This week's Maclean's has yet another installment in its series of apocalyptic economics cover stories (not yet on line, as far as I can tell updated: now available here). One of the points it makes is that where households in other countries are reducing their debt loads, Canadians are borrowing and spending more.
I'm having a hard time interpreting that as bad news. Let's think about how monetary policy is supposed to work during recessions:
- Economic activity slows, generating deflationary pressures.
- The bank lowers interest rates.
- Lower interest rates spur demand in interest-sensitive sectors, especially housing.
- This increased activity helps lead the economy out of recession.
The whole point of lowering interest rates is to induce households to borrow and spend more. It seems churlish to complain that the Bank of Canada's monetary policy is working according to plan.
Indeed, the fact that households in the US and elsewhere are trying to reduce their debt loads is making life extremely complicated for their policy makers. Since lower interest rates are not inducing new spending, they are obliged to rely on fiscal policy to provide stimulus. And if that is not forthcoming – and it doesn't look like it is – then the US economy will have to grind itself out of the recession the slow, hard way. This is not a situation we should be envying.
Yes, Canadian policy makers should follow this file closely. But I don't see the point in trying to dissuade households from spending at this point in the business cycle.
Worthwhile Canadian Initiative 
Maybe the folks at Maclean’s were reading this report from McKinsey. Note the purple shade of the Canadian household sector indicating it to be, in their view, at high risk of deleveraging.
You can’t just increase debt levels (relative to income) indefinitely. I also find it strange that economists buy into an economic theory based on ‘inducing’ people to borrow more, when economists normally advise against interfering with people’s ‘natural’ preferences, and it seems extra strange to ‘induce’ this particular behaviour, when you consider that all of human history has repeatedly demonstrated that people need to be protected from their tendency to borrow too much (see restrictions on borrowing/lending in almost every religion) – not encouraged to borrow more.
Does seem sort of paradoxical.
keynesian!
Yep, but lower interest rates can also work by getting creditor households to want to spend more and lend less. So the effect on household debt can go either way.
I’ve been pushed away from keynesian economics for this very stupid reason. We just had a bad recession/correction triggered by too much lending and the government wants to push borrowing to get growth back to where it was when we were borrowing too much! What? We’ve done pretty well in Canada all things considered. Though I worry a bit about the condo boom, our economy only really took a hit due to external factors of demand (chiefly from the United States).
Before it was irresponsible lending, now it’s about not enough. What do they want? Real growth doesn’t come unless that lending is being put into productive uses, anyways. Canadians bingeing on big screen TVs is not going to sustain an economic recovery. It will just slow it down later on when we try to de-leverage.
And I wish they would get over a tiny little bit of price deflation. I know both monetarists and keynesians both fear deflation (monetarists because it may be that the quantity of money is falling, keynesians because that holds back demand and creates a cycle of doom), but it was painfully evident that this was just caused by businesses clearing out excess inventory.
I haven’t seen the article, so it’s difficult to fully appreciate the author’s point, but I’ll ask a general question:
Does it matter how increasing household debt is financed?
If it’s on the credit card, that to me suggests it’s by individuals who would not pass a means test if they applied for a loan, or a mortgage; or after they obtained a mortgage. And I’m not sure interest rates on credit cards track closely what the prime rate might be, or if they do, they are so high that it doesn’t really matter (23% instead of 25% doesn’t seem such an incentive). Should this demographic be a concern? Maybe if it is growing and reflects the underemployed whose numbers are still high. Don’t know if it is.
I thought one of the problems with the subprime lending in the US was that buyers could include, say, $25 k on their mortgage for appliances, furniture, a necklace for the wife, whatever.
Credit card financing is like a separate silo that, once granted, only seems to increase in credit limits irrespective of one’s other financial obligations. Ability to pay, limited by commitments elsewhere seems less important. Maybe that was the Macleans authors point. Just guessing.
Hmmm… could it be evidence that a (more or less) sound banking system matters. And can we be smug now? Just a little?
Seriously, that McKinsey report makes no sense to me. Canada is down at the bottom in terms of debt as % of GDP, yet we are at risk of a blow-up? I suppose it’s the recent uptick on the right of the graph. But they don’t say who is increasing leveraging and how. Maybe it’s rich people – which would be exactly what we want, wouldn’t it?
Come to think of it didn’t Nick pretty well covered this already? I suppose they missed that lecture.
Hmmm… could it be evidence that a (more or less) sound banking system matters. And can we be smug now? Just a little?
Yeah, so long as you don’t on the otherhand overly complain about risk taking, innovation, and productivity.
There is a cost to being overly risk adverse.
