The commonwealth countries are all facing a property bubble (Canada, New Zealand, Australia, etc). The household debt levels and property prices didn't taper off nearly as much following the 2008 US housing crisis and has pretty much continued unabated: http://www.huffingtonpost.ca/stephen-punwasi/real-estate-bub...
Which is fascinating to consider that the Bank of Canada, et al, have let this happen for so long and are only reacting now...
By artificially keeping rates near 0% the idea was to 'stimulate' the economy by making capital freely available, so for example, banks can more easily loan money to businesses generating long term economic growth and add new jobs. But the side effect has been that retail banks were incentivized to hand out cheap mortgages and the public was incentivized to speculate on the 'hot' property market.
If this bubble doesn't deflate smoothly this will be yet another very expensive side effect of mainstream monetarist policy.
I believe the official stance of the bank of Canada is inflation is below target hence the low rates being acceptable for so long.
What I don't understand (and I hope someone can shine some light on!) is the basket of goods they use to measure inflation doesn't seem to be very impacted by low interest rates - therefore how will the low rates increase inflation? i.e. banks will only lend to me at below 5% if I'm buying fixed assets like a house - which isn't included in the inflation measure. If I want to borrow to buy groceries, gas, or the other things they measure for inflation I would be borrowing at >19.99%. Therefore all low rates does is cause the price of fixed assets to skyrocket. But those assets are tremendously difficult to convert into consumer spending - i.e. You sell your now inflated house, but rather then spending that "profit" (due to the value of your house increasing) on more groceries and gas most people just roll it into another expensive house as they gotta live somewhere. I guess ultimately there will be a trickle down where everything will get more expensive, but seems like it would be a very long process...
Another thing I don't understand about the basket of goods approach to measuring consumer prices is how we're getting inflation figures which are so low. Since goods we buy priced in USD have gone up massively in 2-3 years due to a falling Canadian dollar (electronics, smartphones, computers, SaaS, etc.), the only way the basket stays at 2% YoY growth is if that's offset by other things falling in price.
But, anecdotally, home services, energy cost, health services, food and clothing are all more expensive now than a few years ago, the only exception I can think of off the top of my head is gasoline, which has fallen.
Edit: This StatCan paper (http://www.statcan.gc.ca/pub/62-553-x/62-553-x2015001-eng.pd...) explains CPI in detail and it seems like the basket is thorough and well-thought-out. Appendix B outlines all the components and their weights, and both homeowner costs, rents, and mortgage interest costs do factor into the shelter calculation.
The cynic in me suggests that the basket might intentionally be chosen to hide the fact that the cost of living is going up. Lots of people with money have incentives for inflation numbers to be low. ex: COLA raises are common and benefit if the CPI hides the true costs
Ex2: many government benefits are tied to "inflation" . If your personal basket inflates faster than their example basket then they can get away with paying you less than promised (in spirit).
Wages haven't gone up, so while you may have shifted allocation of purchases within the CPI basket, your total spending is probably around the same as it was last year, and the year before that.
EG you buy more electronics and gas (cheaper), and less clothing and food (more expensive), but your overall spending remains ~50% of your income, which hasn't changed.
Wages are usually the primary driver of higher CPI measured inflation.
Inflation has occurred outside of CPI basket, most notably in equity markets and real estate prices in large urban cities - and bitcoin :)
> Inflation has occurred outside of CPI basket, most notably in equity markets and real estate prices in large urban cities
Those are assets rather than goods. They are neither produced nor consumed. That being said, yeah, it's no mystery that low rates have caused asset price inflation, not consumer price inflation.
It's all a matter of technicalities and definitions :)
You are consuming housing when you pay rent/mortgage. A house is built, and then its owners consume it in "housing units", or rent those "housing units" to other for consumption.
Likewise that ground beef you have in the fridge is an asset - you can sell it to your neighbor at any point before you consume it.
Equity is a claim on a company's assets. If General Electric goes bankrupt and you own GE stock, you will get paid out (after everyone else) a share of the bankruptcy proceeds. So in a way you own some of what GE produces, some of the inputs it consumes, etc.
You can look at literally any transaction as an investment into an asset (generally durable goods) or the purchase of a good for consumption (generally non-durable goods). It depends on how you want to record it on your personal balance sheet...
Assets are not durable goods. Assets different than goods.
When you pay rent you are consuming housing. When you pay a mortgage it is a financing transaction on the asset. Your consumption cost nets out because you are both paying and receiving rent.
Yes all transactions are for either an asset or a good, as Y=C+I...
The problem with your comment is that durable goods do in fact have many of the characteristics which are desireable of financial vehicles and assets: utility/value, portability, indestructibility, homogeneity, divisibility, stability, cognixability. (William Stanley Jevons, Money and the Mechanism of Exchangehttps://archive.org/stream/moneyexchange00jevorich#page/n7/m...)
And whilst land may not be particularly portable, land ownership is.
Other productive assets: metals, grain, productive plant, etc., may also have financial asset value. Also goods which aren't particularly useful such as fine art.
What you have a problem understanding is called 'montary transmission mechanism'. You are thinking about it to directly. The theory basically says that the central bank offers lones above or below the natural interest rate in order to increase or decrease demand for base money increasing or decressing total spending (agregate demand) and thus the general price level.
The problem of conecting the economists theoretic definition of general price level is quite tricky to nail down. The commenly used CPI or even Core CPI does not perform very well.
Many economist would now argue that instread of focusing on CPI price level measure we should use either total spending directly, or use a different price level measure like the 'GDP deflator'.
What I did not talk about is that many prices are foreward looking, so prices start adjusting before demand if things are expected.
In past times, business expansion lowered the unemployment rate, which raised wages, which raised prices.
The first part happened. The last two don't seem to be happening, which is puzzling. Central banks are having to consider that the old model may not hold anymore. No one's really sure what to do.
Consumer tendencies weren't really supposed to enter into it, as far as I know.
I don't think it is puzzling. Technological advances have made each person capable of doing much more, and capital does more and more of the work that people used to (or someone in another country does it). I bet underemployment rate is not low, and with more and more people competing for low skill jobs where they're easily replaceable, again, thanks to technology, there is no reason for wages to go up.
Also of note is that more economic activity is concentrated in fewer and fewer regions, so while a select few (urban) regions experience growth and whatnot, most other areas do not.
I think the majority of technologic trends since at least 2000 have been fundamentally deflationary in nature, for all material goods. We simply are conserving more; using less materials and energy for the same set of consumer uses. Unlike the last industrial revolution where new energy hungry appliances were being invented and new ways of life expanding, most new inventions today are long lasting, low energy consuming, or are just innovations making existing products cheaper.
That central banks and treasuries insist on inflation above zero when we should probably be deflating and letting technology make everyone wealthier...no wonder there are property bubbles. (Note this inflation argument encompasses the effect of trade deficits in creating asset bubbles, because inflation/treasury debt breaks the trade/currency feedback loop)
The theory is simple. Circulating money means the economy is active and producing.
More money circulating means more of the economy is active.
More money in the economy increases inflation because more supply lowers value.
