What is the Bank of Canada doing?

Canadians are carrying massive amounts of personal debt following an orgy of borrowing over the last seven years.  Personal debt now stands at an historic high of over 160% of average income.  Many international commentators, include the Economist which correctly predicted the housing price crash in the USA, have stated that Canada has a massive housing bubble.  In spite of this, the Bank of Canada made borrowing even easier last week by reducing the central bank rate to 0.5%, presumably driving even more borrowing and a larger bubble.  It is worthwhile looking at its possible motives for this latest rate reduction.

Interest rates were reduced starting in late 2007 from 4.5% to 0.5% by the start of 2009.  Rates were move up to 1% starting in mid-2010, to the end of 2010.  Interest rates were then set at 1% for over four years, from the start of 2011 until early 2015, when they were dropped again to 0.75%.  As noted, the Bank of Canada reduced the central bank rate again to 0.5% last week.  

During the over four years that rates were held to 1%, Canada's economic growth was 3% in 2011; 1.9% in 2012; 2% in 2013; and 2.5% in 2014.  The unemployment rate during this time went from over 8% to well under 7%.  Inflation has been tame. The recession that sparked the initial drop in interest rates ended about 6 years ago.

With year after year of positive economic growth over the last half-decade and a falling unemployment rate, it is puzzling why the Bank of Canada did not proceed to raise rates at some point in the last three years, especially in light of what even the Bank sees as localized housing bubbles in Canada.  While Canada now appears to be entering into a period of economic trouble, this has only become apparent in the last six months.  Prior to that, projections for economic growth in Canada were quite positive.  By not raising rates at some point from 2011 to early 2015, the Bank of Canada has left itself with virtually no policy tools to respond should the country sink into another recession.

Since rates were pegged at 1% at the start of 2011, the average price of a house in Canada has gone from an average of $350,000 to over $425,000, or about 17.5%.  In Toronto, prices have gone up by about 26% in a little over four years.  Average inflation has been below 2% a year throughout this period.  It has been impossible to miss this expanding housing bubble.  

One is left wondering what the Bank of Canada was thinking during this four year time period, and why they were not raising interest rates even a little in order to create a cushion in the event that bad times arrived again.  It wouldn't have been difficult to figure out that there will be another recession some day, and that it was important to prepare policy tools in advance - any student of the history of economics could tell you this.  The Bank of Canada has failed to prepare for a housing bubble that many others in the world have seen for years...and they are STILL lowering interest rates!

We need to get real.  A 0.25% drop in interest rates could not possibly compensate for the negative effects of a 50% drop in the price of oil on Canada's economy - but the Bank of Canada reduced interest rates anyway, even with a housing bubble and historic rates of personal borrowing.  A further 0.25% drop in interest rates will not stop the collapse of a housing bubble that threatens to drive unemployment well above 10%, at least for a while, especially in places like Toronto and Vancouver where hundreds of thousands of people who have made their living from that bubble will lose their jobs.

One has to ask if this is all smoke and mirrors at this point.  Having been utterly incompetent in its management of interest rate policy over the last half decade, is the Bank now playing with rates so that they can claim that this was still a real policy once the bubble bursts and they get blamed for it?  

In short, when millions of Canadians start to point fingers at the Bank of Canada as they each lose tens and hundreds of thousands of dollars in personal wealth as housing bubbles burst across the country, will the Bank defend itself by pointing to these recent rate reductions claiming that the low rates policy was still wise and thoughtful even in 2015, and they just got caught by "circumstances beyond their control"?  If this explanation is ever offered up, keep it simple.  The Bank of Canada sets the base interest rate - no one else.   They need to own what they have done.