DAVID DODGE February 10 2003


DAVID DODGE February 10 2003


Canada’s central banker talks about war, openness—and interest-rate hikes



AS THE FIRST OUTSIDER in 67 years to be appointed Bank of Canada governor, David Dodge has brought a new openness to that often-crusty institution. The former finance department mandarin—the architect of the GST—makes it a point to keep Canadians abreast of bank thinking. Still, onthe-record interviews with him are rare, because financial markets tend to parse every word. Last week, Dodge, 59, sat down with a group ofMaclean’s journalists for an hourlong session. Highlights:

Canada is booming, producing more jobs than the U.S. Can that be sustained?

Well, obviously we’re not going to generate 500,000 jobs a year while the U.S. generates zero forever, so the differential is not sustainable, and not practical. Why have we been doing better over the last three years? Part of the answer is we did a lot worse through much of the 1990s, certainly from the ’91 recession, which was far deeper in Canada, and then we recovered much more slowly than the Americans until about ’96 or ’97. Why did that happen? Well, first, we were adjusting to free trade. Second, we were adjusting to low and stable inflation. And third, we were getting our public accounts into shape. All of those put pressure on Canada and forced a lot of adjustment, and that was painful and expensive.

What we’re seeing now is a bit of a payback for having got our macroeconomic framework right. We’re recapturing some of that ground we lost. And there’s more to come. So the answer is that we can outperform the United States over a period of time, through the first half of this decade, just as we underperformed the United States through the middle of the 1990s.

Every time you go on the road there’s a reason. What’s your message this time?

You asked a very important question: is it sustainable that we continue to do well? My own view is it is sustainable as long as we stick to our knitting. There are four key factors.

First, we continue to open in terms of trade to the world. That is extraordinarily important. Second, that we continue to pursue a monetary policy that focuses on maintaining Canadians’ faith that prices are going to be pretty stable, around two per cent inflation a year as far as the eye can see. Third, that we continue to reduce the public debtto-GDP ratio so the burden of the debt, as we get older, doesn’t fall too heavily on those who will then be working. And finally, that we continue to make the structural reforms to free up markets so that we continue to operate efficiently.

As we look out over the next 18 months, there’s a lot of uncertainty. That uncertainty has been generated by financial market turbulence, although we would argue that there’s been actually quite an improvement over the last four or five months. We’re working our way through the accounting and corporate governance problems.

But we do have geopolitical uncertainty. Our best assumption is that it will begin to dissipate by the second half of the year. Exactly how, we’re not sure, but hopefully there could be a peaceful settlement. Failing that, a short war. The other thing we’re seeing is the Canadian economy perhaps operating a little closer to capacity than we at the bank had thought and had told Canadians last fall. We’re communicating this so that as we go through the next two or three months, Canadians won’t be surprised by the bank taking action, should what we’ve seen in the last little while continue.

In other words, you expect interest-rate hikes, probably.

Yeah. As we’ve said, we have an extraordinary amount of monetary ease in the system right now. Following Sept. 11, we thought all the risks were in one direction, and so we eased monetary policy very significantly. Last spring, we thought we saw things tightening up so we began to take a little bit of that ease out. Then in the summer, the financial headwinds were blowing pretty strongly and so we

stopped. But as those pressures dissipate, people have to be prepared for the fact that in order to maintain our two-per-cent inflation target over the next 18 to 24 months, we’re going to have to remove some of the existing stimulus.

What’s driving your concern about inflation?

We had a view, last summer, that it was mainly being drawn by what you might call one-time price adjustments, electricity and auto insurance being two very big ones. What we’ve seen through the course of the fall is that price pressures are just a little bit more generalized than we had thought, and that the one-time increases seem to be a little bit more persistent.

And with the Iraq situation, are you concerned about a pretty quick boost in gas prices?

Oil and gas prices are volatile. As you know, we separate out eight of these volatile items from our core measure. And while obviously there’s a real economic impact of a prolonged period of high oil and gas prices, in terms of domestic inflation that isn’t our primary worry. We expect oil and gas prices to go up and down.

