Financial security Governance Monetary policy

Is Canadian housing price inflation an intended policy outcome?


During the press conference following the Bank of Canada (BoC) July 2014 Monetary Policy Report, bank governor Stephen Poloz was asked whether the Bank was making up excuses – likely in response to his “serial disappointment” remark – to avoid raising its target rate. A lower rate benefits the federal government in a number of ways, primarily by lowering its debt servicing and public spending costs. However, the dangers of an extended period of low interest rates include excessive household debt accumulation, particularly mortgage debt.

But what if the BoC views excessive housing price inflation as a key economic driver – and that view is affecting its policy rate decision?

In 2010, the Bank of Canada published a research report titled Are Wealth Effects Important for Canada? The timing of the publication, at the outset of recovery from the Great Recession, is interesting. Its finding, that “empirical evidence for Canada suggests that consumer spending responds very little to changes in equity wealth but is sensitive to changes in housing wealth,” is even more so.

The research review starts out referencing Milton Friedman’s (1957) permanent income hypothesis. It ignores extensive criticism of the hypothesis and proceeds to analyse the marginal propensity to consume (MPC) out of what it calls ‘non-human’ wealth. This wealth is broadly divided into stock market or housing wealth.

The analysis doesn’t address practical matters – like how perceived housing wealth produces a greater consumption bang for the buck. It references theoretical impact of shocks (permanent/transitory) on consumer spending, without addressing the practical means by which households consume out of stock market vs housing wealth.

As the research notes,  “two-thirds of Canadian households own their residence, while less than one-third of households own equities.” The number of households who own any substantial equity holdings is far less than a third, but that’s another matter.

Effectively, most households have no marginal propensity to consume out of stock market wealth – erroneously referenced as the only type of ‘equity’ by the BoC – because they don’t have any.

What most households do have is their homes, their equity in and value of which they can (ab)use. Whether it’s more credit cards, personal lines of credit or refinanced mortgages, Canadians aren’t just consuming out of perceived house wealth. They’re consuming out of debt afforded by increasing housing wealth, fueled by rising prices.

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