One of Bank of Canada Governor Stephen Poloz’s deputies spoke about housing this week. Lawrence Schembri was disarmingly calm while tackling a subject that can easily lead to hysterics. There was no mention of bubbles or irrational exuberance, suggesting the central bank continues to believe that the situation is under control.
There are those who think otherwise. But Schembri’s speech showed that the Bank of Canada remains more concerned about the 18% plunge in Canadian commodity prices this year than the 10% jump in the average national resale price of homes since 2013.
Here’s one reason why:
The red line is the annualized growth rate of household credit since 2007. The dark vertical lines represent the imposition of measures meant to dissuade riskier borrowers from buying homes, such as the narrowing of the amortization period for an insured mortgage to 25 years from 40 years.
When you hear economists and central bankers talk about “macroprudential policy,” this is what they are talking about. In the aftermath of the financial crisis, policy makers were unsure whether measures like these would work. They had never really before tried to limit the negative effects of low interest rates—asset-price bubbles—while at the same time as applying a heavy dose of monetary stimulus. It’s like taking a cocktail of antibiotics and probiotics mixed together.
The Bank of Canada appears satisfied with the results. Schembri conceded that ultra-low borrowing costs have pushed household debt to record levels, but expressed no worry about a U.S.-style housing crash. “The risks stemming from these vulnerabilities have been well managed by complementary macroprudential policies,” he said.
Schembri’s speech was the latest example of the Bank of Canada applying a subtle adjustment to its position on housing prices and household debt. (His boss first expressed confidence in macroprudential policies in June.) Last year, the central bank sounded an alarm, ranking the expansion of personal credit as the biggest threat to the economy, which is why everyone was shocked when Poloz suddenly cut interest rates in January.
These days, the biggest threat to the economy is the fallout of the collapse of oil prices. Poloz reduced the policy rate again in July, after new forecasts showed gross domestic product likely contracted in the second quarter. But for those cuts to have their full effect, the public must accept that the central bank is serious about leaving rates low. The more Poloz and his deputies repeat their contention that the threat posed by household debt has receded, the more confidence executives and investors will have that they can make decisions without having to worry about a snap interest-rate increase.
It shouldn’t be this complicated. When other countries saw the promise of macroprudential policy, they set up stand-alone entities to apply it, leaving monetary authorities free to concentrate on economic growth and inflation. In 2013, Andy Haldane of the Bank of England reviewed 34 countries and found that 23 of them had established committees with the authority to take significant action in this area. Canada is not among them. The macroprudential measures that give Poloz and Schembri comfort were ad hoc, devised behind closed doors by an informal committee of senior technocrats led by the deputy minister of finance. Final approval was at the discretion of the federal cabinet.
Why should you care about all of this? Because according to a couple of Schembri’s predecessors on the Governing Council, the lack of clarity about how Canada applies macroprudential policy is hurting the central bank’s efforts to fight off a recession. “Over the past two years, Canadian monetary policy would have been better placed to combat low inflation and low output had macroprudential policies been openly and transparently geared to reducing the systemic risks associated with high household indebtedness and high and rising real housing prices,” wrote Paul Jenkins, a former senior deputy governor, and David Longworth, a former deputy governor, in a paper that the C.D. Howe Institute published in June.
Every five years, the Finance Department and the Bank of Canada agree on new marching orders on how to go about controlling inflation. (The current agreement is up for renewal next year.) Jenkins and Longworth argue that macroprudential policy should be handled in a similar manner. They would like to see the government assign a clear mandate to an entity specifically empowered to keep a lookout for asset-price bubbles.
To get an idea of why that’s important, consider how the prime minister is seeking to get re-elected. Harper first promised a tax credit on home renovations, then said he’d allow first-time home buyers to use $35,000 of tax-sheltered savings for a down payment, up from $25,000 currently. These policies are the opposite of the macroprudential measures he implemented after the financial crisis. They raise questions about how serious a re-elected Conservative government would be about keeping watch over housing, shifting the onus for financial stability back to the central bank.
There’s every reason to remain doubtful about the Bank of Canada’s ability to keep interest rates low in the face of rising home prices. Debt is at extreme levels and represents a danger to the financial system, and there is no clarity on how Ottawa intends to deal with it.