Bank of Canada Governor Mark Carney said the Greek government is right to seek broad democratic support on whether it should accept the financial-rescue plan on offer from its partners in the euro area, so he respects Prime Minister George Papandreou’s plan to hold a referendum.
Speaking to the House of Commons Finance Committee Tuesday morning, Mr. Carney notes that it is “imperative that there is widespread support” for tough decisions to implement major fiscal austerity measures, because they will unfold over a long period.
“If it’s the judgment of the Greek government that this is the best approach to validate that support, we fully respect that,” Mr. Carney said.
The central banker, who was accompanied by his senior deputy, Tiff Macklem, was speaking to the panel about the quarterly forecast released last week, in which they cut their projections for the Canadian economy for 2011 and 2012 and called the crisis in the euro zone the biggest threat to the Canadian and global recoveries. The forecast assumes that European policy makers will keep the euro-zone crisis from worsening, but Mr. Carney has stressed that this notion is “clearly subject to downside risks.”
Mr. Carney’s testimony comes two days before leaders from the Group of 20 nations gather in Cannes, France, for a summit that may be the last chance to restore confidence in the global economy and their management of it.
The latest twist in a largely tumultuous three months is the Greek government’s referendum plan, a high-stakes gambit that could undermine efforts to contain Europe's debt crisis, and which sent markets plunging. A surprising drop in a gauge of manufacturing activity in China and yesterday’s failure of American financial firm MF Global Holdings Ltd -- linked to its exposure to debt from euro-zone countries -- also put investors in a jittery, risk-averse mood.
Noting that the overall level of confidence in policy makers’ ability to make the right decisions to secure the global rebound has“been somewhat diminished by events,” Mr. Carney said he expects the euro crisis will be contained, but was careful to point out that solving the underlying issues will take much longer.
“Our expectation for the measures that are being taken by European authorities is that they will contain the crisis, but that’s different than resolving the issues,’’ he said. “Resolving the issues is going to take years, and there may need to be additional steps in the near term in order to ensure containment.”
Regardless, Mr. Carney reiterated that he predicts the euro zone -- which accounts for 15 per cent of global gross domestic product but far less Canadian trade than the United States -- will have a “mild recession” starting late this year.
The U.S. -- Canada’s chief export market -- will grow so slowly through mid-2012 that the chances of another downturn south of the border are higher, the bank said. And the global slowdown that started in the highly-indebted advanced economies is spreading to emerging-market powerhouses like China, too.
At the summit, G20 leaders are expected to name Mr. Carney as the next chairman of the Financial Stability Board, the global body tasked with co-ordinating the overhaul of international banking rules. The FSB is poised to act as more of a “policeman” to make sure governments implement reforms as promised, Mr. Carney said last week in an interview with CBC’s Amanda Lang. Some analysts say they expect that the G20 will give the FSB, which has little true authority to enforce its will, more clout and possibly its own budget so it can properly monitor this.
Panel members also asked about the inflation-targeting agreement that Mr. Carney and Mr. Flaherty must finish by the end of the year. The current agreement, which aims to keep inflation advancing at an annual rate of about 2 per cent, is expected to be renewed with just the smallest of tweaks, but the committee has said it will hold a separate hearing this month to discuss whether other targets, such as unemployment, should be added to the bank’s mandate.
“Our experience has been that targeting 2-per cent inflation is the best contribution that monetary policy can make to low unemployment and to a stable, growing employment market,” Mr. Carney told the committee Tuesday.
The Globe and Mail reported last month that the current inflation target is expected to be renewed, but with new language on “flexible inflation targeting” detailing the bank’s right to respond to economic shocks or dangerous buildups of credit by taking longer than usual to bring inflation to its 2-per-cent goal.
Mr. Carney told the panel that the central bank already practices flexible targeting.
“There is some variability in that time horizon depending on the scale and nature and persistence of various shocks which could be related to household debt, could be related to Europe, could be related to the United States, both positive and negative,” he said. “That’s part of our core job.”
Also, the governor said there may be a role for monetary policy to address a broad-based threat financial stability but that would need to be “well-explained” and, in any case, a last resort after regulatory approaches are considered first.
A report from Statistics Canada Monday showed the domestic economy grew by a better-than-expected 0.3 per cent in August, but much of that was due to energy production that may slow if the global backdrop deteriorates further. Also Monday, the International Monetary Fund said the economy will grow about 2 per cent this year and next, roughly the same as the Bank of Canada’s forecast, becoming the latest to warn that the economy is not immune to the shaky external climate.
Finance Minister Jim Flaherty has hinted that his fall economic update could delay the government's 2014-15 target for erasing the federal deficit in light of slower economic growth and the lower government revenue that comes with it.
Still, according to IMF officials, one of the key challenges Canada faces in the coming years is how to get back to a more “normal” interest rate position after years of rock-bottom rates, and the high level of household debt in Canada -- along with high house prices -- suggest that many families might be in trouble if an “external shock” were to push down house prices.