly way. However, I doubt that this approach by itself would do the whole job, if real exchange rates are not allowed to adjust in a timely manner. Movements in real exchange rates can come from changes in nominal exchange rates, changes in relative wages and prices, or a combination of the two. But when the nominal exchange rate is fixed, the only way to bring about adjustments in the real exchange rate is through large movements in relative wages and prices. Theoretically, this is feasible - but only if wages and prices are highly flexible both upwards and downwards. But this high degree of flexibility is practically non-existent. And so, when exchange rates are fixed, global economic adjustment can still take place, but it comes at a high cost - through shrinking output and rising unemployment in countries with current account deficits and through very high inflation in countries with current account surpluses. While this adjustment is costly, it does work, provided countries that are fixing their currencies through foreign exchange intervention are not offsetting the monetary consequences of this by "sterilizing" the intervention. This is an important point. When intervention is sterilized, this temporarily prevents the movements in wages and prices needed to bring about the necessary economic adjustment. In these cases, adjustment is postponed - in both surplus and deficit countries. But the adjustment and its costs are only delayed, they are not avoided. Indeed, the costs typically end up being larger than they would otherwise be, precisely because they have been delayed. The only way to truly minimize the costs of adjustment is to allow nominal exchange rates to move around. The ability of a flexible exchange rate to help with economic adjustment was a major factor behind Canada's decision to float its currency in 1950. By the end of the 1990s, most industrialized economies and a number of emerging-market economies had done the same. Other economies, particularly in Asia, have opted for a fixed exchange rate regime. However, some of these countries, by sterilizing their foreign exchange intervention, have rejected the adjustment mechanisms that should go along with such a regime. By sterilizing, not only are they accumulating even larger foreign exchange reserves, more importantly, they are undermining the efficiency of their own domestic economies and interfering with the resolution of imbalances. So there are impediments in Europe, the United States, and Asia that are all getting in the way of a timely and orderly resolution. Because of this, global imbalances are growing, and this is increasing the risk of a disorderly correction at some point down the road. In addition, the longer the adjustment is delayed, the greater the risk that industrialized nations will take protectionist measures against emerging-market economies that are perceived as not playing by the rules. The rules of the game So, what are the policy prescriptions that hold the greatest probability of bringing about an orderly resolution of the imbalances? Put simply, what should be the "rules of the game?" I've already spoken about the consensus that exists on the need for action domestically. What I want to do now is talk about what would be helpful on the international front. To begin with, we certainly need to preserve and increase the potential for goods and services to move freely across national borders. This means further enhancement of the rules of free trade through the Doha round and a strengthening of the World Trade Organization (WTO) to ensure proper compliance with the rules. This effort, as you know, is going on rather more slowly than we would have hoped three years ago, and my sense is that the prospects for substantial improvement are not as good as we thought they might be. However, keep in mind that the last round took 10 years to complete. So, it is important to keep moving forward and to support the WTO in its enforcement of proper compliance with the rules. Of course, free trade needs the support of well-functioning capital markets, as well as exchange rate regimes that allow market-equilibrating forces to play a greater role in the adjustment process. Just as the WTO provides critical support for trade, there is also a need for an effective organization to support the international monetary system. Under Bretton Woods, this role was given to the International Monetary Fund (IMF). But world financial conditions have evolved dramatically, while in many respects, the IMF remains the same institution that was created in 1944 for an era of fixed exchange rates. To be clear, the basic mandate of the Fund - the promotion of an international order that fosters economic growth and investment - remains relevant and important. And the Fund's main responsibilities - surveillance, lending, and helping member nations to develop their financial infrastructure and efficient product and labour markets - are the right ones. But the IMF could, and should, be doing its job more effectively. The IMF must evolve to take account of today's realities. Essentially, change is needed in four areas. First, we must recognize that the Fund has little direct ability to affect the policies of non-borrowing members. Consequently, its ability to influence discussions of important global issues, such as external imbalances, hinges on the quality of its economic and financial surveillance, its advice, and its ability to communicate its message. The IMF should focus its surveillance on systemic issues that can affect global financial stability - an area where the Fund's particular expertise gives it a strong comparative advantage over other institutions. This surveillance must be seen to be independent of national authorities - and independent of the IMF's lending activities. The Fund's analytic and surveillance functions must be strengthened and must not be subservient to its lending function. Second, in a world of freely flowing private capital, we must rely on market-based mechanisms to resolve financial crises, if and when they occur. While the Fund has a continuing role to play in providing liquidity assistance to members in financial distress, there