Inflation is good because it is not deflation, but it is not good because it devalues monetary assets over time. Low inflation is best.
The problem is simple. The additional money from cheap loans is not circulating. It is being sunk into mortgages and other debt.
The truth is that the policy is working in the sense that the alternate would have been deflation. Deflation kills retail because it is hard to stay in business if you buy low, sell lower.
As an example - if I get to reduce my mortgage payment by $500 - because interest rate is extremely low - I could technically spend that money on upgrading my car or travel or groceries or eating out - and so pushing up the price. At least that's how I understand it.
I assumed that housing prices were included but apparently not (at least in the US)[1]
I'm under the impression most people are ready to spend a certain portion of their income on their living arrangement and low interest rates just encourage them to buy ~bigger~ more expensive property, rather than actually turning the "savings" into other types of spending.
I'd be interested to find actual data and research about the relationship between interest rates and mortgage spending for given incomes...
Low interest rates directly drive up housing prices of equivalent houses. If you drive down monthly mortgage payments while keeping rents constant, buying residential property and renting it out becomes more economically attractive, which then drives up the house price at which buying an investment property is sufficiently profitable.
In other words, the fixed factor is the spot rent market - how much you can get renting out a house in a certain location. When you lower interest rates, the monthly payment remains relatively constant, which drives up the principle to compensate.
I don't know about Canada, but using a wildly unjustified extrapolation from my country - many a public sector wage, and worse - retirement plans, are following an official cost of living index. Calculating a "realistic" index would have a devastating impact on the long-term fiscal balance of the state.
Low interests rates don't directly cause inflation. For one thing it may not even expand the monetary base, if there are few expansive areas of the economy in need of capital or if there are other even cheaper sources of capital (like trade deficit money returning from overseas).
For another thing, if the monetary base is expanding, it could be that all the new cash gets sucked into fixed asset wealth like land and stock value, but the number of transactions fall so that these price increases don't leak out into broader consumer prices or wages.
Finally it could be that technological change is causing deflation on the same order of magnitude as the banker's monetary inflation.
The main inflation channel works through investment in new projects and labor. The higher asset prices cause more assets to be built. In the case of housing, more house builders get more and higher wages which they then spend which makes other prices rise.
Yes - assume you're buying 1/200th of an "average home" every month as part of a monthly basket of consumption. It's an assumption I use when comparing cost of living between cities.
You're right -- the commonwealth countries are in for a rude awakening! Especially considering government debts worldwide have increased A LOT since the 2008 financial crisis [0], they don't have the same ability to inflate their way out of the next crisis that they had after the 2008 crisis.
Even though I agree with the spirit of your statement, I don't think that central banks "let this happen" -- on the contrary, fiat currencies and central banks BY DESIGN massively exacerbate (and arguably cause) the boom and bust cycle [1].
Without central banks unilaterally determining the price of borrowing money (AKA interest rates) and propping up bankrupt institutions (e.g. see 2008 bank bailouts), the natural boom and bust cycle would have a much lower amplitude as the market would determine the price of borrowing money rather than disconnected bureaucrats sitting in the room pouring over the latest econometric reports. Price controls don't work for goods and services (see the USSR) and they certainly don't work for money either!
Is there a viable alternative to fiat currency? The Gold Standard brought about an era of mineral extraction and colonial pillage, and Bitcoin doesn't seem to work all that well at having a stable value or even as a means of exchanging that value (unconfirmed transaction delay).
Great question, I suspect we'll find one in the next 100 years!
The gold standard over the past 100 years was mostly a government controlled gold standard, where paper money's tenuous link to gold was slowly eroded until it was completely eliminated (Nixon severed the final ties to gold in the US in 1971). If governments had never mettled with money, I suspect the world would already have a well-functioning monetary system (most likely gold).
I'm a big cryptocurrency fan, but as you mention Bitcoin has recently had issues with unconfirmed transaction delays. Without going into the details (don't know how familiar you are with the politics of Bitcoin), I think this will ultimately get resolved, and the transaction delay / high transaction costs / full blocks are ultimately what lead to Bitcoin forking into Bitcoin and Bitcoin Cash.
As for Bitcoin lacking a stable value, that's also an issue, but if it actually has a shot at replacing fiat currencies worldwide (and I think it does), its value will increase massively but ultimately it will plateau and have a relatively stable value (I suspect this would've happened with gold already if governments hadn't mettled with it)!
Government debt is never the problem considering government has monopoly to create new money. The problem is private debt. In fact if you look at why private debt increases it's usually correlated to a DECREASE of government debt. For example, the Clinton surplus forced private sector into massive debt. If you haven't noticed, the common wealth countries have been going through a huge austerity program. This austerity is the likely reason private debt increased heavily. Also since corporate tax rates were also lowered, corporations kept more of their profits. They used these to invest in assets like stocks, bonds, and real-estate. In other words, austerity plus lower tax rates equals high private debt.
"Government debt is never the problem considering government has monopoly to create new money."
Not for long they don't! Cryptocurrencies have finally found a way to get around such unethical control of the world's monetary systems.
And government controlling the monetary systems does not make government debt irrelevant -- even if they can always print more money, they can't always avoid hyperinflation. And regardless, printing money is stealing from savers, so it's not exactly some noble activity.
> Which is fascinating to consider that the Bank of Canada, et al, have let this happen for so long and are only reacting now...
In Canada this is because the real estate bubbles were confined to Vancouver and Toronto. Raising interest rates to cool down real estate in those two cities would have been bad for the rest of the country.
The property bubbles are limited (primarily) to those two major cities, yes. That's a good point. But the high household debt issue is country wide.
Property ownership in those two cities also isn't limited to being a resident of those cities either. A significant amount of properties are rented out and the landlord can live outside of the cities, so the effects of a drop in prices will be widely felt. Combined with the fact those two cities and surrounding areas represent a significant percentage of the total population.
The US housing crisis was itself limited to a group of areas in the country in varying degrees as well, for example Florida got hit way harder than most places. The group was just far larger given the country's population is 10x the size of Canada.
And Bank of Canada has started to add mortgage restrictions this year country-wide so they too see it as something that needs to be addressed nationally.
That may be an exaggeration as well. As a resident of Southern Ontario, but not Toronto, the CREA data shows that home prices in my area were stagnant, to slight decline, for most of the last decade. It has only been in the last year that any meaningful price appreciation has been observed. And I attribute the recent price appreciation to an improving economy and near record low unemployment (currently 2.9%).
And regardless of the scope of the bubble, even if we conceded that it is all of BC and ON, the fact remains that the Bank of Canada has to act in the best interests (ha) of the country as a whole.
Well "only reacting now" might be a stretch. A few years back they elimintated 40 year mortgages putting them back to 25 years and adjusted the loan requirements.
Canada isn't facing a housing bubble as much as they are facing a debt bubble. Most of the recent household debt that has been record breaking year after year has been with credit cards, autos and lines of credit.
> "Canada isn't facing a housing bubble as much as they are facing a debt bubble."
Are you sure? I've seen articles mentioning increasing debt in general, but that's mostly tied to mortgages, which isn't a big deal (unless rates rise quickly, which is unlikely).
