Macklem testifies at Senate Bank committee

Key Concepts

US Tariffs and Trade Uncertainty: A primary driver of Canadian economic weakness, impacting exports, business investment, and productive capacity.
Inflationary Pressures: While overall inflation is near the 2% target, core inflation remains sticky around 3%. Trade friction adds costs, while economic weakness restrains price increases, leading to an offsetting effect.
Monetary Policy: The Bank of Canada has lowered its policy rate by 100 basis points this year to support the economy through structural adjustment. Monetary policy can help the economy adjust but cannot restore it to its pre-tariff path.
Structural Transition: The Canadian economy is undergoing a shift due to US trade restrictions, leading to reduced productive capacity and higher costs.
GDP Contraction: Canada's GDP contracted by 1.6% in the second quarter due to tariffs and uncertainty.
Labor Market: The labor market is soft, with employment gains following losses, concentrated job losses, and slowing wage growth.
Core Inflation: Preferred measures of core inflation have been sticky around 3%, but upward momentum has dissipated. Broader indicators suggest underlying inflation is around 2.25%.
Quantitative Easing (QE): Not currently being considered; it's a policy for extreme circumstances, guided solely by achieving the inflation target.
Foreign Monkey Wrenches: The primary foreign risk is US trade policy, with potential for material escalation of tariffs leading to recession. Global financial market buoyancy and AI boom valuations also pose risks.
Regulatory Oversight: The Bank of Canada is not the regulator of banks; that role belongs to the Office of the Superintendent of Financial Institutions (OSFI). The Bank focuses on monetary policy and payment systems.
Housing Affordability: The primary solution is increasing housing supply. Policies that increase debt capacity are discouraged as they can inflate prices and burden households.
Household Debt: While levels have been elevated, they have been coming down. However, they still pose a vulnerability to financial stability.
Venture Capital: Concerns exist about bias against women-founded companies, with a call for new funds to promote broader access.
Payment Systems: The Bank of Canada is responsible for ensuring the resilience and safety of payment systems, including upcoming real-time rail and stable coin regulation.
Economic Diversification: A long-standing need to reduce dependence on the US, with businesses increasingly looking to diversify trade to Europe and Asia.
Productivity Growth: Identified as a key driver of rising incomes and affordability, with a need for increased business investment and improved competitiveness.
AI Bubble Risk: While elevated equity valuations in AI stocks pose a risk, the impact on Canada's financial system is considered less severe than in the US due to the smaller scale of Canadian AI companies.
Workforce Reduction: The Bank of Canada is implementing a plan to reduce overall expenses by 15%, including a reduction of approximately 230 jobs.

Main Topics and Key Points

1. Economic Outlook and Monetary Policy Stance

Recent Policy Rate Cut: The Bank of Canada lowered its policy interest rate by 25 basis points to 2.25%, marking the second consecutive cut. This decision reflects ongoing economic weakness and contained inflationary pressures.
Four Main Messages on Canadian Economy:
1. US Tariffs and Trade Uncertainty: These factors have significantly weakened the Canadian economy, leading to expectations of very modest growth for the remainder of the year, with a pickup anticipated in 2026.
2. Inflationary Dynamics: The economic weakness is restraining price increases. However, the trade conflict simultaneously adds costs for businesses, creating upward pressure on inflation. These opposing forces are expected to roughly offset, keeping inflation near the 2% target.
3. Monetary Policy Support: To aid the economy through this adjustment period, the policy rate has been reduced by 100 basis points since the start of the year.
4. Structural Transition: The current economic weakness is not solely cyclical but also a structural transition. US trade restrictions have diminished Canada's economic prospects, reducing productive capacity and increasing costs. This structural damage limits the effectiveness of monetary policy in boosting demand while maintaining low inflation.