are limits to such assistance - the IMF does not, cannot, and should not have endless reserves. Third, to help guide market expectations regarding the scale of official assistance, we must be very clear that extraordinary Fund lending is just that - extraordinary. If market players cannot judge whether or not the Fund will intervene, and at what amount, they are unable to make appropriate credit decisions. Without clarity on the rules governing access to Fund resources, we leave ourselves open to delays in resolving crises and to moral hazard. These rules must also be as free as possible from political considerations and must allow funds to be used for liquidity assistance only. The provision of additional loans to insolvent countries helps neither the borrower nor other creditors. In this regard, the Fund must improve its ability to distinguish between cases of illiquidity and insolvency. Finally, and very importantly, the IMF must be more effective in its role as a forum where global economic issues are discussed and solutions are found. The Fund should be considered as the place where national authorities can gather around the same table for a frank exchange about policy issues common to all. The Fund must be imbued with the same co-operative spirit seen at the OECD during the 1960s and 1970s as it helped to build a liberal economic order and framework for freer trade. But it's difficult to discuss problems and find solutions if key players don't feel that they are adequately represented. There is a crucial need to build an international financial institution that is seen as meeting the needs of all members. A good start would be to re-examine the representation of Asian and other emerging-market economies, and the implications for their quotas and voting power on the IMF's Board. A larger stake by Asian members in the IMF also implies greater responsibility on their part for the success of the Fund as guardian of the international monetary and financial systems. Indeed, by taking greater responsibility, Asian nations would affirm their commitment to the Fund's important objectives. Moreover, by being able to draw more on the strengths of the Asian economies, the IMF would be in a better position to do its job properly. Conclusion I truly hope that such an institution - one that makes progress in these four areas - will emerge from the strategic review of the IMF that is currently underway. The creation of a global institution for the twenty-first century is tremendously important, not just for Canada, but for all nations. If we can get it right, a more effective IMF would be helpful in the worldwide effort to resolve global imbalances in an orderly way. But a global institution can't do it all by itself. Policy-makers around the world need to make sure that they are part of the solution and not part of the problem. All countries must recognize that it is doubly important to pursue the sound domestic policies that I mentioned - the promotion of flexible markets, the creation and maintenance of a sound financial system, and the pursuit of sound fiscal and monetary policies. Clearly, following these policies is in each country's own domestic interest. But the benefits would flow beyond national borders. If we all follow appropriate policies, then market mechanisms can defuse the danger posed by global imbalances. And that is an outcome that is in everyone's interest.	bank of canada	2,005	6
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canada China Business Council, Beijing, 2 June 2005.	David Dodge: Monetary policy and the exchange rate in Canada Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canada China Business Council, Beijing, 2 June 2005. * * * It is an honour to be in Beijing and to have the opportunity to speak to you. My purpose today is to talk about what I know best - the conduct of monetary policy in Canada. I want to discuss Canada’s experiences - both positive and negative - in moving from a fixed to a floating exchange rate regime, and our subsequent search for a monetary policy anchor. In doing so, I hope that I can provide some insights that may prove useful as China makes its own important decisions about its exchange rate and monetary policy regimes. Canada’s experience is interesting and potentially insightful for two important reasons. First, Canada has more experience with a flexible exchange rate than almost any other country. The Canadian dollar has floated for all but eight years since 1950. Canada is also one of the few countries to have moved, twice, from a fixed to a flexible currency without either an economic crisis or a rapid depreciation of its currency. A second reason why Canada’s experience may be relevant is that the Bank of Canada has had considerable experience in conducting monetary policy independently and in controlling inflation through a system of inflation targets. In 1991, Canada became the second country to introduce inflation targets. I’m pleased to say that this monetary policy framework - with inflation targets and a flexible exchange rate - has proven to be very successful in delivering high, sustainable levels of output and employment in an environment of low and stable inflation. Moving from fixed to flexible exchange rates So, let me talk first about our experiences of moving from a fixed to a floating exchange rate. As I just mentioned, Canada did this twice during the postwar period. The first time was in 1950, and the second was in 1970, following an eight-year period during the 1960s when we again fixed our currency to the U.S. dollar. In both cases, our decision to float was driven by the desire of the Canadian authorities to do what was best for our own economy. We felt that trying to keep the exchange rate fixed at a time of large capital inflows would have had two serious domestic consequences. First of all, it would have generated large inflationary pressures in Canada. Second, and just as important, it could have created a “boom-bust” economic cycle. But Canada’s decision to float in 1950 was not an easy one to make, particularly because we had been very active in the founding of the Bretton Woods institutions and the global fixed-rate