'We're using antibiotics for the common cold': The case for higher interest rates in Canada
Emergency that triggered rate cuts ended in 2009
Philip Cross rarely deviates from data when talking about Canada's near-decade run of extraordinarily low interest rates.
But he does indulge one metaphor: "When you're seriously ill, of course you use antibiotics … they're designed for emergencies. But we've maintained the emergency [measures] for eight years. After eight years, it's not an emergency anymore."
The Bank of Canada's key lending rate is still just 0.5 per cent. The measure has made borrowing ultra-cheap and driven a worrying rise in household indebtedness, says Cross, a fellow with the Macdonald-Laurier Institute.
"We're using antibiotics for the common cold."
Since the U.S. Federal Reserve is expected to raise rates on Wednesday, he says it's an obvious time for Canada to stop overlooking the risks and withdraw the medicine.
We're using antibiotics for the common cold.- Philip Cross, Macdonald-Laurier Institute
Cross was a senior economist with Statistics Canada in 2008 and remembers the sense of urgency when the financial crisis hit. "I was aware of the seriousness of the situation … We were downtown [meeting government officials] all the time."
Shoring up the Canadian banking system as foreign counterparts like Lehman Brothers collapsed was the top priority of the government and the Bank of Canada, he says. Quickly slashing interest rates was one of the emergency measures taken to accomplish the goal.
Emergency ended in 2009
But in 2009, it was clear the Canadian banks were stronger than many of their international peers. That's when the Bank of Canada could have begun returning rates to what had been normal levels (they were above four per cent when the U.S. housing market began to slide toward crisis in 2007). But that never happened. Canada's key lending rate has yet to poke its nose past one per cent.
The recession was the original reason for cutting rates, but weak growth became the central bank's rationale for keeping them so low. Despite the cheap money, business spending never led a strong recovery and growth has sputtered along between one and two per cent.
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More recently, the central bank has tried to encourage growth through a low loonie. If our dollar is cheap, our goods will elbow out the competition and sell well abroad. Or so goes the thinking. But the latest U.S. Department of Commerce trade figures show Mexico is now selling more to the U.S. than is Canada. The devalued peso, as well as cheaper Mexican labour and electricity, have conspired against us and the low loonie leaves us paying through the nose for imports.
Houses and consumer debt
Canada has seen growth in sectors tied to housing, but that boom is driven by rising household borrowing and indebtedness.
Cheap money encourages borrowing. "People, and young people in particular, are racking up enormous amounts of debt because what's of interest to them is their monthly payment, not the amount of the loan," says William Jack, a certified financial planner in Toronto.
Canadian household debt sits at an all-time high. And last week, credit rating agency Equifax reported that delinquency rates, not including mortgages, have begun to nudge higher.
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Low rates have fuelled demand for houses. Prices have risen roughly 50 per cent since 2008, with half the growth concentrated in just two cities: Toronto and Vancouver, where prices have more than doubled, according to the Canadian Real Estate Association.
The Canada Mortgage and Housing Corporation recently called the market "overvalued" because prices are higher than fundamentals like income and population growth warrant. A bubble by any other name.
All the while, savings rates have fallen. After all, why would you save when it pays so badly? The fattest yield available on a high interest savings account is EQ Bank's two per cent, and many of the highest rates at the bigger banks don't crack one per cent. Most bank accounts likely bear negative rates of return once fees are deducted.
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Stocks have benefited from the search for a better rate of return than bonds. Financial planner William Jack says "people are actively chasing yield by taking more risks in the stock market."
No surprise when the 10-year Canadian government bond yields less than inflation. That means the price of stuff you'd like to buy is rising more quickly than the value of your money when it's tucked away in a bond.
But the shift to stocks comes at a price. They're riskier than bonds and investors have a greater chance of losing their money.
Which brings us back to the U.S. Federal Reserve. If it boosts the overnight rate to 0.75 per cent on Wednesday as expected, Canada will have the cover to do the same without pushing up the value of the loonie. Years of low rates have done little more than borrow growth from the future, but "it's time," says Philip Cross, "we're living in that future."