"[credit card] delinquency rates in British Columbia and Ontario dropped by 2.1 per cent and 3.3 per cent, respectively." (by contrast to Alberta and Saskatchewan)
As I understand it, housing is out of control in Toronto and Vancouver which accounts for most of the averaged out increase in Canada's housing prices over the last 8 years. These out of control cities are experiencing the increases because of foreign purchasers pushing up the prices (they may only account for 5-10% of purchases, but that money has impacted all pricing through competition). And Canada is a great place for foreigners to have their money.
[edit: note that TO is in a short term downwards price adjustment due to the 15% foreigner tax put in recently, that will stabilize this year, but still over the last 8 years TO pricing has skyrocketted]
Even so housing across Canada has gotten more expensive. Through gentrification in these big cities, smaller cities have seen people move in causing some nominal increases too.
The result is that people all around are needing to allocate more and more money towards housing leaving them having to use credit cards and loans more. You can do a Google search on Canada household debt and there's no shortage of articles declaring record breaking household (non-mortgage) debt levels.
So yeah it's all one big problem, but it's the household debt that's going to kill them, not the mortgage debt. Foreigners will continue to invest in Canada even during a recession, because Canada will still be a good investment on a relative basis. Big cities like Vancouver and TO will hold their value as all big cities tend to even during recessions. Just look at how quickly NYC managed/recovered post 2009 compared to other US cities.
All this leads me to believe that people are in financial trouble due to household debt, though maybe it's semantics. For some when, mortgage renewals come about, does it really matter which?
1) rates were kept low to keep the Canadian dollar exchange rate low
2) Chinese and foreign investors loaded up on real estate and locals also jumped on the band wagon
3) condos are 2x per sq ft as expensive to build as regular housing
4) building regs in Van and Toronto push everything to condos
5)low rates and mortgage insurance helped fuel the boom
6) tax policy also fueled it
7) as does immigration policy and bad transit systems
8) productivity gains in construction for the past 20 years are basically flat. Driving up relative cost of construction to other goods
Summary: govt created a housing bubble let's see what happens.
Well I'm not going to bother arguing the merits of supply demand curves altering pricing models. We can just agree to disagree.
I don't understand your comment on roles being reversed. I didn't realize I had a role in this and I don't know what possibility you're referring to or how it might relate. Maybe you can elaborate.
"Fixed rate" mortgages in Canada still need to renew every five years, even on a 30 year amortization.
As a result, people who bought homes in 2012/2013 will be affected by rising rates as well as a new affordability test. They'll need to prove they could qualify for the loan at 2-3% higher rates in anticipation of the rate environment at their next renewal.
As a result, people who qualified & budgeted for loans at 2.5% in 2013 will suddenly have to be qualified for 6% loan interest within the next few months.
In terms of financial impact, this could represent an additional $1300 monthly expense people will have to budget for on a ~$450,000 loan.
> will suddenly have to be qualified for 6% loan interest within the next few months.
What if they are not? If the loan isn't granted, then the lender will have to go elsewhere, and worse case they will have to sell the property, possibly at a loss. That would seem like it just exposes the bank to more risk? Situation here is that you simply keep paying and the bank doesn't care whether you pay 110% of your income because you are unemployed, or 10% of your income because you got promoted - so long as you are paying.
Stress tests/qualification can therefore be against a "high interest rate" which is typically 7-8%.
What's interesting is that even a 4% interest rate at this point would probably lead to a recession because people are so highly in debt that they would cut saving/spending immediately. That recession would likely see interest rates plummet again. So the "new equilibrium" is a scary low.
Alternative in 2008 was to let the banking system collapse, then rebuild from scratch.
Personally I believe many older/sick people would have died if central banks hadn't dropped interest rates and embarked on QE asset purchasing schemes to keep the system afloat.
Credit/lending would have all but disappeared for a while, many would have lost access to financial instruments necessary to secure housing, healthcare, insurance.
As a young person I'm not happy that we've propped up the status quo, that my rent is stupidly expensive, and that the majority of recovery has gone to the wealthy/those who owned existing equity/assets/real estate, but I can see why it was necessary.
Dropping interest rates, backstopping systematically important institutions during the immediate crisis, and even the first QE were arguably necessary. The subsequent QE's and eight years of 0 interest rates were not.
While it's easy to blame CB's for the past 8 years of stagnation in developed economies, I don't think it's their fault. It's also very hard to say what exactly is the right amount of repurchasing through QE (1.3T in QE1 vs. 4.5T total).
CB's just kept repurchasing until unemployment bottomed out, and now that we've hit the bottom, they will start to shrink their balance sheets. That's their mandate - maximize employment, keep consumer prices relatively stable.
All CBs can really do is make sure banks have enough money to lend into the economy by adjusting reserve requirements and interest rates. They could massively screw up the economy by jamming interest rates up right now, or dumping all their purchased QE assets back on the market, but they can't really improve the economy strictly through monetary policy.
That would require better fiscal and regulatory policy, such as tax code reform, increased spending on R&D and infrastructure, spend on education, etc. Even then it's not guaranteed this spending would lead to any technology-advancing breakthroughs that could raise the standard of living across the economy.
Ultimately I believe that low productivity (we've hit a ceiling on the returns to the internet, computer, and smartphone for the moment), plus a lot of the rest of the world catching up in terms of infrastructure, is to blame for the stagnation.
Unemployment would have bottomed out regardless. QE did not speed it up or slow it down, and all of it went into boosting asset prices and malinvestment instead, that much is plain to see. In pegging rates to zero and compressing credit spreads, the central bank had essentially been telling everyone that there was no return in investing in the real economy and that there was not much difference between a good and a bad investment.
I think we mostly agree, and I am pretty fed up with the situation too. It is painful to be raised in a system that seems to pride itself on freedom, social mobility, hard work, and meritocracy, and then to get into the labor force in the middle of a great stagnation and discover that reality is much different than the ideals you were raised to believe in.
I just don't have enough economic knowledge to say with confidence that unemployment would have bottomed out without QE2 and QE3, and that monetary policy post QE1 has been bad/unnecessary. I have to defer to CBs judgement on this matter.
If you have studies/data to the contrary I would definitely want to read them.
Good timing actually - a paper came out today from the Federal Reserve Board. Supports the finding that QE1 and QE3 significantly lowered lending standards and increased risk taking among banks:
No, fed bought bonds. That's like moving money from your savings to your checking account. In fact it likely decreased money supply because more money would have been created if bonds were held longer.
> But the side effect has been that retail banks were incentivized to hand out cheap mortgages and the public was incentivized to speculate on the 'hot' property market.
Don't forget that property prices were also inflated by foreign buyers looking for a safe place to put their money outside their governments' reach, and that this practice was encouraged by the outgoing government (probably the current one as well).
Also, another issue is that you can cause a housing market crash and financial crisis by abruptly increasing the rate when household debt is at a high.
Australia hasnt had 0% interest rates or even close, and all banks compare you against an 8% interest for seviceability comparisons - and the prices still skyrocketed with so much foreign investment.