system. Canada had struggled to stay within this system during the late 1940s. But by 1950, sharply higher commodity prices and strong capital inflows into our resource sector led to upward pressure on the Canadian dollar. In addition, there were speculative short-term capital inflows, which added to the upward pressure on the currency. To maintain the fixed exchange rate, the Canadian authorities first intervened on a massive scale. Foreign exchange reserves rose by 40 per cent in less than three months, and the money supply grew rapidly at a time when the domestic economy was already operating at capacity. Given the desire to both maintain stable domestic prices and to avoid an economic boom that could lead to a bust later on, Canadian authorities felt that they had two options. One was to revalue the Canadian dollar; the other was to let the Canadian dollar float. The IMF strongly favoured a revaluation - but to what level? It was impossible to know exactly what the correct level for the currency should be. So Canada chose to float the dollar. We allowed the market to set its own level for the currency, with the intention of re-fixing the Canadian dollar at a new level later on. What was surprising was just how quickly the speculative flows eased once we floated our currency. As it turned out, the Canadian dollar appreciated by just 5 per cent during the following three months. While the IMF was very critical of Canada’s decision to float, it accepted our action on the condition that this move would be temporary. The IMF expected Canada to return to the Bretton Woods system as soon as a new equilibrium rate for the Canadian dollar was found. But the flexible exchange rate worked better than almost all observers had expected, and the “temporary period” lasted for 12 years. With the exchange rate allowed to float freely, the Bank of Canada was able to direct monetary policy to the needs of the Canadian economy. We were able to deal with the inflationary threat posed by rapid economic growth and strong investment flows. With the appreciation of the Canadian dollar and with the end of the speculative flows, inflation came down from more than 10 per cent in 1950 to under 3 per cent by 1952. Like most other countries at the time, Canada had extensive foreign exchange controls in place when it floated the Canadian dollar. But with growing confidence in the functioning of currency markets, capital controls were essentially eliminated in 1951, well before this occurred in most other countries. Moreover, the elimination of controls and the move to a flexible exchange rate facilitated the development of our domestic financial markets. And this, along with the floating exchange rate, helped the economy to make the necessary adjustments at a time when large numbers of Canadians were leaving farms and moving into the cities. Now let’s look at 1970, the second time we floated our currency. Canada’s reasons for floating then were similar to those in 1950; that is, there was upward pressure on the Canadian dollar and a rapid buildup of international reserves. This pressure came from high commodity prices, renewed capital inflows, and strong foreign demand for Canadian goods - demand associated with a strong global economy and very loose fiscal policy in the United States. These pressures again led to concerns that an inflationary buildup in Canada could lead to a boom-bust economic cycle. And once again, there were fears of speculative short-term inflows that would make the problem worse. The authorities looked at a number of alternatives, including the setting of a new higher value for the Canadian dollar against the U.S. dollar and a revaluation with a wide band. But these options were rejected because they might have invited further speculative pressures. It was clear that the least risky option for Canada was to return to a floating currency. Domestic policy anchors The floating exchange rate again proved to be useful, because it eased the immediate inflationary pressures. But at the time, we did not understand that a flexible exchange rate alone does not provide a complete monetary policy framework. What was missing was a nominal anchor. What I mean by the term “nominal anchor” is a clear target for monetary policy, a way to give people confidence that policy is on track, and a way to tie down or “anchor” expectations of future inflation. The Bank of Canada searched for such an anchor throughout the 1970s and 1980s. The outcome of that search was our eventual adoption of inflation targets. In February 1991, the Bank and the federal government announced a series of inflation-reduction targets. The authorities saw explicit inflation targets, with a clear time frame to achieve them, as a way to shape inflation expectations. This would make it easier to reduce inflation and, at the same time, make the central bank accountable for its actions. The inflation-control agreement has been extended three times, and since 1995 it has called for the Bank to aim to keep inflation at 2 per cent, the midpoint of a 1 to 3 per cent target range. Let me stress a few points about our inflation-targeting system. First, our commitment to inflation control is the best way that the Bank of Canada can contribute to high sustainable growth of output and employment. In other words, inflation targeting is a means to an end, not an end in itself. The second key point is that we operate in a symmetric way. We care just as much about inflation falling below target as we do about inflation rising above target. If demand for goods and services pushes the Canadian economy against the limits of its capacity, and inflation is poised to rise above the target, the Bank will raise interest rates to cool off the economy. And when the economy is operating below its production capacity, and inflation is poised to fall below the target, the Bank will lower interest rates to stimulate growth. Finally, inflation targeting is very important in terms of the Bank’s accountability to the Canadian public. If inflation persistently deviates from the target, we must explain why this has happened, what we intend to do to bring inflation back on track, and how long we expect