2. Economic Conditions and Impacts

GDP Contraction: Canada's Gross Domestic Product (GDP) contracted by 1.6% in the second quarter. This contraction is attributed to tariffs and uncertainty, which reduced exports and business investment.
Sectoral Impacts of US Trade Actions: Targeted sectors such as autos, steel, aluminum, and lumber are experiencing severe effects from US trade actions.
Household Spending: Household spending remained resilient in the second quarter, supported by strong consumer spending and a pickup in residential investment.
Labor Market Weakness: The labor market is described as "soft." Employment gains in September followed two months of significant losses. Job losses have been concentrated, and the unemployment rate remained at 7.1% in September. Wage growth has also slowed.
GDP Growth Projections:
- Second half of the current year: Expected to resume but remain weak, averaging 0.75%.
- 2026: Expected to pick up on a quarterly basis as exports and investment recover.
- By 2027: Expected to average about 1.25%.
- Implication: Excess supply in the economy will be absorbed only gradually.

3. Inflation Analysis

CPI Inflation: CPI inflation was 2.4% in September, slightly higher than anticipated.
Core Inflation: The Bank's preferred measures of core inflation have been "sticky" around 3%, but the upward momentum has dissipated.
Underlying Inflation: A broader range of indicators suggests underlying inflation is around 2.25%.
Inflationary Outlook: The Bank expects inflationary pressures to ease in the coming months, with CPI inflation remaining near 2% over the projection horizon.
Offsetting Forces: Businesses face new costs due to trade reconfiguration and market searches, which could boost inflation. However, the weak economy makes it difficult for them to pass on these costs, leading to discounting. These opposing forces are expected to roughly offset.

4. Monetary Policy Effectiveness and Limitations

Policy Rate Appropriateness: The Governing Council views the current policy rate as appropriate for keeping inflation close to 2% while supporting the economy through its structural adjustment.
Data Dependency: The Bank will carefully assess incoming data relative to its outlook and is prepared to respond if the outlook changes.
Monetary Policy Cannot Undo Tariff Damage: A key message is that monetary policy cannot reverse the damage caused by tariffs. Trade friction leads to a less efficient economy with higher costs and lower income.
Lower GDP Path: Even with economic recovery, the overall GDP path is lower than it was before the shift in US trade policy.
Restoring Pre-Tariff Path: Monetary policy can facilitate adjustment as long as inflation is controlled, but it cannot restore the economy to its previous trajectory.
Country-Level Actions: The speaker emphasizes that there are actions the country can take to achieve a higher economic path and avoid accepting a lower standard of living.

5. Risks and Uncertainties

US Trade Policy: The most significant and ever-present danger is the unpredictability of US trade policy. The upcoming review of the Canada-US-Mexico Agreement (CUSMA) next year is a key point of focus. A material escalation of US tariffs could lead to a recession in Canada, as depicted in a July scenario.
Global Financial Markets: Buoyant financial markets, stretched equity prices (particularly in AI), and narrow corporate credit spreads against a backdrop of uncertainty raise the risk of a sharp downdraft in markets and a tightening of financial conditions if sentiment shifts.
Supreme Court Ruling on Tariffs: Regardless of the Supreme Court's decision, the Bank expects to continue dealing with tariffs for some time.
Other Risks: Beyond tariffs, other risks include a sharp tightening in global financial conditions and the potential for a more difficult or prolonged structural adjustment to increased border friction.
Positive Upside: Progress in reducing sectoral tariffs with the US or a renewed CUSMA could lead to upside potential.

6. Quantitative Easing (QE) and Balance Sheet Management

No Plans for QE: The Bank is not considering quantitative easing and is nowhere near that policy.
QE Rationale: QE is only used in very extreme circumstances, guided solely by achieving the inflation target, not by government financing needs. It has only been used once during the pandemic.
Balance Sheet Management: Apparent movements in government bonds and indemnity agreements are attributed to normal balance sheet management, matching assets and liabilities, not bond purchases for QE.