They are doing the right things here and targeting increased rates for investment owners over home occupiers
I agree with your sentiment and artificially is a powerful word for conveying that. But strictly speaking the rate the central bank sets for lending new money is artificial, or fiat, no matter what we decide it should be (So long as it is > 0).
You could set the rate for lending new money algorithmically based on a set of other observed statistics of the credit markets. Then it would not be artificial or fiat. The algorithm might be artificial but the rate itself would not. This is not (to my understanding) how it usually works.
I would say the rate is still artificial. If windows were the only allowed OS and Linux and Apple users were regularly jailed, I think we would say the price for windows was artificial, no matter if it were set by a government approved algorithm or not.
My point is that the connotation we associate with the word artificial varies with our opinion of the legitimacy of the monopoly in question. People who are disinclined toward the federal reserve will read artificial differently from those who think it does a good job.
It's not necessarily artificial to keep rates low. I would argue it's artificial to set rates anywhere, and likely market rates without intervention would be close to zero. Your theory of bank lending and asset bubbles is not consistent with mainstream monetarist theory. Banks are not that affected by the interest rate channel of monetary policy since borrowing at 0% and lending at 1% is not that different from borrow at 4% and lending at 5%. Low interest rates are supposed to spur inflation through the interest rate channel (which affects businesses by making them want to invest more, not banks) and the credit channel. Because of sticky prices and sticky wages in the short term the economy can grow faster than usual in the short term. Long term real effects should be negligible. I don't believe the conventional story is accurate either but your description is not completely correct.
The rate the central bank sets is effectively a floor below which banks will not lend. The effective Federal Funds Rate in the U.S. is around 1.16% The one year Treasury rate is around 1.24%. People and banks are lending money to the government for one year for essentially .08%, and this is not entirely risk free. Rates went negative after the financial crisis, and German bond rates are below Treasuries. If banks could find funding at 0.1% they would make money lending at 0.2% (depending on and adjusting for risk). So central bank rates are probably keeping interest rates higher than they would be. All of this is controversial and no one knows for certain how central banks, interest rates, and inflation interact, it's a complex dynamic system and popular descriptions are simplifications that are probably wrong.
Their open market operations affect short term bond yields which in turn affect long term bond yields. They clearly intervene and it's hard to imagine interest rates being as low as they have been without the intervention.
When they buy bonds, it pushes the yields lower, if things were where they were naturally the fed/ecb etc wouldn't have the sheer number of bonds they do on their balance sheet.
The prices of all goods and services in the economy are determined by the intersection of supply and demand. Central banks exert enormous influence over the money supply, and therefore the price of borrowing money is influenced by central banks.
In the absence of central banks it's likely the world would eventually settle on a single commodity to be used as money, and it's unlikely to be a commodity that's inflated into oblivion like fiat currencies. Additionally it's unlikely that people will somehow start loaning out money for a rate of almost 0%, why would people loan money (and therefore risk losing it) for a return of 0%? They'd be better off just holding onto it.
I'm sorry but you seem to have no idea about the what and why of montary policy.
A central bank has to conduct montary policy for the economy as a hole. Attempts by central banks to 'clamp down' on bubbles have generally been catastrophic.
Also the low interest rates are simply not just 'artefically low' because of central banks. The montary effect of the interest a central bank sets is determained by the difference to the natural rate.
Propery bubbles or any other bubbles by themselfs don't relay cause much problems beyond the markets in question if montary policy stays on target.
Aditionally the idea that all these things are bubbles is quite suspect in a lot of places there is real demand for property.
Contracting montary policy in order to fight a property bubble would lead to the hole economy going into a recession.
The last time the 'fighting bubble theory' was really popular was in 1929. I'm not saying that was the only reason for the Great Depression, but its one of the major reasons.
>Additionally the idea that all these things are bubbles is quite suspect in a lot of places there is real demand for property.
What do you define as 'real demand'? There are three main areas of demand for housing property:
1. People requiring shelter (i.e. people who will purchase a property to live in themselves) or
2. People purchasing property to extract rents (landlords) or
3. People purchasing property to later on-sell for a greater amount (property investors)
It's the third class of buyer that many believe is driving demand, and there's certainly a strong argument that the property investor class is bigger today because of depressed interest rates. Because of this increased demand, prices increase. But that price increase is driven only by the perceived future sale value of the property. This is why it's a bubble - The returns are predicated only on continued buy-in to the market. It's little more than a ponzi scheme.
This assertion falls apart if you don't accept the premise that current activity is being driven by investors, of course.
I dont know if something is a bubble or not. At some time in the future the value will be lower then now, is that in 1 year or 10 years, or never. Nobody knows that. That however had nothing to do with montary policy. If you want to crack down on the third class of buyers to protect the others from price volatility or other things that is something else that I dont have a opinion about.
Also, investment however flawed is simply not the same as a ponzi scheme.
Fundamentaly however you have to realise that low interest rates are not artefical. If the natural interst rate were as high as in 2006 with the rates we observe now we would see a massive collapse of the money supply and a recession worse then the great depression. Interest rate in the hole world have been going down since 1970. A recession itself depresses real rates, because investment is simple not as profitable.
The idea that the central bank can indepentenly fix housing bubbles and create stable demand is just flawed, its simply not possible. Its the wrong tool for the thing you want to fix.
The central bank could simple start buying and selling property instead of bonds, but that just replaces stability in one market with instability in another.
>Aditionally the idea that all these things are bubbles is quite suspect
I agree with your point that monetary policy may not the right place to solve a property bubble. I disagree only with the assertions that property bubbles might not currently exist and that bubbles can never be easily identified.
>Also, investment however flawed is simply not the same as a ponzi scheme.
It is if the return on your investment is solely dependent on the continued input of other people's investments.
>Fundamentaly however you have to realise that low interest rates are not artefical.
I am not arguing that they are. Are you confusing me with another poster?
>The idea that the central bank can indepentenly fix housing bubbles and create stable demand is just flawed, its simply not possible. Its the wrong tool for the thing you want to fix.
If you could predict bubbles then you should be rich.
If your meaning of 'bubble' is that at some unknown time in the future the price will be lower then it is now, then the concept is economically speaking useless.
> It is if the return on your investment is solely dependent on the continued input of other people's investments.
Still not the same thing. There is still a real asset that exists, it might change in price but it exists.
In a Ponzi scheme that is not the case, it falls apart if there is no further and nobody will have anything.
That is why you can go to prison for a Ponzi scheme but not for property speculation.
> A central bank has to conduct montary policy for the economy as a hole. Attempts by central banks to 'clamp down' on bubbles have generally been catastrophic.
Which is why Central Banks don't make sense as independent arms of Government.
Bubbles are very very dangerous (as we all discovered in 2007/8) but they cannot be fought with interest rates alone. It takes a combination of government regulation, legal reform and government spending adjustments to bring bubbles under control before they infect the entire economy (which they will always inevitably do if left to fester).
By the way, calling people out for trying to stop the 1926-29 boom is a bit like blaming firefighters for fires getting out of control. The real mistakes were made after the bubble burst.
Bubbles are not by themselfs a problem. The property bubble in the US started collapsing in 2006 and by itself had no impact on employment or GDP.
