Governor Carney’s Advice – spend but reduce your debt

A view of the Ottawa skyline suggests that the housing boom is not over in this part of Canada. Fueled by continuing low interest rates, the Economist reports that in the last year house prices in Canada have increased 5.4% (-0.7% in the US) and 17.8% since 2007 (-7.8% in the US). In Canada houses are 77% overvalued relative to rental rates while in the US houses are 15% undervalued relative to current rental rates.
The average sale price of residential properties, including condominiums, sold in August 2012 in the Ottawa area was $346,949, an increase of 2.5 per cent over August 2011. The average sale price for a condominium-class property was $272,367, an increase of 7.6 per cent over August 2011. The average sale price of a residential-class property was $367,661, an increase of 1.7 per cent over the same period.
Condominium towers appear to be popular in Ottawa given the visible cranes. Some borrow and buy to live there, others to own and rent, and others to flip hoping to make a profit. While real estate prices are rising, rental rates are not, suggesting that the boom may be ending.
Bank of Canada Governor Mark Carney has warned consumers about carrying too much debt, but keeps interest rates low – he may not have much option. A rise in interest rates would harm those owning houses financed with low rates, and would depress housing values in general. What does he expect the consumer to do in the face of current policy?
Carney also chides companies for carrying too much cash, urging them to invest and create jobs, or pay larger dividends. But what happens with the latter? Consumers receive more cash and many may put it in their savings accounts, and not spend it or will pay down existing debt. While firms build up retained earnings as a form of insurance, individuals may do the same.
Economic policy is like a water mattress. If you sit on one side it bulges out somewhere else; if companies reduce their retained earnings and pay larger dividends, there will be effects elsewhere in the economy. No one is sure what those will be. Some outcomes may be welcomed, some not. It would be helpful if Carney and his advisors explain why their advice will lead to the desired outcomes.

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