7. Regulatory Roles and Bank Practices

Bank Regulation: The Bank of Canada is not the regulator of banks; this falls under the Office of the Superintendent of Financial Institutions (OSFI). The Bank's role is primarily in monetary policy and payment systems.
Client Relationships: The Bank does not have a direct role in addressing issues related to banks' relationships with their clients, such as pressure on advisors to meet sales targets or banks discontinuing services.
Licensing: The Bank does not license banks; OSFI does.
Payment Systems Oversight: The Bank has oversight and coordination responsibilities for banks concerning the payment system.
New Regulatory Areas: The Bank will have new responsibilities in areas like the Retail Payments Act (RPA), open banking, and stable coin regulation. The aim is to create a streamlined registration regime for businesses operating in these overlapping areas.

8. Inflation and Rate Reduction Indicators

Prioritized Indicators: The Bank prioritizes a broad range of indicators to assess underlying inflation and determine the timing and pace of rate reductions.
Core Inflation Concerns: While headline CPI has been fluctuating around 2%, core inflation measures around 3% are a concern, as is the potential for CPI to move up to core inflation levels.
Dissipating Upward Momentum: The upward momentum in core inflation has eased, and the Bank anticipates gradual declines in core inflation and continued stability in CPI around 2%.
Wage Pressures: Wage growth has slowed considerably, and the labor market is soft, so wage pressures are not seen as a major cost driver for companies.
Reaction to Shocks: The Bank will assess whether deviations from the outlook are temporary or indicate a fundamental change in the outlook before adjusting interest rates.

9. Business Investment and Productivity

Impact of Budget Measures: The recent budget's measures, including the productivity super deduction, are expected to lower the cost of investment and encourage more business investment. However, the actual impact will depend on private sector uptake.
Productivity Growth: Weak productivity growth over decades is identified as a fundamental reason for affordability problems and stagnant income growth.
Need for Investment: To grow the economy, increase productivity, and improve competitiveness, more business investment is crucial.
Budget's Focus: The budget is seen as a significant shift, with reduced operating expenditures and increased spending on public and private investment. Execution and private sector uptake will be critical to its success.
Uncertainty as a Barrier: Uncertainty, particularly regarding US trade policy, continues to hold back investment decisions. Businesses need to take calculated risks rather than waiting for absolute certainty.

10. Housing Affordability and Household Debt

Increasing Supply: The primary solution to housing affordability is increasing housing supply.
Interest Rate Impact: While interest rates have come down from their highs, the housing affordability problem predates the rate increases, stemming from a mismatch between supply and demand.
Discouraging Debt-Fueled Demand: Policies that simply increase the amount of debt households can take on are discouraged, as they can keep prices high, burden young families, and pose financial stability risks.
Household Debt Levels: Household debt levels remain elevated, making the economy more vulnerable to shocks. While the system weathered the pandemic and interest rate hikes without major financial stability issues, continued monitoring is essential.
Mortgage Renewals: A significant portion of mortgages will renew at materially higher rates, posing financial stress for some households. Lenders' flexibility, wage increases, and savings have so far helped alleviate this stress.

11. Financial System Resilience and Emerging Technologies

Payment System Resilience: Canada's payment system is considered good and will improve with the implementation of real-time rail. The Bank is responsible for ensuring the resilience of these systems.
Stable Coin Regulation: The Bank will oversee the implementation of stable coin regulation, focusing on ensuring stability through adequate backing with high-quality liquid assets and operational resilience.
AI Bubble Risk: While elevated equity valuations in AI stocks pose a risk, the direct impact on Canada's financial system is considered less severe than in the US due to the smaller scale of Canadian AI companies. The primary risk is equity losses, not a systemic impairment of the banking sector.
Stress Testing: The Bank regularly stress-tests banks against scenarios like increased unemployment and mortgage defaults, and current capital levels are deemed sufficient to withstand such stresses.

12. Economic Diversification and International Trade

Reducing US Dependence: There is a recognized need to reduce economic dependence on the United States.
Trade Diversification: Businesses are increasingly looking to diversify trade to Europe and Asia, and there is a slight uptick in exports to non-US markets. This is seen as a business imperative.
China Trade: China is an important trading partner, particularly for natural resources and agriculture. Improving trade relations with China is viewed as beneficial for the Canadian economy, though specific issues like Chinese tariffs on canola are significant.