Just as after the great depression when everybody believed overspeculation on the stock market had been the problem. Economist have studied this for 70 years and the practically universal conclusion was that montary policy errors was the real problem.
In Australia montary policy did not fail and they did not experiance a recession, the have not had one since the early 1990s. Whatever housing prices might do.
Simularly the stock market crash of 1987 (just as big as the one in 1929) did not even cause a blip in GDP.
Montary policy might have caused a little boom between 1926-1929 but if you really believe that the reslution of that boom required the US economy to contract by 30% then you are totally misguided. The problem was a contractionary montary policy.
The same goes for 2008, montary policy was the problem. Its the same story, everybody blames bubbles and speculators but economist have increasingly rejected this view.
Your story of 1926-1929 is basically the Rothbardian story, even his the majority of his studends and others influenced by him have since rejected this story. Its an intellectually dead idea that refuses to die because it perfect for the political left to demand control over all markets. Exactly what you advocate.
An independend central bank focus on macro economic stability should only have one job, stability of nominal demand.
Outside of that we can have political debates about how much banks and markets must be controlled.
Just because it took until 2008 for the full effect of the property bubble bursting to be felt in the wider economy doesn't mean that the two weren't tied at the hip.
There's a direct line from Bear through AIG and Lehmans to the wider economy. Everyone was over-leveraged and GDP growth was predicated on the understanding that other people would keep on spending more. With house prices tanking that fantasy collapsed and everyone immediately started re-trenching. Cue recession. Any bubble large enough will always trigger a recession.
The government did everything it could to lessen the impact (sadly pretty much guaranteeing the next bubble will happen sooner and be larger in the process) but a recession was inevitable because people couldn't keep on spending money they din't have.
The Great Depression wouldn't have been as bad if economic stimulation had been applied earlier (although it may well turn out to have ended sooner, thanks to better targeted stimulation) but it couldn't have been avoided with better monetary policy. The boom relied on stocks continuing to climb exponentially. It was a ponzi scheme. And it burst.
Ultimately Central Bank policy is failing now because it doesn't have enough levers to restore balance to the economy. What lift we got in 2009 was from the automatic counter-cyclical kick of government spending that has largely petered out.
ps I didn't provide any story for 1926-29 boom so I have no idea what you're talking about there. You appear to be projecting.
The NGDP was well falling BEFORE Bear, AIG and Lehman. Those things happened because the central bank allowed a liquidity crush. Take a look at the numbers and you will see that it is true.
There might have been a slight recession even if monetary policy was on point but its hard to see one sector declining so much that it shows up as a recession in macro data. In smaller less diversified economy that can happen easier.
> The government did everything it could to lessen the impact (sadly pretty much guaranteeing the next bubble will happen sooner and be larger in the process) but a recession was inevitable because people couldn't keep on spending money they din't have.
That is just false. If you look at the data you will see that nominal GDP was dropping like crazy in 2008 and even at the end of 2008 the central bank had not changed policy.
In fact they refused to change policy for so long that they literally ran out of (or at least went to low level that they did not want to go below) that they were forced into easing.
You can see this very clearly in the data during 2008.
When people talk about 'they did everything they could' they usually refer to stuff that started to happen well after that QE2 and QE3 for example. The big mistake was made in 2008 and early 2009, the later monetary policy action just insured that NGDP would not flatten out completely (as it did in Eurozone).
> The Great Depression wouldn't have been as bad if economic stimulation had been applied earlier (although it may well turn out to have ended sooner, thanks to better targeted stimulation) but it couldn't have been avoided with better monetary policy.
Australia practically avoid it. Sweden and Israel did way better in the early years and this was because of monetary policy. Australia keeped up NGDP growth and thus they did not suffer a recession.
> Ultimately Central Bank policy is failing now because it doesn't have enough levers to restore balance to the economy. What lift we got in 2009 was from the automatic counter-cyclical kick of government spending that has largely petered out.
A central bank is job is not to find some mythical balance. A central bank job is targeting demand and the Fed does a sort of OK job at it.
The argument that fiscal policy was the determining factor simply holds no water. Changing in government spending have absolutely no predictable impact on overall demand. The Fiscal Cliff of 2013 was the best example, everybody who believes in these fiscal theory were predicting disasters even writing a open letter signed by many economics. Their predictions proved to be absolutely wrong.
The magnitude of automatic stabilizers is simply not large enough to account for massive swings in the macro economy. If you however look at NGDP relative to trend line you will see that those swings are in fact large enough.
> ps I didn't provide any story for 1926-29 boom so I have no idea what you're talking about there. You appear to be projecting.
I implied that there was a unsustainable boom between 1926-29 and that the mistakes were made there. That is simply incorrect and basically no economist today who believes in that story as a large contributor to the Great Depression.
For those not following Canada's economy. Two weeks ago no one was sure if they'd hike the rate again, and no one thought they'd do it so quickly (though it seemed likely they'd do it ~oct/nov).
But, Canada posted exceptionally strong growth numbers (4.5%) at the end of August, which kind of made this very likely.
Also, the government just sold bonds that mature in 2064 (at 2.2%) and has indicated that it might issue more "ultra-long bonds" in the coming months.
All this to say, money's going to stop being cheap.
Why would any entity buy bonds that when matured will not have kept up remotely with inflation? Obviously I'm missing some key idea here, I just have no idea what it is.
There is nothing unnatural about negative real returns on stores of value (even though negative nominal rates can create issues). Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of.
Even in societies with financial systems, getting low risk, hassle free, liquid, positive real returns has been difficult for most of history. This just reflects the natural laws of thermodynamics that tell us that everything tends to decay without a constant supply of work and energy. In general, most things require maintenance to keep their worth.
The 20th century was probably the most notable exception. Because of unprecedented demographic and technological growth, positive risk free real returns were easy to find. The recency effect probably explains some of the confusion people have about this. It is possible that under favorable conditions, wealth can have positive returns and even compound into very good long run returns but it is not a guarantee and there is nothing natural about it. It may not continue forever, particularly amidst an aging and retiring population in a world no longer as rich in easy to exploit natural resources.
Government bonds are seen as ultra-safe, comparable to cash, and while 2.2% is not great it's better than 0%.
Maybe they think inflation will stay low. My sense is that at the moment there's a lot of money sloshing around chasing not-so-great returns, so returns on everything are low - capital is subject to supply and demand like anything else.
Bank "clearing" means that ultimately a bank is keeping its money either with other banks or with the central bank. They're records, but not necessarily interest-bearing, and keeping it with other banks is not risk-free.
I'm not an economist or finance expert so take the following with a grain of salt, but this is how I understand it...
When you talk about "money being electronic" you're basically talking about bonds. When people (or companies, foreign governments, etc.) want to hold large quantities of USD they don't really hold USD, they hold short-term US government bonds.
The only truly "real USD" is physical cash, or an account balance at the Federal Reserve (which is available only to banks).
So people don't own bonds just because of the coupon, it's also really the only convenient way to own (something mostly equivalent to) currency -- other than keeping it in a private bank, which is much more likely to fail than the government.