the process to take. With the adoption of inflation targets, we have gained all the expected benefits, and even gained some that we weren’t expecting! Let me list some of them. Inflation has become more stable, averaging very close to 2 per cent, and private sector inflation expectations have become well anchored. Importantly, our symmetric approach has also worked as an economic stabilizer, helping to smooth the peaks and valleys of the business cycle. Businesses and individuals can make long-term economic plans with increased confidence about the future. And scarce economic resources are no longer wasted in efforts to hedge against the threat of either high inflation or deflation. Moreover, with inflationary expectations well anchored, we have found that movements in the exchange rate have much less impact on inflation than in the past. This is because markets know that the central bank is committed to protecting the domestic value of the Canadian dollar. Because we have a clear objective, and because we explain publicly how we plan to meet that objective, financial markets can now better predict how the Bank will react to different circumstances. At the same time, inflation targeting has brought increased discipline and clarity to policy deliberations inside the Bank. Let me make two more points about our inflation-targeting framework. First, our experience with inflation targets has also allowed us to see the importance of having an anchor for fiscal policy. After the adoption of inflation targets in 1991, short-term inflation expectations came down quickly. But longterm expectations adjusted much more slowly, for a couple of reasons. It took some time for the Bank to earn its credibility. But more importantly, the federal government also needed to address its fiscal problems. Indeed, the Bank of Canada found that it could not be as accommodative as it wanted to be in its monetary policy during the first half of the 1990s because of the difficult fiscal position at that time. But by the middle of the 1990s, the government committed to ending a series of budget deficits and to putting Canada’s public debt-to-GDP ratio on a sustainable, downward track. With that commitment, Canada finally had anchors for both its monetary and fiscal policies. This now allows us to gear monetary policy more directly to our domestic economic conditions. The other point I want to make is that with these two policy anchors in place, the floating exchange rate can work more effectively for the Canadian economy. It performs a very important function by helping the economy adjust to changing conditions. Movements in the exchange rate send appropriate signals to businesses and consumers, helping the economy to adjust to changing circumstances. To take a recent example, when there is increasing world demand for Canadian goods and services, this tends to lead to a stronger Canadian dollar. The stronger dollar, in turn, tends to restrain exports and to encourage imports. In doing so, the floating exchange rate helps to maintain a balance between total supply and demand in the economy and that helps keep inflation under control. This process also works in reverse. The point I want to emphasize here is that with these policy anchors in place, a floating exchange rate can be a tremendous asset for an economy by helping to keep total supply and demand in balance. Conclusion In closing, let me say again that Canada has been a pioneer both in having a floating exchange rate and in operating with inflation targets. As a consequence, we have a lot of experience that may be of use to others who are contemplating changes to their monetary policy framework. Canada’s long experience with flexible exchange rates has been very favourable, and a floating exchange rate continues to be a key part of our monetary policy framework. But our experience has also taught us that a flexible exchange rate on its own is not enough. A country also needs a domestic anchor for its monetary policy. After trying a number of different approaches, we have now settled on a monetary policy framework based on inflation targeting and a floating exchange rate. This framework helps the economy handle both external and internal shocks. These policies, together with a fiscal policy based on keeping our public debt-to-GDP ratio on a sustainable downward track, have helped to stabilize output and employment at a high level. At the same time, they have delivered low and stable inflation. Finally, let me say that the recent transformation of the Chinese economy has been nothing short of remarkable. The Chinese authorities and the Chinese people should be congratulated for their efforts to raise living standards and to become a dynamic part of the global economy. But there remains much work to do. So, I hope that my description of Canada’s struggle to develop the appropriate policy framework for our country will yield some insights that may prove useful as China makes its own decisions about its own policies.	bank of canada	2,005	6
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Chamber of Commerce, Tokyo, 9 June 2005.	David Dodge: How the Canadian economy is adjusting to global forces Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Chamber of Commerce, Tokyo, 9 June 2005. * * * I am happy to have the opportunity to be back here in Tokyo, and to address this group. No matter where you are in the global economy these days, everyone is talking about the same powerful, economic forces. We are all aware of the large and growing financial imbalances in the United States and in Asia. Rapid growth in emerging-market economies is driving up demand for commodities, and that has pushed up world prices for oil and many non-energy commodities. Meanwhile, productivity improvements in some countries and a competitive world environment are lowering the prices for some consumer goods, communications services, and computer equipment. All of these forces are causing significant movement in the exchange rates of key currencies, including a sharp appreciation of the Canadian dollar against the U.S. dollar over the past couple of years. In short, these are challenging economic times, not just