I was invited the other day to hear a chief economist of one of our major banks give his assessment of the Canadian economy. The presentation was being given to an audience made up of their retail customers in the Greater Toronto Area. After giving a thorough talk on everything in Europe, China, the US, which included a large section on Trump and his outlook for Canada, he opened it up for discussion. It quickly became apparent that all the retail base wanted to hear more on was the housing market in Canada, not more on Trump. It was all about the housing market, when they should sell, or if they were ever going to be able to buy. In retrospect, it was not surprising that this was the focus following the presentation as it was also the topic du jour over a glass of wine ahead of the event. I admit I was taken aback with the amount of emotion surrounding this topic. Bubble anyone?
Now given that I have a post graduate degree in economics, sadly I guess that makes me an economist. And according to many central bankers, economists are unable to tell if a particular asset class is experiencing a bubble. Given no change in aggregate economic fundamentals, but watching housing prices soar relentlessly from a market that clears through frantic bidding wars apparently is no basis to conclude that the market is in a bubble. This is merely the price that is required to clear a market starved of supply when you have many readied buyers armed with ample credit. Thank goodness it’s not a bubble. Because if it was a bubble, the prescription written by the same economists who can’t recognize one is to do nothing. For them, it is better to remain a Bambi, stay motionless in the lights and then clean up the mess if/when there is an explosion. This is based on the premise that the potential cost of any clean up to the economy following the bubble popping will be less than the cost imposed by reducing economic activity through higher rates targeted to dampen any perceived bubble.
This seems to be a hard argument to swallow after the cost we saw imposed on the global economy of a clean up strategy following the housing calamity in the US in 2008. Unfortunately, we will never know the cost to the economy of what a firmer policy in 2006-7 would have been to make a comparison. So with no data to refute this chosen protocol, all a central banker can do is stick to the protocol. The Bank of Canada, by publicly deflecting responsibility of responding to the housing situation to the politicians, is sticking to the central bank handbook and is setting itself up to be Molly Maid if and when the time comes.
However, the results of following the protocol depends on the starting point. If a central bank is limited in its firepower to add stimulus when the blow up occurs, the cost of any clean up risks being larger than if the monetary authorities start with a full chamber, as the recovery will likely be more protracted. In the current Canadian context, with rates near zero and deficit spending already reducing fiscal capacity, the risk of a long costly clean up rises appreciably. Policy makers need to acknowledge that the calculus is changing. With housing prices in a economic significant area of the country increasing by the day, the expected potential cost of any clean up strategy will soon rival any estimated cost to the economy from accepting an inflation rate being below its target for a longer period of time.
It’s time for the Bank of Canada to be responsible and accountable for the impact of their monetary policy, bubbles and all. This will require the inclusion of asset price behaviour into their monetary policy decisions and the acceptance that hitting an inflation target in a reasonable period of time at all costs may turn out to be too costly.
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