The OECD's Peter Jarrett is weighing in on the issue of Dutch disease that has sparked so much political controversy of late.
The Harvard-trained economist, who began his career at the Bank of Canada in 1979, is also the man behind the OECD's recent call for the central bank to begin gradually hiking its benchmark lending rate.
In Canada for the release of the Organization for Economic Co-operation and Development's latest report on Canada, Mr. Jarrett, who has worked for the international group for 27 years, sat down with The Globe and Mail to chat about some of the most pressing economic issues.
Q: Is Dutch Disease in Canada real? And what can we do about it?
A: Yes, [Canada's] current account has deteriorated, and trade has deteriorated thanks to a higher dollar, but the Canadian economy is still generating jobs and growing. It's foreign direct investment that we're not getting much of in Canada, whereas Canadian companies are investing very heavily abroad.
Norway is the prototypical example [to look to] because they have oil coming out of their ears, and oil to the Norwegian economy is much bigger than oil to the Canadian economy. If they didn't do anything, then the Norwegian krone would have shot through the roof. They would have had Dutch Disease galore.
Norway has been saving [oil revenues] in the form of a sovereign wealth fund, and the Chileans do the same thing with copper. We have the Heritage Fund in Alberta but it's pretty small potatoes, and it has enjoyed almost no inflows for a very long time.
Alberta should be putting money away for the future, and if it did that on a decent size scale, then the dollar no doubt would be weaker, Dutch Disease, or whatever you want to call it, wouldn't be a problem ... and the pressure on manufacturing would be less.
The federal government could even consider contributing money from corporate taxes to a sovereign wealth fund.
Q: The OECD is calling for the Bank of Canada to gradually raise its overnight rate beginning this autumn. You called for this last year too and were ignored. How do you expect the central bank to respond this time?
A: We weren't listened to before because things changed. Last year our projections weren't realized because the euro-area problem flared up again. There were problems due to flooding in Thailand and the Japanese tsunami. There were various things that depressed the short term. This year it looks like there might be a repetition of that. In many countries it looks like the second quarter is weakening quite a bit. There are a lot of entrepreneurs and managers around the world who are deciding to wait and see rather than start new investment projects.
Q: If the Bank of Canada follows your advice and raises the interest rate to 2.25 per cent by the end of 2013, that would create a relatively large spread between the Canadian and U.S. interest rates, given expectations the U.S. rate will stay low until 2014. This would mean more upward pressure on our dollar. Is this a problem?
A: If you're considering a big investment and you're saying, well it makes sense at parity, but if the dollar is at $1.05 it's not going to be profitable, the only way that is really a relevant input into your decision is if you think somehow that the U.S. is almost never going to raise rates. [The Canadian and American central banks] would be a little bit out of sync and they get out of sync from time to time.
Q: How should the Bank of Canada respond to the hot housing market if they are committed to keeping the interest rate low?
A: If the housing market continues to look too frothy, I think the bank will deal with that using sector-specific, macroprudential measures. They might tighten up even further on the standards that are applied to mortgage lending. If there is a tension between keeping a low interest rate to keep near full employment versus a low interest rate that leads to excessive risk taking, the overall health of the economy dominates.
Mr. Jarrett was at the C.D. Howe Institute in Toronto on Thursday for a private, round-table discussion with the organization's members. Jarrett and co-author Alexandra Iwanchuk Bibbee discussed policy suggestions to boost productivity and innovation in Canada, as described in the OECD's latest Economic Survey of Canada.
This interview has been edited and condensed for clarity and length.