13. Inflation Measurement and Monetary Policy Framework Renewal

Total Inflation Target: The Bank's target is for total inflation (CPI), not underlying inflation.
Underlying Inflation Measures: Underlying inflation measures are used to gauge stickiness and trends, but recent supply shocks have made it harder to remove noise and identify clear trends.
Dashboard Approach: The Bank is considering publishing a dashboard of various inflation indicators to provide a more comprehensive view and will make decisions on the best approach during the monetary policy framework renewal.

Important Examples, Case Studies, or Real-World Applications

US Tariffs on Autos, Steel, Aluminum, Lumber: These are specific examples of trade actions with severe effects on targeted Canadian sectors.
Canada-US-Mexico Agreement (CUSMA): The upcoming review of this agreement in 2026 is a significant point of uncertainty for the Canadian economy.
July Scenario of Recession: The Bank published a scenario in July illustrating the potential for a recession in Canada if US tariffs were to escalate materially.
Dot-com Bubble Burst (Early 2000s): Used as a historical example of a tech bubble correction that caused a shallow recession in the US but did not lead to a major financial stability problem because it primarily involved equity investors.
Subprime Mortgage Crisis (2008-2009): Contrasted with the dot-com bubble, this crisis significantly impaired US banks and led to a worse recession due to its impact on the core financial system and a prolonged period of deleveraging.
Russian Invasion of Ukraine: Cited as a factor that led to a significant run-up in global food prices.
Counter Tariffs on Food: Mentioned as an instance where tariffs directly impacted food prices, leading to grocery stores labeling affected products.
Mortgage Renewals: The significant number of Canadian households renewing mortgages at higher rates over the next 12-24 months is a current real-world scenario being closely monitored.

Step-by-Step Processes, Methodologies, or Frameworks Explained

Bank of Canada's Approach to Monetary Policy:
1. Assess Economic Conditions: Analyze GDP, inflation (CPI and core measures), labor market data (employment, unemployment rate, wage growth), household spending, and business investment.
2. Identify Key Risks and Uncertainties: Monitor external factors like US trade policy, global financial market sentiment, and internal structural issues.
3. Formulate Outlook: Develop projections for GDP growth and inflation based on current conditions and identified risks.
4. Determine Policy Stance: Set the policy interest rate to achieve the inflation target (2%) while supporting economic adjustment. This involves considering the balance between stimulating demand and controlling inflation.
5. Monitor Data and Respond: Continuously assess incoming data against the outlook and be prepared to adjust policy if the outlook changes significantly.
Assessing Inflation:
1. Track Headline CPI: Monitor the Consumer Price Index as the primary inflation target.
2. Analyze Core Inflation Measures: Use preferred measures of core inflation to understand underlying price pressures and their stickiness.
3. Examine Broader Indicators: Look at a wider range of indicators to estimate underlying inflation.
4. Consider Offsetting Forces: Evaluate factors that push inflation up (e.g., trade costs) and down (e.g., economic weakness).
Stress Testing Financial Institutions: The Bank regularly tests banks against scenarios like increased unemployment and mortgage defaults to assess their resilience and capital adequacy.

Key Arguments or Perspectives Presented, with Supporting Evidence

Argument: US trade policy is the primary external risk to Canada's economic outlook.
- Evidence: GDP contraction in Q2 due to reduced exports and investment, severe effects on targeted sectors (autos, steel, lumber), and the potential for a recession scenario if tariffs escalate.
Argument: Monetary policy cannot fully compensate for the structural damage caused by tariffs.
- Evidence: Tariffs reduce productive capacity and increase costs, leading to a permanently lower GDP path even with recovery. Monetary policy can facilitate adjustment but not restore the pre-tariff economy.
Argument: Increasing housing supply is the most effective solution for housing affordability.
- Evidence: The problem stems from a mismatch between housing supply and demand, which predates rising interest rates. Policies that increase debt capacity are counterproductive.
Argument: Weak productivity growth is a fundamental cause of Canada's affordability problems and stagnant income growth.
- Evidence: Decades of weak productivity have meant that incomes have not risen sufficiently, making everything feel more expensive, even after inflation moderates.
Argument: The Bank of Canada's current policy rate is appropriate for balancing inflation control and economic support.
- Evidence: The rate is at the lower end of the neutral zone, providing some stimulus. The Bank believes it has the right balance based on its outlook, but is prepared to do more if conditions worsen significantly.

