Housing is a mess, the economy is stalling. But interest rates will be going up anyway

4 min. read
Toronto Star

Tiff Macklem made a choice.

Even as the International Monetary Fund, the national housing agency and a growing list of private-sector economists are now flagging that a recession is in the offing, Bank of Canada Governor Macklem is fixated on raising rates to crush inflation.

We are in a stagflation environment (that’s stagnant growth and inflation at the same time), however, and the traditional recipe for stabilizing prices looks different in the light of the day.

Nowhere in the Bank of Canada’s mandate does it say he is obliged to coax inflation down to two per cent within two years.

That’s just the assumption we all make because central bankers always talk about a two-year time frame, and we all go along for the ride.

And it is a ride because the bank’s forecasts are a bit like a fairy tale, always ending with inflation, supply, demand and labour conditions in perfect harmony after a two-year time horizon. The policymakers work backwards from there, determining policy — interest rates — accordingly.

These days, that means ratcheting interest rates up repeatedly, regardless of the relentless external causes of inflation and independent of what other countries around the world are doing.

But in fact, since 2011, the Bank of Canada has had “flexible” included in its mandate. And since its most recent mandate-renewal exercise late last year, it has also had instructions to pay closer attention to employment and inclusion.

Macklem could argue he can’t do all of those things at the same time — drive inflation back to two per cent while also being flexible, caring about labour and keeping an eye on the vulnerable people of society all at once.

He could argue he needs to prioritize the fight against inflation and then everything else will fall into place.

He could, and does, argue that a laser focus on stabilizing prices is the best thing he can do for everyone in Canada, and especially those with precarious personal finances.

“Canadians need to see inflation really moving towards the target,” he said Friday in Washington after meeting with counterparts from around the world.

Yes, he sees a growing risk that so many countries aggressively raising rates at the same time will have unintended consequences. Yes, he sees the massive hikes of the past six months already taking a serious bite into Canada’s housing market. And yes, from his vantage point, the path to avoiding a recession in Canada is “narrowing.”

But he also says too-high inflation can’t be allowed to become entrenched and must be his sole priority.

“We are more worried about upside risks to inflation than downside risks,” he said. “So this is not the time to be using flexibility. We’ve been very clear with Canadians that we are taking forceful action with inflation to get it back to target.”

And so he will continue to hike rates.

But that’s a choice, not a given — and it’s a controversial choice because many of the driving forces behind Canada’s inflation are beyond his influence. And the forces within Canada that he can influence are already on their way down, even as the longer-term effects of interest rate cuts have yet to take hold.

Manufacturing is showing signs of losing momentum. The amount of stuff we are buying from stores has declined. And of course housing — the most sensitive part of our economy when it comes to reacting to higher interest rates — is in a mess.

Canada Mortgage and Housing Corp. projected this week that house prices will decline by 15 per cent as higher mortgage rates deter buying. Affordability for homebuyers and renters alike is deteriorating further, and the economy as a whole will fall into a mild recession towards the end of the year before resuming some growth in the second half of next year, CMHC predicts.

There’s no surprise why we’re so vulnerable on the housing front. So much of our personal savings and the national wealth are tied up in real estate that home ownership is thought of as a right, and a retirement savings vehicle. When housing stumbles, a large section of society feels deep effects.

Traditionally, if we were falling into a recession, fiscal policy would come to the rescue with a stimulus package. But because we’re in a stagflation environment, the IMF, Macklem and even Finance Minister Chrystia Freeland argue that big spending is the opposite of what we need right now.

The Parliamentary Budget Officer sees the federal deficit coming in at about $27 billion this fiscal year, about half of the $53 billion that was initially set out in the federal budget. Inflation and lower spending, along with the planned retiring of COVID-19 supports, have contributed to the fast pace of deficit reduction.

So, both the central bank and federal government are tightening fast, just as the economy is stalling.

Basically, after both went the extra mile during the pandemic to ensure everyone had a job, and even those traditionally disenfranchised groups on the sidelines of the labour market could have a hope, they’re both now retrenching — and quickly.

Would it hurt to just slow down a bit and look around to see what’s happening, in the hopes of preserving those gains?

That wouldn’t mean giving up on the fight against inflation. Instead, it would mean allowing dramatically higher rates to take their effect and assessing the results. It would mean watching and evaluating global developments carefully to see if financial markets seize or if supply chains work themselves out. It would mean observing what happens when the housing bubble in Canada pops, and then determining the best course of action.

It’s worth the wait.


Toronto Star Twitter: @hscoffield