Is infinite household debt a good thing?
No, and that is why this is a concern. If Canadian households had been running surpluses during the boom years, then they should borrow during a recession. But they were not, they were piling on debt during the good times and even more during the bad times. That does not make for a stable economy.
Whereas the governments were running surpluses. So they should be the ones running up extra debt now, not the already over-indebted average Canadian.
Does it make sense now?
asp: Based on Stephen’s summary, Maclean’s didn’t say who was increasing leverage and how.
If it’s poor households experiencing lots of unemployment maxing out their credit cards, then we have a problem. But if it’s wealthy households and/or households with low debt levels taking advantage of low interests by pulling the trigger on consumption then we’re all good; it’s exactly what we need.
I wish the hysteria about debt and leverage would stop. It totally misses the point.
Well, whose job is it to analyse which households are piling on the debt? Where’s an economist when you need one?
Besides, I thought that the point of having artificially low interest rates was to encourage business to borrow money, keeping people employed and spending money they earned?
Yeah I think Patrick is right. The financial crisis was partially caused by irresponsible borrowing by people who didn’t have the means to repay their loans, so if that’s the kind of borrowing we’re seeing, that’s bad.
But given that that kind of borrowing wasn’t much of an issue in Canada, it’s probably pretty normal borrowing we’re seeing, and if it’s going up, it shows that there isn’t a credit crunch. Which is good. And spending is good too. It stimulates the economy.
I’m not a big fan of Maclean’s.
“Canada is down at the bottom in terms of debt as % of GDP, yet we are at risk of a blow-up?”
Down at the bottom due to low corporate, government and financial sector debt, the risk of a blow-up is in the household debt – the same worry that Mark Carney has been expressing for a while now. If you read the full McKinsey report they go into a little more detail on their methodology.
“But if it’s wealthy households and/or households with low debt levels taking advantage of low interests by pulling the trigger on consumption then we’re all good; it’s exactly what we need”
We need people to take on more personal debt, borrowing to spend on non-productive assets? Why?
We’ve had a 30 year bull market in bonds with falling interest rates, rising median personal debt, inflated asset prices, and relatively small income gains. These trends should not continue because interest rates are now at zero. How can households continue to finance ever more debt? They need rising incomes to do so. I don’t think that is going to happen with all the slack in the economy and labour markets. Never mind what happens when the interest rates reverse.
Rising debt levels are a real problem in the developed world. People act like there is nothing wrong since nothing bad has happened yet, but at some point you must go over the falls. The average house in Vancouver is now $1 million dollars, a condo is 500k, and the average 30 something is borrowing 10 years of income to pay for it. Can they borrow 100 years of income? If not, then this game will surely come to an end, won’t it?
Debt is not free. It costs money to borrow money, and we’ve simply had a generational bull market in everything due to falling interest rates. I’m sure some think they should drive interest rates negative to continue the trend. I for one will not be holding anymore Canadian dollars. I’m 30 years old, trying to save for the future, and I can’t save my own country’s currency. Inflation will take 1% of my net worth and 2% of my income every year. This is simply theft.
Furthermore, the CMHC is recklessly expanding credit and driving up the price of houses. They offer to let my wife and I borrow 7.5 times our gross annual income and put nothing down. What is this, crazy world? Have you ever heard of something so stupid?! This ponzi scheme will collapse and when it does it will blow a hole in the government’s budget the likes of which have never been seen. Their insurance in force is 500 billion, it doubled in the last 5 years, and they are leveraged 70:1. Sound familiar? It sounds like Lehman Bros!
Some relevant points from the article:
-In ten years the amount of consumer and mortgage debt held by Canadians has more than doubled to $1.4 trillion and $100 billion of that came last year during the recession.
-Credit card balances are up fourfold in the same 10 years to $54 billion.
-As of Q2 2009 the Bank of Canada (BoC) put the debt-to-income ratio of Canadian households at 142%. The BoC expects that number to hit 160% in two years.
-In the early 1990s $4 billion had been taken on personal lines of credit. Now it’s $200 billion.
-In the last two years, residential mortgage debt load in Canada ballooned 18%.
-In December average national house prices had jumped 19% from the year before and (Canadian Real Estate Association) and sales of existing homes went up 72%.
-The article does refer to the McKinsey report saying a reckoning will need to come as Canadians need to deleverage and pay down unsustainable debt and that could “drag down growth rates for years.”