in Canada and Japan, but throughout the world. Today, I’d like to raise two issues. I’ll talk first about how the Canadian economy has been adjusting in the face of these forces - an adjustment that is being facilitated by the Bank of Canada’s monetary policy framework. Then, I’ll talk briefly about what needs to be done internationally to help bring about an orderly resolution of global imbalances. Adjustments in the Canadian economy So let me begin with the Canadian economy. I should set the scene by saying just a few words about how the Bank of Canada conducts monetary policy. The Bank of Canada Act calls on the Bank to “mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada.” The way we do this is by trying to keep inflation low, stable, and predictable. Specifically, we aim to keep the annual rate of consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent target range. In order to keep inflation at the target, we try to keep the economy operating at full capacity. By this, I mean that we aim for a balance between total demand and supply in the economy. Simply speaking, if the demand for goods and services is pushing the Canadian economy against the limits of its capacity, and if inflation is poised to rise above the target, the Bank would raise its key policy interest rate. This, in turn, would push up other interest rates and help to cool off demand. Conversely, if the economy is operating below its production capacity, and inflation is poised to fall below the target, the Bank would lower its key policy rate, to help stimulate demand. So, by maintaining low and stable inflation, monetary policy also promotes greater stability in economic output. I should add that since Canada adopted its inflation-targeting system in 1991, our track record has been excellent. Inflation has averaged very close to 2 per cent and has remained within the target range, with rare exceptions that were due mainly to large swings in the prices of oil and natural gas. And we have seen evidence that our symmetric approach to inflation targeting has helped to smooth the peaks and valleys of the business cycle. I should also add that a flexible exchange rate is a critical part of our monetary policy framework. We do not have a target or preferred exchange rate for the Canadian dollar. But it is an important relative price in our economy. A floating currency helps us to achieve our inflation target and can act as a shock absorber to cushion our economy from the effects of events both inside and outside Canada. I’ll say a bit more about this in a few moments. With that as background, let’s now look at the ways in which Canada’s economy is responding to global economic developments. As I mentioned, the Canadian dollar has appreciated sharply and commodity prices have risen dramatically over the past couple of years, though both have been relatively stable in recent months. Canada’s terms of trade - that is, the ratio of the prices that Canadians receive for their exports to the prices that they pay for their imports - have improved by about 15 per cent since late 2001, generating higher real incomes and stronger domestic demand in Canada. How has the Canadian economy reacted to these higher prices and stronger demand? In the Bank’s April Monetary Policy Report, we noted that we have seen increased business investment spending in oil and gas extraction, other mining activity, and wood-product manufacturing. We are also seeing rising investment in sectors that are not very exposed to international trade, such as electric power generation, finance and insurance, and information and cultural industries. In these cases, firms are reacting to strong growth in Canadian domestic demand. As well, we’ve had very strong investment in residential housing. But there are other sectors, highly exposed to international trade, where prices are either not rising or are rising very slowly. Here, I am referring to goods-producing sectors such as auto parts, textiles, and clothing manufacturing, as well as service sectors such as tourism. Firms in these industries are feeling the pressure of the higher Canadian dollar, and they are also facing increased competition from other regions of the world. The good news is that many Canadian firms are making adjustments. Investment spending is being directed towards increased specialization, higher productivity, and lower costs. Since much of the productivity-enhancing machinery and equipment is priced in U.S. dollars, the stronger Canadian dollar has made it easier for firms to buy tools that boost their productivity. Stiffer competition is encouraging firms to increase their specialization and offer more value-added, customized services. Other adjustments are also taking place. A growing number of firms are looking to cut costs by importing more inputs. We’ve certainly seen this type of adjustment taking place among the manufacturers of telecommunications equipment. Other firms are phasing out the production of goods and services with low profit margins and concentrating on those that yield higher returns. Looking at the economy as a whole, we can see that growth will come primarily from domestic demand this year and next, as the past appreciation of the Canadian dollar continues to restrain net exports. As we noted in our last Monetary Policy Report, we expect the Canadian economy to move back to its production capacity in the second half of 2006. But of course, our outlook remains subject to both upside and downside risks. These are related largely to the global developments and associated relative price changes that I have already mentioned, and the way that the Canadian economy is adjusting to these factors. How is the Bank of Canada contributing to the adjustment process? At this point in time, monetary policy is aiming to maintain strong growth in domestic demand. Low interest rates help encourage consumer and business spending, which in turn helps keep the economy operating close to its production potential. This is an important point in terms of the adjustment process. Because we keep inflation low and stable, businesses and consumers are better able to read price signals in markets, and this helps