The odds of a commercial bank going bust is higher then Germany going bust. Commercial banks only need to keep a few % of the money deposited at them on their books (its called fractional reserve banking), the other 95% or so can be invested or lent out elsewhere. There are regulations that restrict the risk, require hedging, insurance, etc but those don't help much if the insurer or a significant amount of the borrowers go bust as well due to systemic problems.
Banks are allowed to loan out the money, but they don't have to, and could take business from the negative-yielding government bonds by just leaving the money alone, in their electronic reserve account.
FWIW we're used to thinking of bank deposits as risk free- but realize, FDIC insurance is capped at $250k! Bank deposits of large sums, then, carries some risk, which can be translated to cost/depreciation.
(I realize we're talking about German banks, and FDIC is a US institution)
Because it may make more sense to free up the capital to put it in a better performing allocation. You'd sell the bond for a loss in order to get the cash to invest in something else.
Banks (and other financial institutions). They more or less have to in order to make the books add up; or, in the clearing process, leave their money with another bank, most likely the central bank, which will pay little or no interest.
Canada's consumer price index hasn't exceeded 4% since 1990 and has averaged 1.74% since then. So investors who are buying those bonds could reasonably see things differently than you do.
The USD isn't some gold standard of truth. Like any currency it also appreciates and depreciates over time. You can't just look at the exchange rate between two currencies and make any meaningfully claims. Definitely, you can't make any claims about Canadian inflation by just looking at the exchange rate. When we went up to 1.10 it didn't cause deflation and when we went down to the low .70s we didn't see inflation.
I don't mean it as some expression of hegemony or to demean Canada, it's just that USD is one of the major global reserve currencies, and a large percentage of international trade is conducted in USD. If it's your opinion that it has depreciated less against the other currencies that are commonly used in trade, I'm happy to hear about that. Given a depreciation against the trade currencies, I'd expect a large number of imports to get more expensive nominally, including many necessities like clothing. Maybe this isn't the case, and if it's not, I'd be very interested to hear why.
If you assume markets price the bonds efficiently, then the price of the bond should contain what the market expects inflation will be over the duration of the bond at the time of the sale.
Those aren't as valuable in a crisis as you might think. Pure gold and junk gold are largely interchangeable. If you want to be ready for some societal meltdown, load up on junk gold. A small gold ring is easier to barter with than a gold brick.
You can buy much smaller denominations too. There's something called the combibar which is a bar with a bunch of scored 1 gram pieces that you can snap off, like a chocolate bar.
That said, I agree that gold is probably not that useful in a collapse.
I bet drugs, canned food, and weapons/ammo are an even better thing to stock up on if you want to be ready for a TRUE meltdown, where civilization descends into total anarchy/lawlessness.
But there is a pretty wide spectrum between that and what we have now. Gold is a hedge against something like what happened to Yugoslavia, even if it's not a good hedge against the apocalypse.
The closest thing to the "apocalypse" you're likely to see is what happened in Argentina and what's happening in Venezuela.
Having a "prepper bunker" full of expensive supplies is not an asset, it just makes you a target. Having a small cache of things you can easily hide, secure, and trade is significantly better. If you have to bail in your city because things get too ugly you don't need a trailer truck to move.
Any normal person who needs more than a bug-out bag and a passport to survive is doing it wrong.
You joke, but I'd be willing to bet that TP Would retain value in much the way it can in some prisons.,. Ditto with soap. If you don't believe me, see how desperate people get for it when they don't have it.
Okay, but at the same time yields on US government debt just reached their lowest point since last November. Due to various factors (North Korea, natural disasters, etc) the Federal Reserve is now talking about raising interest rates slower than they had originally planned, which was already pretty slow. The era of cheap money has to end eventually obviously, but it doesn’t seem like things are going to change all that fast.
Because they're a good match if you have a nominal (non inflation linked) book of liabilities, eg a pension fund that pays pensions that increase by a fixed rate every year.
For those like me who didn't know what the over night rate is:
"The overnight rate is the interest rate at which major financial institutions borrow and lend one-day (or `overnight`) funds among themselves; the Bank sets a target level for that rate."
More importantly, the "prime rate" at the banks almost always is relative to the overnight rate, and almost all short term or floating interest rates are relative to the prime rate.
I'm not sure I understand "target" in this context. Does it mean "a suggested rate" or "lowering/increasing the current rate over time toward this target" or "the actual rate"?
It is a rate they attempt to achieve through their actions. They can influence the rate, but not outright set it due to market conditions.
Think of it like setting the temp on a thermostat. You are attempting to achieve a temperature through the use of a device to put energy into a system, but there are other factors that contribute to the actual temperature achieved.
Just to be clear, the Bank of Canada can control the overnight rate if it moves outside of the "operating band" by directly intervening in the market with overnight repo and reverse repo operations [1].
I'd say it's more like adjusting the input voltage to the AC directly than simply setting the thermostat. They have to monitor the results and changing conditions and then make adjustments manually, rather than rely on an automatic feedback loop.
Informational note: The notion of fixed rate mortgages does not exist in Canada. You can lock in for about 5 years, but otherwise your mortgage rate floats with prime.
If prime rates rise, borrowers can be on the hook for large amounts of defaults as incomes fail to keep up with higher payments.
(canadian housing market exhibits higher sensitivity to interest rates)
What you're describing is a fixed rate mortgage with a 5 year term. We may not allow 40 year terms, but that doesn't mean we don't allow fixed rate mortgages. After the term is up you can renegotiate a new fixed rate term if you want, or move your mortgage.
That said, fixed rate mortgages almost always cost you more in the long run, though a 5 year term is probably going to screw you less than a 25+ year term.
Oh my. We are arguing over semantics. In the US, a fixed rate mortgage typically has a term equal to its amortization schedule. I.E. your interest is fixed for 30 years. In Canada, there are things called "fixed rate mortgages" where the interest is fixed for the term of the mortgage, but I have never seen a term longer than 5 years (most are shorter). The mortgage is typically amortized over a period of no longer than 25 years. So, in Canada, you have to get a new mortgage every few years and you are at the mercy of interest rate changes.
This sounds like its both good and bad, depending on which side you're on. Tracking current interest rates helps keep the market liquid, something that many "hot" markets aren't (Bay Area).
A lot of people in the Bay Area got their 30y mortgages locked in at a fantastic (low) 3.x% in the last ~5y, and would be hesitant to give that up, even if they wanted to upgrade. Combined with with property taxes that are locked to inflation, means that a homeowner has an incentive not to sell, and buyers compete for limited inventory.
> but I have never seen a term longer than 5 years (most are shorter).
Five is pretty standard, but you can get longer if you want. RBC has seven year rates on their website, and if you ask you can get the full term of your mortgage. The rate is ridiculous though, for example, in April 2013 the RBC posted rate for a 25-year term was 8.75%. Obviously negotiable, but still a high starting point.
When I was financing our first home our mortgage broker said he only ever had one person get a 25-year term.
In Canada, banks offer fixed and floating rate mortgages; the mortgage rate is always prime + some %.
