Interest rate policy is failing

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(DALE CUMMINGS)

Federal statisticians this week refined their method of counting the assets, liabilities and income of Canada. The exercise brought fresh attention to the high level of Canadians' household debts and it may increase pressure on the government to start raising interest rates before Canadians get too comfortable with the low rates that have prevailed since 2009.

Before the revision, the ratio of debt to income in Canadian households was estimated at $150.60 of debt for every $100 of disposable income. With this new revision, Canadian household debts in the second quarter of this year are now estimated at $161.70 of debt for every $100 of disposable income.

The new, higher figure is likely to catch the attention of federal Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney. They have been keeping interest rates low in order to encourage Canadian businesses to borrow, expand and hire. To their dismay, businesses have responded cautiously. Canadian consumers, however, have been borrowing and spending at record levels with the encouragement of their banks.

Some of those families will be unable to pay when interest rates rise -- as they must do eventually -- from the exceptionally low level that has prevailed for the last three years. The deeper Canadians slip into the debt trap, the more difficult it will be politically for the authorities to raise interest rates. Higher rates will be required when economic activity speeds up and inflationary pressures increase.

This week's revision of household debt estimates does not reveal a sudden increase in debt. It does show that the country was formerly kidding itself about the depth of the problem. Formerly, churches, charitable organizations, non-profit daycare centres and a host of other non-profit institutions (not including hospitals and universities) were lumped in with families when the statisticians estimated the wealth and incomes of Canadians. Statistics Canada estimated families' debts and incomes together with those of many non-profit organizations to calculate the 150.6 per cent indebtedness ratio. Starting this week, the sector called non-profit institutions serving households, in Canada as in other countries, is excluded from the figures for households. This helped bring the ratio up to 161.7 per cent.

Mr. Flaherty and Mr. Carney are not the only ones worried about the debts of Canadian households. The Washington-based International Monetary Fund last week issued its World Economic Outlook in which it found Canada's growth prospects to be one of the few bright spots in a gloomy global economic prospect. An economic policy priority for Canada, the IMF said, "is to limit risks related to elevated house prices and household debt levels."

The government has already curtailed the insuring of mortgages by Canada Mortgage and Housing Corporation in order to cool the housing market. Canadian banks and their customers, however, are free to make their own decisions about lending and buying. An increase in the Bank of Canada's administered interest rates would have an immediate effect on consumer loan rates and on Canadian families' appetite for debt. A sharp drop in house prices in Toronto and Vancouver might spell trouble for families with home-equity loans based on high estimates for their house values.

The longer the Bank of Canada keeps its overnight rate at one per cent, the more Canadians grow accustomed to cheap borrowing. Cheap interest rates have not induced the economic expansion the authorities were hoping for. Canadian families who gambled that interest rates would stay low are winning their bet so far. Bit by bit, the debt trap for families is turning into a low-interest trap for the bank and the government. The day the government tightens the screws on them, indebted families will probably not blame themselves for their predicament and they may not even blame their banks. They are more likely to blame Mr. Carney and Mr. Flaherty.

Republished from the Winnipeg Free Press print edition October 17, 2012 A12