Notable Quotes or Significant Statements with Proper Attribution

"US tariffs and trade uncertainty have weakened the Canadian economy." - Governor of the Bank of Canada.
"This weakness is restraining price increases. While this weakness is restraining price increases, the trade conflict is also adding costs for many businesses and this is putting upward pressure on inflation. We expect these opposing forces to roughly offset keeping inflation close to the 2% target." - Governor of the Bank of Canada.
"The weakness we're seeing in the Canadian economy is more than a cyclical downturn. It's also a structural transition." - Governor of the Bank of Canada.
"Monetary policy cannot undo the damage caused by tariffs." - Governor of the Bank of Canada.
"Trade friction means our economy will work less efficiently with higher costs and less income." - Governor of the Bank of Canada.
"Even as economic growth recovers, the entire path for GDP is lower than it was before the swerve in US trade policy." - Governor of the Bank of Canada.
"There are things this country can do to get on a higher path. We don't need to accept a lower standard of living and we shouldn't." - Governor of the Bank of Canada.
"The biggest and most everpresent danger is what happens to US trade policy." - Senator Veroni, quoting the Governor.
"We're not even thinking about quantitative easing. We're nowhere near that." - Senior Deputy Governor Carolyn Rogers.
"The incentives at play appear to leave the investor in the back seat." - President of CARP, quoted by Senator Dendler regarding bank practices.
"We have a good payment system here in Canada." - Senior Deputy Governor Carolyn Rogers.
"We've waited too long to reduce our economic dependence on the Americans." - Governor of the Bank of Canada, as quoted by Senator Wallen.
"The number one thing we need to do to improve housing affordability is increase supply." - Governor of the Bank of Canada.
"Uncertainty is still going to hold back investment." - Governor of the Bank of Canada.
"We don't have any big huge AI companies in this country." - Governor of the Bank of Canada, regarding the AI bubble risk.
"It's time to break the glass, boys and girls. Like we're in a crisis." - Deputy Governor Rogers, quoted by Senator Wallen.

Technical Terms, Concepts, or Specialized Vocabulary with Brief Explanations

Basis Points (bps): A unit of measure used in finance to describe the percentage change in a financial instrument. 100 basis points equal 1%.
GDP (Gross Domestic Product): The total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period.
CPI (Consumer Price Index): A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is a key indicator of inflation.
Core Inflation: Inflation that excludes volatile components like food and energy prices, providing a clearer picture of underlying price trends.
Monetary Policy: Actions undertaken by a central bank to manipulate the money supply and credit conditions to stimulate or restrain economic activity. The primary tool is the policy interest rate.
Policy Rate: The interest rate set by a central bank that influences other interest rates in the economy.
Structural Transition: A fundamental shift in the economy's underlying structure, often driven by technological changes, trade policy shifts, or demographic trends, leading to long-term changes in productive capacity and economic prospects.
Productive Capacity: The maximum output an economy can produce when all available resources are fully utilized.
Quantitative Easing (QE): A monetary policy whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to inject money into the economy to expand economic activity.
Balance Sheet Management: The process by which a central bank manages its assets and liabilities, which can involve buying or selling securities for reasons other than direct monetary policy stimulus.
OSFI (Office of the Superintendent of Financial Institutions): The federal government agency responsible for the prudential regulation and supervision of federally regulated financial institutions in Canada.
Real-Time Rail: A new payment system being implemented in Canada that will enable very fast payments.
Stable Coin: A type of cryptocurrency designed to maintain a stable value, typically by being pegged to a fiat currency or other asset.
CUSMA (Canada-United States-Mexico Agreement): The trade agreement that replaced NAFTA.
Productivity Super Deduction: A tax measure designed to incentivize businesses to invest in new capital expenditures.
Venture Capital: Financing that investors provide for startup companies and small businesses that are believed to have long-term growth potential.