If you get a fixed-rate mortgage, you're locked in to your rate for 5 years regardless of how the Bank of Canada changes the prime rate. This has been the product of choice for Canadians for the last several years because it protects you against rising interest rates, and rates have had nowhere to go but up.
If you get a floating-rate, your rate moves when the Bank of Canada moves the rate. This is desirable if you think the BoC is going to lower interest rates.
Yeah, but locking in a rate for 5 years is so different from locking it in for 30 that it seems kind of misleading to say "both places have fixed-rate mortgages." I'm actually a little unclear on the specifics here; is it that you have a balloon payment and the typical thing is to get another, smaller loan to pay that off?
Technically, yes, you are on the hook for a balloon payment. In practice, however, you would get a new mortgage for the remainder owing. You can, of course, be screwed in the event of rising interest rates or collapsing property values.
Unlike the US, there are hefty fees for early payoff of the mortgage, so if you were in the position to pay it off, you would probably want to wait until the end of the current mortgage (depending on lots of different factors, of course).
OK, got it. Frankly, it seems like a system that makes owning a home less attractive, but I suppose US policy has been driven by the idea that home ownership should be encouraged.
Other differences: Canada does not have a mortgage interest tax deduction nor does it have low/no down payment mortgage options. Generally, the more conservative approach to banking makes things more sane and is part of the reason that Canada rode out the global financial crisis relatively unscathed.
Well, it also makes people less likely to own homes, and I'm not really convinced you couldn't have a relatively cautious system that still had long, federally backed mortgage terms or tax deductions or even relatively low down payment options. The big crash was preceded by lots of outright fraud.
I got curious, so I did a google search. It appears that the home ownership rate is very similar between Canada and the US. At the moment, it is higher in Canada as the US is still recovering from the effects of the mortgage crisis. That said, I don't disagree with you. The US has made a policy of promoting home ownership, more so than other countries. That has potentially come with adverse side effects. On the other hand, Canada's relative banking conservatism has arguably prevented Canada's own housing bubble from bursting which could be, itself, a bad thing.
It doesn't seem like there's anything radical about a standard, simple interest, fixed rate loan with no balloon payment. Setting aside questions of rate and term, your typical USA 20% down 30 year fixed mortgage is about as simple/ordinary/traditional as loans get.
Which makes me think it's not really any special favoritism in the US...
It's my understanding (which I freely admit may be in whole or in part mistaken) that such loans didn't really exist until heavy political intervention/the creation of Fannie Mae.
Love the tool to help visualize; however, you need to allow mortgage period to be up to 30 years. CHMC insured mortgages (if you put anything less than 20% down payment have a maximum of 25 years); however, many banks offer up to 30 years. As an example, see the TD Bank mortgage calculator: https://tools.td.com/mortgage-payment-calculator/
In the US, the most standard "fixed rate" mortgage has the rate fixed for 30 years. A mortgage where the rate changes before loan maturity would be called an "adjustable rate mortgage" ("arm" for short).
Aren't we only talking about a difference in term length then? i.e. it's more common for the term length to equal the amortization length in the U.S.? In Canada even the amortization/maturity can't be greater than 25 years. And terms are commonly 5 years.
Exactly. In a US 30 year mortgage, it is reasonable to expect a borrower to pay it off. In a 5 year mortgage, you will typically refinance after 5 years (unless you hit the jackpot in the interim).
Toronto's property market is insane. I am still seeing condos (e.g. Gibson near North York center) being priced at 600K+ for 1+1 and larger units well over 1 million dollars. Not sure who can afford this.
Places as far as Vaughan and Milton are expensive. We're talking decent detached houses (slightly above starter home) for over 1 million.
It's just as bad or worse downtown. I rent in Liberty Village (paying a blessed 300 dollars a month below market and crossing my fingers it stays that way for now), and around here studio units can start in the mid 500's. The larger units easily run upwards of 2 - 4 million dollars if you go for the trendier, older buildings like the old Irwin Toy factory.
Rents are feeling it as well. I think the numbers just came out yesterday or today and an average 1 bed is about $1950. I've seen one bedrooms rent in this neighbourhood for upwards of $4000 a month -- again for the trendier buildings. And this is by no means the upper limit.
I remember approximately 2 years ago, when the average attached houses in the downtown were ~600k (usually 2 or 3 bed, kitchen, living, dining, basement, yard, garage). They hardly exist for anything less than 950k
Back then the average 1 bed rented for 1200 - 1500 a month. That's a long lost dream now.
Milton is completely understandable given that it grew by 34% in just 5 years[1] and is the sixth fastest growing community in Canada according to Statscan. That is a considerable amount of pressure on existing housing stock. Vaughan gained nearly as many people in absolute numbers, although being larger city means smaller growth as a percentage.
It's just investors selling them to other investors until they, as a collective hive-mind, realise this and then investors will stop buying houses and the price will go down.
Sydney is up there as well. A one bedroom apartment in my building just sold for nearly US$900k. This is a nice area, 30 mins from the CBD, but still..
This will be very interesting to watch. The Toronto real estate market has already started to correct. Prices are down 20-30% seconds nice earlier this summer. A ton of people eager to buy "before prices go even higher" are getting creamed.
Interest rates going up will only make this worse.
Prices aren't down 20-30% - you're referring to average sales price. Big difference. It's been attributed to the sales mix (people opting for condos/townhomes)
Sorry. Your info doesn't match the same reality I live in. As the parent said, sales went down (don't know about mix). Prices for detached homes have not. We were seriously putting offers in March and got outbid for INSANE sums. e.g. 720K offer in Milton .. property went for 100K over. In Mississauga, homes listed for 850K went for 950K-1million. I am looking at data now and it has slowed but not gone down yet.
Real estate is local. I've seen multiple listing in the Toronto area, SFH, that haven't sold and are delisting at 20-30% below comparables from 3 months ago.
Unless I'm reading the reports wrong, according to the Toronto Real Estate Board (TREB) the average price of a detached housed in the "416" (Toronto) area in July 2017 was $1,304,288. In August it was $1,191,052.
So that means a -8.7% change from July to August alone.
Numbers for recent months - Detached houses in "416" area code:
August: $1,191,052
July: $1,304,288
June: $1,386,524
May: $1,503,868
April: $1,578,542
Yeah, I get that - I was responding to a comment above about the "sales mix" between detached, townhouses, and condos. The data I referenced directly contradicts the assertions made above that the price declines were due to shifts in the "sales mix" between those three types of homes. Sure, you could argue that the prices declines were shifts within the detached housing market, but I haven't seen anyone provide data on that.
"From the market's peak in April this year, the average price for detached homes in the GTA has fallen 19.6 per cent to $968,494 in August from $1,205,262 in April, bringing the average detached home price back below $1,000,000 in the region."
It is also worth noting that there was exceptionally abnormal growth[1] early in the year. The average price for July only brought it back to trend. It will be interesting to see what August numbers bring.
