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Side-Effects Include: Household Debt

Side-Effects Include: Household Debt
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0629polozBank of Canada Governor Stephen Poloz fancies himself a surgeon. He compares cutting interest rates to life-saving surgery for the economy. I consider it more like bloodletting, a terrible practice that is now widely accepted as pseudoscience. According to Canada’s central banker, if the interest rate cut resulted in an increase of household debt, that should be viewed as a necessary side effect.

If the Bank of Canada has one job it’s to focus on the 2 per cent inflation target and that means cutting the benchmark rate by 25 basis points when global crude oil prices tumble. Or at least, that’s what Stephen Poloz said to the central bank of central banks, the Bank for International Settlements.

“If the doctor says you need surgery to avoid death, the side effects usually don’t deter you, you just go ahead and manage them somehow,” Poloz said. “Other issues must be subordinate and I think of them as side effects.”

Likewise, if a bloodletter tells me I need to balance my “humors”, the side effects of losing so much blood won’t deter me. I’ll just go ahead and manage them somehow.

Of course, what Poloz is really saying is that the Bank needed to intervene to prevent death, or rather, a contraction of credit and available money. The side effects of more household debt, the prospect of higher prices in the future, the misallocation of resources – those are all side effects where the alternative is deflation. And we can’t have that.

“When we cut rates to stabilize the economy we don’t picture some heavily indebted household going out and adding to their debt pile, rather we picture a household with no debt at all deciding finally to buy a house and taking out a mortgage,” Poloz said.

That’s good to hear. Good that “we” as a nation are not further binding our seniors, baby-boomers and students to debt, but rather the coming-of-age middle class that have managed to secure a salary and still have high hopes for the future. Yes, you there. The graduate with a spouse, steady income, and no debt. Here, take this mortgage.

Household debt-to-income ratio is at 163.3 per cent. A surge in condominium building in Toronto and Vancouver are using up real resources. People care about the environment, but they don’t seem to understand how central banks ensure resources for long-term use are instead profitable in the short-term. Of course, the economy is a little more complex than that. We can’t blame everything on the central bank, right? Poloz reminds us,

Even though financial stability concerns are very important to us we must keep them in their proper place… We must acknowledge of course the possibility that financial stability risks at some point become so great that they become primary, but preventing this is the job of macro-prudential policies, not usually the central bank.”

Don’t blame me, I just work here.

Poloz’s interest rate cut in January “accomplished two things,” he told reporters last month. “First, it reduced the downside risk to inflation by helping bring the economy back to full capacity over our projection horizon. Second, the cut helped mitigate the risk to the financial system by addressing the drop in incomes and employment caused by the oil price shock.”

In other words, it bought us some time. The next interest rate announcement will be on July 15.

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@Caleb983

Caleb McMillan is a writer that lives in Vancouver, British Columbia.

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