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.
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...
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 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.
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.
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.
[1] http://www.nytimes.com/2011/04/02/business/02charts.html?mcu...
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.
In the US, credit cards are often a fixed + prime rate, so changing national bank interest does affect credit card rates.
As as aside, ~20% is an insanely high rate for credit card purchases (again, in the US).
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!
[0] Worldwide Government Debt - https://data.worldbank.org/indicator/GC.DOD.TOTL.GD.ZS
[1] Austrian Business Cycle Theory - https://en.wikipedia.org/wiki/Austrian_business_cycle_theory
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.
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.
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.
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).
For example: http://www.cbc.ca/news/business/canada-credit-cards-transuni...
"[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)
Car loans are ~ 2% of total debt, at least in Quebec: https://www.desjardins.com/ressources/pdf/pv170828f.pdf?resV...
In Sweden we moved from interest only mortgages to 100 years as the norm. Still too long. Doesn't work well with near zero interest rates.
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.
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.
Any source for this?
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.
Housing prices went nuts in Canada because Canadians felt they were being priced out and "real estate always goes up".
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).
Why would interest rates be zero without intervention? Who would lend money to someone else for free?
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.
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.
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.
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.
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.
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.
If you try to leave your money with the Swiss Central Bank they will charge you 0.75%. Buying bonds is definitely preferable to that. https://www.snb.ch/en/ifor/finmkt/operat/id/finmkt_nz
…looks like the market expects 1.57% inflation over the next 10 years, so these bonds are expected to beat inflation handily.
The answer to your question "why would any entity buy bonds..." is: to sell them moments later at a profit.
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.
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)
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.
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.
Self-plug - I made a tool to look at how sensitive your monthly mortgage payment is to movements in interest rate: https://pycal.github.io/real-time-ammortization/
...
"You can lock in for about 5 years"
what?
Places as far as Vaughan and Milton are expensive. We're talking decent detached houses (slightly above starter home) for over 1 million.
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.
[1] http://www12.statcan.gc.ca/census-recensement/2016/dp-pd/pro...
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.
Interest rates going up will only make this worse.
Hold on tight!!
[1] http://creastats.crea.ca/treb/images/treb_chart05_xhi-res.pn...
An apt caption for the uncertainty in Toronto introduced by Wynne's last desperate attempts to change people's minds on her.
http://www.bankofcanada.ca/core-functions/monetary-policy/ke...
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.
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)
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.
It is (and has been for a while) the goal of the Bank of Canada to keep inflation between 1% and 3%: http://www.bankofcanada.ca/core-functions/monetary-policy/in...
And it is not doing too bad: https://tradingeconomics.com/canada/inflation-cpi
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.
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).
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"
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.
*BoC actually has no reserve requirements: http://www.bankofcanada.ca/1997/04/working-paper-1997-8/
> 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.
Erm, thanks... but I'm using Chrome on a Google Pixel?