I think a lot of this is cause for concern. Maybe it’s because as a 23-year-old I am overexposed to young people who, after somehow accumulating $30,000 – $80,000 in student loans for a BA, decide to go buy a house on a variable rate mortgage because it’s only 2%! When you see mortgage, line of credit, and credit card debt going up it seems to leave the economy quite vulnerable to drops in real estate prices and rises in interest rates. Considering your last post expected the Bank to raise interest rates to 4.25% when the output gap closes, you and Macleans are closer to agreement than you think. That incremental shift will likely start soon and this irresponsible debt will become increasingly uncomfortable between 0.25% and 4.25%.
Stephen, I would really encourage you to write a critique (with both pros & cons) of the Macleans article — this would be best if they would agree to a guest article, but a letter would be better than nothing. I know at least some of the writers at Maclean’s appreciate this blog (I found it from theirs), so I suspect you’d be a welcome contributor.
I’ll admit, when I got about 1/3 the way through the article, I started asking myself “what would WCI say about this?” — I’m glad to be finding out!
I don’t think that concern with debt levels is misplaced, if only because it will complicate how and when the Bank decides to increase interest rates. But this particular point was put on the front cover, and I thought it should be put into the perspective of why interest rates are low in the first place.
Stephen Gordon says “I’m having a hard time interpreting that as bad news……….The whole point of lowering interest rates is to induce households to borrow and spend more. It seems churlish to complain that the Bank of Canada’s monetary policy is working according to plan.”
Yes BOC monetary policy is working according to plan. The debt orgy by Canadian households has provided a short term boost to GDP as intended. However no one is complaining that BOC monetary policy is working according to plan. People are concerned about the plan, and its longer term implications.
Good catch Stephen. So the news in. Monetary policy in Canada works!
Thanks Declan. This chart sure puts things in perspective.
Did not know that our total debt levels as a portion of GDP was lower than Switerland. Interesting.
From the same McKinsey report:
What history teaches about deleveraging
To understand what deleveraging might look like going forward, we analyzed 45 significant, historical deleveraging episodes: those in which the ratio of total debt to GDP declined for at least three consecutive years and fell by 10 percent or more. The deleveraging episodes ranged from the US Great Depression (1929–43) to Argentina’s current troubles (2000–present).
In 32 of the episodes, the deleveraging process commenced after a financial crisis and followed one of four paths. Three typically occur under economic conditions that are not currently present, so they are unlikely now: high inflation, which causes deleveraging by increasing nominal GDP growth; massive default, which typically follows currency crises; and rapid economic expansion fueled by war or oil booms…
Since “We are all [now] Albertans”, should one be any more concerned about being overly dependent on one commodity, the third case? Isn’t that a large part of why we’ve been able to break from the pack in the above graph, starting 1998ish?
Over at the Progressive Economics blog I’ve posted a column which argues that we need to rely much more on fiscal policy than monetary policy to engineer a stable recovery.
http://column.global-labour-university.org/
The fact that the Bank has expressed some disquiet about the impact of their actions on household balance sheets is surely room for thought.
“But this particular point was put on the front cover, and I thought it should be put into the perspective of why interest rates are low in the first place.”
Well for christsakes people, its Macleans! Formerly known as the most boring magazine in the world, now going out of its way to be sensationalistic, with covers saying things like “all lawyers are rats” and “why the leafs suck.” Aren’t dentists offices the only actual subscribers to this rag?
Aren’t dentists offices the only actual subscribers to this rag?
Apparently not.
First half of 2009: Maclean’s circulation 355,054, similar to the daily circ. of the G&M
OFF-TOPIC
Over at the Progressive Economics blog I’ve posted a column which argues that we need to rely much more on fiscal policy than monetary policy to engineer a stable recovery.
……………
The fact that the Bank has expressed some disquiet about the impact of their actions on household balance sheets is surely room for thought. -Andrew Jackson
That’s a brave position given that many economists are decidedly skeptical if not outright negative on the social benefits of discretionary fiscal measures. The private benefits are indisputable.
But if the objective is to channel resources to politically powerful recipients, I can see the interest in promoting discrete fiscal policy. Personally, I think we need tax increases. Sooner than later. The US, in particular, should announce a schedule of excise taxes on gasoline and similar that eventually brings it in line with the Nordic countries. Such excise taxes on fuel would accomplish a level of “energy security” for the USA, and by extension the globe, that the world’s largest and most expensive armed forces have been utterly incapable of accomplishing.
The Bank of Canada is concerned about a higher dollar crowding out non-resource activities. Additional discrete fiscal stimulation risks helping to push the Canadian dollar higher not lower. Organized workers in rent-producing concentrated sectors–including the public sector–should make out OK. I dunno about everybody else though. (Do they matter?)
Stephen: If this is so far off topic that you want to delete, please feel free.