A Wynne-ing Strategy?

Recently in a church basement in downtown Toronto….

“Hello, my name is Ontario and I am a speculative bubble.” 

“Welcome Ontario.  My name is Kathleen.  I take it that this is your first time to one of our meetings?  We are heartened that you have recognized that you have a problem and that you would like to do something about it.  That truly is the biggest step.  Please relax.  I know this is suppose to be anonymous but you may recognize some familiar faces in the group from Australia, Asia and some cities in Europe.”

“Most of the people here are already familiar with many aspects of our 16 step program but let me just run over the basics for you.  The good news is that our program is painless.  The biggest step is the imposition of a property transfer tax of 15% on non-citizens and on those who are not permanent residents of Canada.  Vancouver, sitting in the back over there, went through the same thing and there was just some temporary mild discomfort.  For you, Ontario, they tell us that this will have even a smaller impact on you as about only 8% of buyers fall into this category.”  

“For pain management, we are imposing the tax only around the Golden Horseshoe.  Maybe this will push some of the speculative buying up to The Nation’s Capital.   If federal policy makers start seeing their home prices go up, maybe they won’t be so grumpy and envious…I’m just kidding.”

“The other big part of our program is that we will be implementing rent controls, keeping them at the rate of inflation with a cap at 2.5%.  Again, this should be relatively painless for you.  We were just trying to stop some people from using your state to take advantage of others.”  

“One last big thing. We want to put in place a vacancy tax once we figure out what that means.  Any questions?”

“You are not going to do anything about domestically-driven speculative activity?”

“Nope.  Those buyers will probably back off for a few weeks until they get a feel for how important the foreign buyer was to the price increases, but I’m sure fundamentals will reassert themselves in no time.”

“You are not going to do anything about new housing supply?”

“Well, we are doing something.  The Government had some acreage that they weren’t using so we will construct some low income housing.  It’s not that those people were driving the speculative frenzy, but it does look good.”

“What about the greenbelt around Toronto?  People tell me if restrictions were changed that could deliver significant amounts of new housing.”    

“Our program is designed to be painless for both our voters and the environment.  If we released too much supply, prices could come down too quickly.  We don’t want to hurt the boomers by risking their hard-earned housing lotto winnings.”

“And nothing is going to be done about interest rates?  I don’t have to suffer withdrawal from mortgage rates moving higher?”

“Well now that you have joined our program, that is all the Bank of Canada wanted to see.  They can wipe their hands clean now.  Now that you are a card-carrying member of regions carrying out macro-prudential measures against speculative activity, or MPMASA, they could even lower rates if they felt they had to once Mr. Trump milks NAFTA of its anti-American biases.   Doctor Poloz up in Ottawa has done some fascinating work recently on the subject, claiming that interest rates have no impact whatsoever on what is happening to home prices in your region.  It really is ground-breaking stuff.”

“Okay, so let me get this straight.  This program will help address my speculative sickness by directly attacking 8% of the problem and by indirectly tinkering on the edges of some other things.  I may have some very temporary side effects but they will probably subside in a month or so and now that I am carrying a membership card to MPMASA, this frees the central bank up to cut rates and give me a quick boost if they feel it is necessary because Poloz doesn’t think interest rates had anything to do with my predicament in the first place.”

“Yep.”

“I’m in.”

Unemployment: Poloz's Final Frontier

Let me be one of the first to welcome Captain Poloz and his spacecraft the HMS BoC back to reality from their recent intra galactic voyage.   The Bank’s latest version of the MPR seems to be more in tune with our world.  They finally acknowledged a number of data points that had been read by us earthlings as actually occurring but until this week appeared to be largely ignored by our monetary masters.  Don’t get me wrong, they are still claiming some economic relationships that may work only in zero gravity, but overall they have touched down, however briefly, and joined us in reality.

First, let’s look at their log book that recorded observations when the ship’s wheels hit the tarmac.  They acknowledged that growth had come in much stronger than they were expecting when they left in January.  The oil and gas sector getting up off its knees, strong demand for autos and, of course, an out of control housing market contributed to a surge in activity.  First quarter growth is now strong enough to give the Governing Council enough fortitude to say that interest rate cuts are now off the table.  The Governor during the press conference even said that the recent economic data was good news.  Now if he would only look like he meant it.  

