Bank of Canada's reversal on guidance welcome but late: Larry MacDonald

There are other tools in the toolbox.

(Photo: Adrian Wyld/CP)

(Photo: Adrian Wyld/CP)

The Bank of Canada earlier this week withdrew its longstanding warning that the overnight rate was headed upward. But the central bank may still be behind the curve: an argument can be made that it should have already cut its lending rate by this stage.

Consider economic conditions over the past year or so. In particular, annual inflation has been hovering near 1%, the lower boundary of the bank’s inflation target. On this basis, one would think there has long been adequate justification for trimming the bank rate to make sure inflation doesn’t fall below the minimum required by policy guidelines.

But something has stood in the way: the fear that additional monetary stimulus will cause debt levels and house prices to overshoot even more so. This concern is evident from the Bank of Canada’s past guidance on interest rates—it has often been accompanied by statements that alerting Canadians to impending rate hikes serves the useful function of discouraging them from going deeper into debt or participating in panic buying of houses.

Yet the fear of blowing a bigger “bubble” seems unwarranted because monetary easing can be accompanied by a tightening of the regulatory framework that governs demand in housing and mortgage markets. In other words, the Department of Finance and other regulators can continue to deploy the strategy adopted in recent years of using regulatory tweaks to hold down borrowing and house prices independently of monetary policy.

There is still plenty of scope for applying this tool. For example, the Office of the Superintendent of Financial Institutions has been considering an extension of the rule changes for CMHC-insured mortgages to uninsured mortgages. Also, federal and provincial officials may be able to agree on similarly tightening the rules for credit unions and other provincially regulated financial institutions.

The added benefit of regulatory tightening is that it helps address the concern that government policy over the decades has gone too far in promoting home ownership. The Bank of Canada will not only have the latitude to pursue expansionary measures but the incentives and implicit subsidies in the housing sector can to some degree be rolled back or offset.

Nevertheless, the stance to date has been to postpone stimulative monetary measures. This has allowed a slowdown in the Canadian economy to emerge. Exports and business investment have not ramped up as much as expected; as a result, they are not ready to pick up the slack left behind by a cooling house market.

Deterioration in economic growth and job creation is not something to welcome. It increases the odds of what we most fear: a violent adjustment in debt and housing markets.

It would be better to get on with reviving the Canadian economy through lower rates and any other required remedies (which would have the effect of bringing down the Canadian dollar from overvalued levels, thus removing a key obstacle to export growth). The sooner the economy picks up and improves personal incomes (while house prices are held in check with appropriate regulatory settings), the sooner the risk of debt and housing crashes can be brought down to safer levels.

Larry MacDonald is a former economist who manages his own portfolio and writes on investment topics. He is the author of several business books.