them to make better long-term decisions in the face of major economic developments. These price signals prompt sectors that are shrinking because of weak demand to release resources that can be absorbed by expanding sectors, where demand is strong. Of course, adjustment takes time, and is never simple or without pain. Individuals may have to retrain or relocate, and expanding businesses may require time to put the necessary capital equipment in place to increase productivity. And of course, some firms will go out of business and some people will be unemployed for a period of time. But from a macroeconomic point of view, adjustment can take place with less social and economic cost overall when inflation expectations are well anchored, the economy is operating close to its potential, and a floating exchange rate is helping to absorb external shocks. International adjustments That’s a quick look at how the Canadian economy is adjusting to global forces. Our flexible exchange rate is helping to bring about movements in the real exchange rate, which is what matters in terms of the adjustment process. But this is not the case in all countries. Where the nominal exchange rate is fixed, the only way to bring about adjustments in the real exchange rate is through large movements in relative wages and prices. This is theoretically possible if wages and prices are highly flexible, both upwards and downwards. But in practice, wages and prices aren’t that flexible. And so when exchange rates are fixed, adjustment can still take place, but it comes at a high cost - through shrinking output and rising unemployment in countries with current account deficits, and eventually through very high inflation in countries with current account surpluses. While this adjustment is costly, it does work, provided countries that are fixing their currencies through foreign exchange intervention are not offsetting the monetary consequences of this by “sterilizing” the intervention. This is an important point. When intervention is sterilized, this temporarily prevents the movements in wages and prices needed to bring about the necessary economic adjustment. In these cases, economic adjustment is postponed - in both surplus and deficit countries. But the adjustment and its costs are only delayed, they are not avoided. Indeed, the costs typically end up being larger than they would otherwise be, precisely because they have been delayed. The only way to truly minimize the costs of adjustment is to allow nominal exchange rates to move around. For decades, Canada has benefited from having a flexible exchange rate that can help bring about economic adjustments. By the end of the 1990s, most industrialized economies and a number of emerging-market economies had also realized the benefits of having a floating currency. But other economies, particularly but not exclusively here in Asia, have opted for a fixed exchange rate regime. And unfortunately, some have rejected the adjustment mechanisms that should go along with such a regime. By sterilizing their interventions, they are accumulating even larger foreign exchange reserves. But more importantly, they are undermining the efficiency of their own domestic economy, and interfering with the resolution of imbalances. Because of this and other impediments, global imbalances are growing, and this is increasing the risk of a disorderly correction at some point down the road. Furthermore, the longer the adjustment is delayed, the greater the risk that industrialized nations will take protectionist measures against emerging-market economies that are perceived as not playing by the rules. And this may be the greatest threat to the global economy - a rise in protectionism which could choke off the growth of international trade that has led to rising incomes around the world. So what is to be done? The adoption of appropriate exchange rate regimes is an important start. But this is only one element of a policy framework that will facilitate adjustment and promote the resolution of global imbalances. First, we all must actively support the Doha round of talks at the World Trade Organization (WTO), recognize the legitimate role of the WTO as arbiter of international trade, and resist calls for protectionist measures in our own economies - measures that will ultimately hurt us all. Second, we all must enhance the flexibility of our domestic markets. Third, we all must create and maintain a sound financial system. Finally, we all must follow appropriate fiscal and monetary policies. We know what needs to be done to help our economies adjust to global economic forces. We all talk a good line about these policies, but action has been slow. If we can get on with the job, not only will we help ourselves, we will also improve the long-term prospects for the global economy. And that is an outcome that’s in everyone’s interest.	bank of canada	2,005	6
Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Winnipeg Chamber of Commerce, Winnipeg, Manitoba, 15 June 2005.	David Dodge: Adjusting to change Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Winnipeg Chamber of Commerce, Winnipeg, Manitoba, 15 June 2005. * * * Good afternoon. I'm glad to be back in Winnipeg. The last time I delivered a speech here was in January 2002. A lot has changed since then - in this city and in the Canadian economy. At that time, our economy was recovering from a worldwide economic slowdown and from the impact of the September 2001 terrorist attacks in the United States. Today, we face more-intense international competition, but we also face new opportunities, as expanding economies become important markets for our products. Like the rest of Canada, Winnipeg and Manitoba are feeling the impact of these international changes. Change is the central theme of my remarks today. First, I will talk about some of the changes that have taken place at the Bank of Canada over its 70-year history. Then, I'll talk about some of the changes that are currently taking place in the global economy, as well as how we see our economy across Canada and right here in Manitoba - adjusting to these changes. Changes at the Bank of Canada This year marks the 70th anniversary