Once they landed they also noted the housing market in the GTA and, given their reading off their price increase meter located on the bridge, concluded that there may be some speculation going on in the region.   They went as far as to include the housing market as a near term positive risk to inflation and to admit that it could also potentially create a macro and financial vulnerability in the future.   

Alas, this was all too much good news for them.  After admitting that economy is in a better place, they quickly reverted to their suck and blow approach to keeping financial conditions accommodative.  Before anyone should get excited about the possibility of increased rates or a stronger dollar as a result of a higher starting position, they stressed that they believe that the recent surge in growth and inflation are just temporary.  From now on, everything is down hill.   The material excess capacity in the economy will be slow to absorb and until every young adult leaves their parents’ basement and finds gainful employment you will have Captain Poloz keeping the shields up and continuing to demand lasers be targeted at non energy exports and be set on accommodation.  GC concluded, after pulling a new rabbit out of their hat with respect to potential growth, that the output gap will not close until the first half of 2018, ever so slightly sooner than envisioned in January.  Their message: Everybody calm down and buckle up in preparation for serial disappointment.  

Confusingly for us, when they create a narrative, they continue to defer to the economics text book they picked up while visiting Uranus University (known as U2 to the alum) on the transmission of monetary policy in zero gravity.  Economic relationships that apparently are theoretically robust in space, but don’t seem to be consistent with what most of us on earth deem to be reality.  According to profs at UU, interest rates have no impact on the housing market (or colonies).  Hell, as the Governor told us several times, rates could go to 5% and still not have an impact.  Those darn speculators are immune.  I remember in economics classes taken on earth, we were always taught that as a result of leverage, the housing market was one of the most interest rate sensitive sectors.  As a result, I am still going to believe an increase in rates would have some impact in cooling the housing market.  But again, a different world.  

More fascinating in zero gravity is that changes in interest rates apparently can have very concentrated effects. In space, changes in rates have no impact on housing investment but do leave an impression on other components of growth, including business investment.  The MPR tells us that the only sources of growth we have to look forward to in the near term will be household spending which will be supported by accommodative monetary policy (except, I guess, for anything to do with housing which is unresponsive to rates) and fiscal stimulus.  The next time GC departs into space, I hope further work will be done studying the elasticity of certain sectors to changes in rates.  Maybe try to understand why in space, rates can rise by 5% and have no impact on a bubbling housing market while at the same time business investment, which we are told is partially paralyzed by uncertainty around US trade measures, is hyper sensitive to the downside given even the slightest hint of a rate increase. On this planet, it wouldn’t matter to business investment if rates went higher.  It would be like stabbing two day old road kill.  

And while the crew is up there, they should track down the financial market literature on the role of “chunks” in dampening financial asset bubbles.   Even without gravity apparently some things can still go down.  The theory apparently states that since the speculator has to buy the entire house,  as prices go ever higher he/she will be unable to muster up sufficient funds to either buy a house or find a buyer who has the financing for the house he/she is trying to flip.  The market then falls under its own weight.  On earth what we are seeing as prices are going through the roof are speculators banding together and splitting any profits.  What we have is the price (known in space as “chunk”) divided by however many speculators want to be involved.  Suddenly the chunks are small again.  Heck, in the 905 region around Toronto, families are combining their incomes to buy one home to live in permanently together.  Having said this, it would be great to get a hold of the work done so we can be better prepared.  The last thing we all want to see is a market blowing out chunks.

The Governor concluded the MPR saying that they are now decidedly neutral.  The market seemed to view the acknowledgement of the stronger data as slightly hawkish.  With the captain of the spaceship convinced that there is excess capacity, and emboldened by low readings of core inflation, economic theories taken from both our world and from their travels will be used to create a narrative to justify extremely accommodative policy.  This is a captain a few years into his seven year mission who is nobly focussed on getting as many people working as he can before the asset bubbles he has created come crashing down on top of him.  He is going where no man sitting in his chair has gone before—unemployment below its natural rate (NAIRU).

Don't blame me

Just when I think I have heard it all….The Governor was asked by Macleans magazine if his institution bears any responsibility for the ongoing speculation in the housing market?  

His answer was an emphatic NO.  Apparently when housing prices are expected to increase dramatically, the level of rates that people would borrow to finance their investment becomes irrelevant.   I would think that higher rates might act to reduce the available leverage to a prospective speculator based on income but I don’t have a Phd.  No, the answer was clear.  “It’s not low interest rates that are fuelling speculation.”

No siree, Bob.  And for the record, it’s not alcohol that fuels intoxication.