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Bank of Canada Governor Stephen Poloz highlighted the challenges central bankers face in dealing with financial stability issues, arguing monetary policy should be the last line of defense and the problem is better handled by regulators and industry players.
Speaking in Lima, Peru, Poloz acknowledged Canada’s rising house prices -- particularly in Vancouver and Toronto -- have been fueled by historically low borrowing costs and the sector remains a key risk to the Canadian economy. Still, the bank needs to be focused on its inflation target, like it was when it lowered interest rates twice this year.
“We knew that easing policy would have implications for financial stability,” Poloz said in a speech Saturday to the Institute of International Finance, during meetings held by the International Monetary Fund. “However, we also knew that those concerns had to remain subordinate to the primary mission of achieving our inflation target and getting our policy back in the zone where the risks are balanced.”
Poloz’s comments come amid growing concern from real estate executives and some economists that his two interest rate cuts this year are exacerbating the debt boom, and placing real estate markets in Toronto and Vancouver at risk of a correction. The central bank has countered by arguing the threats to the financial system would have been worse without rate cuts, which were prompted by a collapse in oil prices.
Poloz also downplayed the danger of rising household debt levels as a share of income, given lower borrowing costs have kept debt servicing costs relatively flat since 2008.
“Given this, the increase in household debt levels is no surprise,” said Poloz, adding that higher debt-to-income ratios don’t “necessarily mean an increase in the vulnerability of the economy or the financial system.”
“I’m not trying to diminish the threat posed by elevated household debt. We are continuing to watch this closely,” he said. “The point is that there is more to the story than the debt-to-income ratio.” Poloz said house prices rising faster than incomes means the size of first-time mortgages have also increased, which leads, mathematically, to higher total debt-to-income ratios.
To be sure, the days when central bankers could pay little heed to financial stability seem “quaintly naive,” said Poloz, and policy makers need to better understand how these issues are integrated into monetary policy.
Still, trying to incorporate financial stability issues into the central bank’s decision making is a "risk-management" issue, especially given uncertainty over how financial imbalances affect the real economy.
“Given all of the uncertainty, it seems to me the proper response of the monetary authority is to acknowledge and accept all the things we don’t know, gauge the risks facing the economy as best we can, and manage those risks as we conduct monetary policy,” said Poloz.
The Bank of Canada believes regulatory oversight of the financial system and government policies that pinpoint specific problems -- such as over-borrowing by vulnerable households -- are more appropriate tools to tackle financial stability, Poloz said. The first line of defense are borrowers and lenders, who need to live with the consequences, he said.
“They bear the ultimate responsibility for their own decisions at the individual and firm level,” Poloz said. “It is not the role of monetary policy to protect individuals from making bad choices.”