of the Bank of Canada. The Bank opened its doors on 11 March 1935, at a time when the Canadian economy was reeling from the effects of a Prairie drought and a worldwide Depression. In its early days, much of the Bank's work was focused on trying to cushion the economy from the effects of high unemployment and falling prices, and replacing bank notes from different issuers with Bank of Canada notes. Almost every aspect of the Bank's work has changed since that time. But today I'll focus on the changes that have taken place in the conduct of monetary policy. By the late 1950s, the Bank's monetary policy and the federal government's fiscal policy were trying to find a balance between controlling inflationary pressures in the economy and encouraging high levels of employment. The economic boom of the 1960s and the bitter inflationary experiences of the 1970s eventually led to an increased focus on price stability as the goal for monetary policy. We developed a better appreciation that keeping inflation low, stable, and predictable is the best contribution a central bank can make to the economic welfare of a nation. During those decades, we learned some key lessons. The first is that a floating exchange rate is a tremendous asset in helping an economy adjust to changes, particularly an economy as open as ours. A floating currency gives a country the flexibility it needs to adjust to economic forces that originate from inside and outside its borders. The second lesson we learned is that, for monetary policy to be successful in controlling inflation, a floating exchange rate is not enough. An "anchor" for monetary policy is also needed. Canada first floated its dollar in 1950, but returned to a fixed exchange rate for eight years during the 1960s. After the decision to float the dollar again in 1970, the Bank spent the 1970s and 1980s searching for an appropriate monetary policy anchor. By this, I mean a clear target for monetary policy, a way to help policy-makers keep policy on track, and a way to tie down or "anchor" expectations about future inflation. The outcome of that search was the eventual adoption of inflation targets as the anchor for Canadian monetary policy. In February 1991, the Bank and the federal government announced an agreement on a series of inflation-reduction targets. This agreement has been extended three times, and since 1995, it has called for the Bank to keep inflation at 2 per cent, the midpoint of a 1 to 3 per cent target range. This inflation-targeting system, supported by a floating exchange rate, has done more than keep inflation low - it has delivered strong and sustained growth in output and employment in Canada. Let me quickly stress that our inflation-targeting framework operates in a symmetric way - we care just as much about inflation falling below target as we do about inflation rising above target. If demand for goods and services pushes the Canadian economy against the limits of its capacity, and inflation is poised to rise above the target, the Bank will raise interest rates to cool off the economy. And when the economy is operating below its production capacity, and inflation is poised to fall below the target, the Bank will lower interest rates to stimulate growth. This symmetric approach helps the Canadian economy adjust to changing circumstances, while maintaining strong, sustained growth in output and employment. The Bank's commitment to the idea of transparency is another way in which our monetary policy has evolved. There was a time when central bankers kept their actions and thoughts shrouded in secrecy, convinced that their policy would be more effective if implemented with an element of surprise. Times have changed, and best practices in monetary policy have evolved. We have found that monetary policy is more effective when people understand what we are doing and why. That's why we communicate regularly with parliamentarians, with markets, and with the public. We do this through our regular Monetary Policy Reports and Updates to those reports. We do this through press releases on fixed announcement dates for interest rate decisions, eight times a year. And we do this through public speaking engagements with audiences across the country. Our methods of communication also continue to change. Today, we use more tools and more technologies to reach Canadians and explain our work. For example, the audio portion of this speech is being broadcast live on the Internet. And we have just completed a redevelopment of the Bank's website. Since its creation in 1995, our website has been central to our efforts to conduct the Bank's business in an open and transparent manner. The site is visited over 180,000 times a week. In 2003, it was named "Central Bank Website of the Year" by Central Banking Publications in the United Kingdom. We wanted to make the site even better, and so on Monday we launched a new version. It features an attractive graphic redesign, improved navigation, and a lot of new content. I encourage you to visit our new site, and we welcome your comments. Changes in the global economy So that's a quick look at some of the ways that the Bank has changed in 70 years. I'll spend the remainder of my time today discussing some of the major changes afoot in the global economy and how the Canadian economy is adjusting to these developments. I've just returned to Canada from meetings with central bankers in China and Japan. I have also attended meetings in Switzerland, the United States, and Morocco over the past month. And in two weeks, I will head to the United Kingdom. In these countries, and in almost every other nation, people are being affected by the same powerful forces - growing competition from emerging-market economies, such as China and India, and large and growing financial imbalances in the United States and Asia. The growth of emerging-market economies has driven up demand for commodities, and that has pushed up the world prices for oil and many other commodities that we produce in Canada. Meanwhile, the more competitive world environment and productivity improvements in some countries are lowering the prices for a number of consumer goods, communications