Bank of Canada Governor Tiff Macklem says the central bank will examine how its policies affect housing demand and affordability as part of its 2026 framework renewal.
When the Bank of Canada adopted its 2 per cent inflation target, it focused on a symmetric approach: If inflation was running above or below 2 per cent, policy would aim to bring it back to target to firmly anchor long-run expectations at 2 per cent. The single numeric target has the advantage of being a simple, clear and precise long-term commitment. It is easy to communicate and widely understood.
The Bank has also navigated periods of sub-2 percent inflation. In those periods, the risk is that sustained low inflation could result in a downward spiral in inflationary expectations. I believe part of the reason the Bank has been concerned about these situations is that they could imply a lower equilibrium nominal short-term rate, pushing it closer to the effective lower bound[1] (ELB) and limiting the Bank’s flexibility to respond to an economic downturn.
In response to the global COVID-19 pandemic, the Bank of Canada aggressively lowered its policy interest rate and eased monetary conditions further through forward guidance and quantitative easing.
In a July 2020 press conference, Macklem stated, “Interest rates are very low and they are going to be there for a long time. Canadians and Canadian businesses are facing an unusual amount of uncertainty, so we have been unusually clear about the future path for interest rates.”
The Governing Council’s official statement confirmed it would “hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 per cent inflation target is sustainably achieved.” Analysts interpreted this as the Bank not expecting to raise interest rates for several years.
The Bank was conducting monetary policy in an environment where credibility and commitment were crucial to success. In hindsight, relying on forward guidance – at a time when models and data were less reliable – exposed the Bank to a much higher risk of policy error. Clearly, they want to avoid repeating a situation in which their comments were seen as encouraging home purchases on the expectation that mortgage rates would remain “cheap.” In some markets, house prices spiked by as much as 40 per cent, only to drop by 25 per cent once the Bank began tightening rates.
The challenge is that mortgages play a central role in the transmission of monetary policy. They are the largest household liability in Canada and the main direct channel through which monetary policy affects household consumption. In Canada, this transmission mechanism is particularly direct due to short mortgage terms and, in the post-COVID era, a high proportion of borrowers with variable rate mortgages (taken to maximize borrowing under OSFI’s qualifying rate rules). This close link between mortgages and monetary policy makes the transmission mechanism highly effective, which the Bank will want to preserve. However, in a low-rate environment, the Bank does not want a repeat of the early-2020s house-buying frenzy.
We should not expect to see housing affordability become a direct objective of monetary policy. Rather, the Bank will aim to ensure that its policy actions – especially in unusual circumstances – do not create asset bubbles, particularly in housing, that worsen affordability. I anticipate that if forward guidance is used, there will be no statements about how borrowers can expect rates to remain low for the foreseeable future. In a low-rate environment, I also expect there will be macroprudential tools used to counter housing market booms, which are largely driven by credit conditions and household leverage. The Bank is likely to focus on tools to counterbalance the impact of low rates, either through tighter credit conditions or leverage ratio limits.
[1] In practical terms, nominal interest rates cannot fall below zero because investors can always earn a zero nominal return simply by holding cash. This concept has been termed the “zero lower bound” on nominal interest rates. Theoretically, the existence of this zero lower bound limits a central bank’s ability to provide further stimulus to the economy through conventional decreases in policy rates below zero. In 2009, the Bank of Canada determined that the ELB on its key policy interest rate was 25 basis points (bps). In December 2015, the Bank released an updated version of its Framework for Conducting Monetary Policy at Low Interest Rates, which includes the potential use of negative policy rates in Canada as part of the Bank’s unconventional policy tool kit, and estimated Canada’s ELB to be around -50 bps.
Independent Opinion
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