Overnight rate directly affects the prime rate, the rate at which commercial banks loan to their least risky customers. In the US, prime rate hovers 3% above overnight rate (federal funds rate). You can see that relationship here: https://fred.stlouisfed.org/graph/fredgraph.png?g=eY9Y
In basic economic theory, when interest rates go up, the economy slows down. Higher interest rates encourage saving/purchasing safe assets, and make lending/investing in risky assets or new business ventures more expensive. Banks generally make less loans that fuel direct economic activity when interest rates are higher.
Context/So What:
Canada's economy showed strong signs of growth and low unemployment, so the central bank decided to bump up the interest rate a bit while the data supported the decision to "cool off" the economy.
OK, so commercial loan interest rates will rise 0.25%. Not a huge deal for majority of the economy.
More importantly, the central bank is slowly gaining back the overnight rate as a tool for monetary policy. Many central banks are unwilling to drop the overnight rate below 0%, effectively taxing banks for the reserves they are usually mandated to hold with the central bank.*
If the Bank of Canada can continue to bump the overnight rate up to traditional 4-5% level, it can then cut the rate again to spur economic activity in the case of a downturn. The closer the overnight rate is to 0%, the less effective the rate is as a monetary policy tool.
Personally I believe it will be a long time before we see 4-5% overnight rates again, but overall this is a reaction to good economic news. It happened before investors expected, so the markets are buzzing about it a bit, even though the small bump will probably not have a large impact on Canada's economy.
I'm still learning all the tendencies of these macroeconomic trends...
So, this should mean mortgage loan rates, savings account interest rates, and inflation are all now on an upward trend. Right?
And thus housing prices should begin to curb, since the cost of loans making buying houses more expensive and less appealing, thus lowering demand.
(I've already noticed increasing savings account rates and mortgage rates, so it definitely seems like this is an upward trend, though I haven't seen much curbing of housing prices yet)
Correct on housing. Low interest rates tend to increase housing prices. Rising interest rates tend to decrease them. The rent paid on money captures the rent paid to housing owners. It's a bit like a Georgian land tax, except that banks win.
> and inflation are all now on an upward trend. Right?
Not inflation. Inflation isn't going up much anywhere. It's a conundrum for central bankers. The old model may no longer work.
Normally, when unemployment goes low enough, wages and then prices go up. That hasn't really happened. Instead, house prices (in Canada) and consumer debt are rising.
They're raising rates while inflation is at the low end of their band. Normally, they wouldn't do that. Or rather, normally inflation would be going up now that the economy is. My point was that inflation and growth/employment may have decoupled.
> The move, which will likely be a surprise for some, came less than a week after the latest Statistics Canada numbers showed the economy expanded by an impressive 4.5 per cent in the second quarter.
> "Recent economic data have been stronger than expected, supporting the bank's view that growth in Canada is becoming more broadly-based and self-sustaining," the bank said.
> The rate increase means governor Stephen Poloz has now reversed the two cuts he introduced in 2015 to help the economy deal with the plunge in oil prices. The bank said Wednesday the increasingly robust economy shows it no longer needs as much stimulus.
> Others predicted the bank would refrain from moving the rate out of concern such a move would drive up an already strengthening Canadian dollar and pose a risk to exporters.
> In its statement, the bank also said headline and core inflation have seen slight increases since July, largely as expected. It noted, however, that upward pressure on wages and prices remain more subdued than historical trends would suggest, which has also been seen in other advanced economies.
I don't buy fuel (don't use a car) and aside from the rates set by the electricity provider (essentially a monopoly provider in California) and public transit provider (a city monopoly), fuel costs don't affect me and I actually choose to spend a higher amount with discretion since I moved to the Solar Choice program.
Food is such a small part of my discretionary spend (I buy grains in bulk, specifically quinoa, and greens from the farmer's mart).
Looking back at my spend, the majority of it is in technology that is undergoing massive deflation, or my pet hobby of collecting rare books (neither of which is accounted for in the basket).
I am probably an edge case, but the point remains -- the basket that is set seems outdated. I can't imagine that people are spending as much on food as you think. ex: "USDA data shows that in 2010 Americans spent 9.4 percent of their disposable income on food"
More expensive loans, higher interest rate on mortgages and credit cards. Traditionally saving accounts won't be affected and still have near zero return rate thought.
Another thing to note is that variable rate mortgages will see their rates increase within a day or two. Mine hasn't gone up yet, but I expect it to increase tomorrow. This does not necessarily translate to higher payments, instead it just means the mortgage will take a little longer to pay off.
To explain a little further: A variable rate mortgage can have fixed payments - every day your mortgage accrues a bit of interest, then when you make the payment it pays off that interest and the remainder pays off the principal. If the interest rate increases that just means that the interest that accrues every day is a bit higher and less of your payment goes against the principal, so it takes longer to pay it off.
If the interest rate hits the point (the trigger rate) where your monthly payments no longer cover the interest, then your bank will call and want to increase your payments. In this case, a rate hike will translate to higher payments.
>saving accounts won't be affected and still have near zero return rate
While the big banks have near zero savings interest rates, most of the credit unions and low-fee banks (like Tangerine) have higher rates. I've used Outlook Financial for years, as they tend to have the highest rates (1.7% for regular savings, at the moment).
I don't understand why you say "saving accounts won't be affected", as savings rates are ultimately tied to mortgage rates (the difference between the two gives the bank their profit).
Credit unions do, and banks have to compete with them. Also, CIBC's chief economist says "Recent history suggests an increase to the overnight rate will translate into a corresponding increase in interest earned from savings accounts", so I think I'll take the word of CIBC's chief economist over an anonymous HN user :)
>About, why banks shouldn't increase saving accounts interest, the answer is, of course, profit.
Credit unions will increase rates, and if banks don't they'll lose profit. That's business 101, and it's why all gas stations have virtually the same price.
> I don't understand why you say "saving accounts won't be affected", as savings rates are ultimately tied to mortgage rates (the difference between the two gives the bank their profit).
They don't, that's why. In contrast variable mortgages and credit card rates are explicitly tied to the prime rate.
It's true that bank loans create money rather than banks acting as middlemen who match up depositors with creditors, but savings and loans are still fundamentally tied together. The reason banks can create money through loans is because the loaned amount becomes a balancing deposit in one of their accounts, and even if it's used to pay people that use other banks that's fine so long as the outflow of loan-created deposits to other banks is balanced out by inflow of deposits created by loans. If they charge below-market interest rates and everyone starts moving their money elsewhere, this money printing trick breaks down and the magic money starts turning into actual debt.
So even though banks aren't really lending out savings in the way people assume, they still need to keep their saving account returns competitive and somewhat related to money they're making on loans. The main difference between the incorrect model and how banks actually work has to do with the willingness of the banking industry as a whole to lend out money and the availability of credit - that genuinely is pretty much untethered from saving rates.
Which is fascinating to consider that the Bank of Canada, et al, have let this happen for so long and are only reacting now...
By artificially keeping rates near 0% the idea was to 'stimulate' the economy by making capital freely available, so for example, banks can more easily loan money to businesses generating long term economic growth and add new jobs. But the side effect has been that retail banks were incentivized to hand out cheap mortgages and the public was incentivized to speculate on the 'hot' property market.
If this bubble doesn't deflate smoothly this will be yet another very expensive side effect of mainstream monetarist policy.