services, and computer equipment. All of these forces are causing significant exchange rate movements, including a sharp appreciation of the Canadian dollar against the U.S. dollar over the past couple of years. Higher prices for many commodities produced in Canada means that our terms of trade - that is, the ratio of the prices that Canadians receive for their exports to the prices that they pay for their imports - have improved by about 14 per cent since late 2001. This has contributed importantly to higher real incomes and stronger domestic demand. How has the Canadian economy been adjusting to these various economic forces? In the Bank's last Monetary Policy Report, published in April, we noted that we have seen increased business investment spending in oil and gas extraction, in other mining activity, and in wood-product manufacturing. These sectors are benefiting from higher world prices for their products. We are also seeing rising investment in sectors that are not very exposed to international trade, such as electric power generation, finance and insurance, and information and cultural industries. In these latter cases, firms are reacting to strong growth in domestic demand. We've also had very strong investment in housing. But in other sectors that are highly exposed to international trade, prices are either falling or are rising very slowly. Here, I am referring to goods-producing sectors, such as auto parts, furniture, and clothing manufacturing, as well as service sectors such as tourism. Firms in these industries are feeling the pressure of the higher Canadian dollar, and they are also facing increased competition from other regions of the world. The good news is that many Canadian firms are making the necessary adjustments. Investment spending is being directed towards increased specialization, higher productivity, and lower costs. Since much of the productivity-enhancing machinery and equipment is priced in U.S. dollars, the stronger Canadian dollar has made it easier for firms to invest in equipment that boosts productivity. Stiffer competition is also encouraging firms to seek new markets, increase their specialization, and offer more value-added, customized services. Other adjustments are also taking place. A growing number of firms are looking to cut costs by importing more inputs. We've certainly seen this type of adjustment taking place among manufacturers of telecommunications equipment. Other firms are phasing out the production of goods and services with low profit margins and concentrating on those that yield higher returns. Current economic developments in Canada and Manitoba Through its monetary policy, the Bank is helping these adjustments by supporting domestic demand. In our April Monetary Policy Report, we projected that domestic demand would grow by almost 4 per cent in 2005. According to recently released data, it grew by slightly more than expected during the first quarter of the year. So we continue to see evidence that strong domestic demand is offsetting the smaller contribution that net exports are making to economic growth. On 14 July, we will publish our Monetary Policy Report Update, which will contain our latest views on the Canadian economy. The Bank is in the process of gathering and analyzing the full set of information on the global and the Canadian economies that will feed into our next interest rate decision, and into the Update. On our last policy-announcement date in May, we decided to maintain the target for the overnight interest rate at 2 1/2 per cent. At that time, we indicated that global and Canadian economic developments had been unfolding broadly in line with our expectations and that our outlook for the Canadian economy through to the end of 2006 was unchanged from the one we presented in our April Monetary Policy Report. The analysis contained in that Report is still relevant. So is our statement that, in line with this outlook for growth and inflation, a reduction of monetary stimulus - that is, an increase in our key policy rate - will be required over time. Now, let me say a few words about the economic prospects for Manitoba. The provincial economy grew by an estimated 2.3 per cent last year, up from 1.5 per cent in 2003. Like the rest of Canada, Manitoba will rely heavily on domestic spending as an engine of growth in 2005. Private sector forecasters are expecting output growth of about 2.7 per cent this year, largely as a result of strong consumption and investment. Exports should also continue to grow, albeit at a slower pace than in 2004. This projection assumes that agricultural production will increase in 2005. It is too early to predict the impact of the recent floods that have ruined many fields in the province. Diversification in Manitoba's economy has been helpful. This province's economy is one of the most diversified in Canada - with a good mix of goods-producing and service industries, resources and manufacturing, traditional and new technology. And there is growing diversity and innovation within industries, such as pharmaceuticals, furniture manufacturing, and the transportation-equipment sector. The broadening of Manitoba's economic base has provided stability to the economy and has kept the province's unemployment rate well below the national average. Manitoba has also been helped by continued fiscal prudence. Conclusion Change is rarely made without difficulty, even when we know that the change is for the better. This is certainly true of adjustments in response to the global economic realities of today. In some cases, industries are being forced to rethink the way they do business. Some firms will close, and some jobs will be lost. This type of adjustment is never easy. But economic change creates new opportunities. And in cities like Winnipeg, and all across Canada, individuals, businesses, industries, and public sector institutions are making the adjustments that will help them improve their competitiveness and seize new opportunities. These efforts also make the Canadian economy stronger and more resilient. That is the best way to prepare ourselves and our economy for whatever changes the future may bring.	bank of canada	2,005	6