Logical Connections Between Different Sections and Ideas

The transcript flows logically from an overview of the Bank of Canada's recent monetary policy decision and its economic outlook to a detailed discussion of the factors influencing that outlook.

The opening remarks establish the core messages about US tariffs, economic weakness, contained inflation, and the structural transition.
This is followed by a deeper dive into economic conditions, providing specific data (GDP contraction, labor market softness) to support the initial assessment.
The discussion then moves to inflation analysis, explaining the interplay of opposing forces and the outlook for CPI and core inflation.
The limitations of monetary policy are then addressed, emphasizing that it cannot fix structural damage caused by tariffs, creating a crucial link between policy tools and external economic shocks.
Risks and uncertainties are elaborated upon, with US trade policy identified as the paramount threat, directly connecting to the earlier discussion of tariffs.
Questions about quantitative easing and balance sheet management clarify the Bank's current policy tools and their limitations.
The conversation shifts to regulatory roles, distinguishing the Bank's responsibilities from those of OSFI, and then to payment systems and emerging technologies like stable coins, highlighting the Bank's evolving mandate.
Discussions on business investment, productivity, and housing affordability connect the broader economic challenges to specific policy areas and the need for structural reforms beyond monetary policy.
The interplay between household debt, interest rates, and financial stability is explored, linking monetary policy decisions to household financial well-being.
Finally, the renewal of the monetary policy framework and the complexities of inflation measurement lead to a discussion on the challenges of forecasting and communicating economic trends.

Data, Research Findings, or Statistics Mentioned

GDP Contraction: 1.6% in the second quarter.
Unemployment Rate: 7.1% in September.
Wage Growth: Slowed.
GDP Growth Projections:
- Second half of current year: 0.75% average.
- By 2027: 1.25% average.
CPI Inflation (September): 2.4%.
Core Inflation: Sticky around 3%.
Underlying Inflation: Around 2.25%.
Policy Rate Reduction: 100 basis points since the start of the year.
Current Policy Rate: 2.25%.
Government Borrowing (Current Year): $138.4 billion.
Government Refinancing (Current Year): $476 billion.
Government Borrowing (Next Year): $149 billion.
Trade with the US: 75% of Canada's trade.
Venture Capital to Women-Founded Companies: Estimated at 5%.
Mortgage Renewals: Approximately 30% of outstanding mortgages will renew over the next year, with about half seeing a larger payment shock.
Auto Sector Contribution to GDP: Approximately $55 billion.
Auto Sector Jobs: Approximately 450,000 at risk.
Homebuilding Industry Contribution to GDP: Approximately $140 billion.
Homebuilding Industry Jobs: Approximately 1.2 million at risk.
Bank of Canada Workforce Reduction: Approximately 230 jobs (about 10% of its workforce).
Bank of Canada Expense Reduction: 15%.

Clear Section Headings for Different Topics

The summary is structured with clear headings to delineate the different topics covered in the transcript.

Brief Synthesis/Conclusion of the Main Takeaways

The Bank of Canada's current economic assessment highlights a Canadian economy weakened by US trade policies, leading to a structural transition rather than just a cyclical downturn. While inflation is near the 2% target, core inflation remains sticky, and the Bank is navigating the complex interplay of trade-related cost pressures and economic weakness. Monetary policy has been eased to support the economy, but its effectiveness is limited in addressing the structural damage caused by tariffs. Key risks include further escalation of US trade tensions and potential global financial market volatility. The Bank is focused on maintaining price stability while acknowledging the need for broader national strategies to improve productivity, housing affordability, and economic diversification. Regulatory responsibilities are expanding into new areas like stable coins, and the Bank is committed to ensuring the resilience of the financial system and payment infrastructure. The overall message is one of cautious optimism, emphasizing the need for structural reforms and strategic action to secure a higher economic path for Canada.