What’s the outlook for the dollar?

As you know, we don’t comment on shortrun movements in the Canadian dollar. What is happening now is something that we talked about a year ago. We are beginning to see some retracing of the U.S. dollar, which had been extraordinarily strong. We’ve seen it decline markedly against the euro. And as that happens we would expect, over the medium run, that the Canadian dollar would appreciate a bit relative to the U.S. dollar.

Do you see it as part of your mandate to help the dollar?

No. We anchor our monetary policy to try to keep domestic prices relatively stable in our own currency, and then the exchange rate will move around to allow the adjustments to take place. That’s the choice we’ve

made—we made it back in 1991—and increasingly, most countries in the world are coming to that view.

Though it runs counter to those who advocate currency union with the U.S. What are your views on that?

If you’re looking at integration of economies, you first start with the market for goods and services, and then capital, and then labour. Once you’ve got those integrated, then you can consider whether a single currency would make sense. We’ve got reasonable integration in the goods and services markets. We’ve got reasonable integration in capital markets. We’re really nowhere in terms of labour markets, or very little. So there’s a lot more to do on that side of things before you would

consider a single currency. But even then it might not make sense, because the structure of our economy is so different from that of the United States.

How do you gather your information?

Obviously, we have access to all data sources. We spend a lot of time on telephones, and that varies a lot, from the analyst through to plant managers through to people running distribution centres. It’s really important to try to understand what’s actually going on on the ground. So we have been beefing up staff at our five regional offices. They now go out and talk to a rotating group of about 100 companies each quarter to try to get that softer information, if you will, that more touchy-feely sort of information. We

also spend quite a bit of time analyzing what’s going on in credit markets, so we’re talking to credit managers at the banks, and to people in the market. And not just in Canada. We pay a lot of attention to what’s going on in New York, a bit of attention to Chicago, to London. And we work with other organizations, such as the Conference Board, and we get StatsCan to do special work for us, and so on. So it’s a pretty pervasive intelligence-gathering network.

You’ve talked about more openness. What are the benefits to the bank?

I think there are three major benefits. First of all, when we’re open going out, then people tend to be more open with us, so the quality of the information that we get back is bet-

Q&A | >

ter. Number 2, Canadians shouldn’t really ever be surprised by what we are doing. They may be surprised on any individual fixed action date, but they should have a pretty reasonable fix on what our thinking is. And finally, the big payoff comes when a real crisis arises, because then Canadians will have built up some degree of trust that we’re not trying to hoodwink them.

Are you concerned about the rising debt load of Canadian households?

A good chunk of this debt has been built up through mortgage debt, roughly 70 per cent. That hasn’t changed very much. And our analysis would say that, unlike Britain or Australia, here house prices have really not gone up at an unsustainable rate. We’re seeing quite a supply response to, by world standards, the rather modest rise in the price of housing. So we think that market is relatively healthy. And at the moment, because longer-term rates are quite low, there’s quite a bit more financing at five years, so that is protecting consumers as well.

The real issue, then, is the consumer credit side, and that clearly has been growing more rapidly. Part may be due to the extraordinarily generous interest rates offered by auto companies in either lease or purchase arrangements. So we’re not as concerned as some analysts would be by that rise in consumer debt, but over time that line can’t continue. The recent sharp increases may be an indication that consumer credit has been just a little bit too easy.

You encouraged Senator Michael Kirby to do his report on health care. As the GST’s guiding force, what did you think of his proposal to increase the GST to provide extra revenue for health care?

If you look at ways to raise revenues for health care, then taxing consumption is a very appropriate way to do it, because you don’t discourage the generation of wealth, on the one hand, and secondly, consumption does rise very much with income. The person buying $100,000 worth of goods and services in a year obviously is contributing more than the person buying $20,000. Finally and very importantly, consumption grows over time, so those revenues grow appropriately over time.

But it couldn’t fly politically.

It depends on the pilot! IT]