National Post (National Edition)
TREADING WATER on the POLOZ ODYSSEY
Ponder the position of the Bank of Canada these days, and clichés inevitably spring to mind. My personal preference, over the likes of “between a rock and a hard place” or “the horns of a dilemma,” is “caught between Scylla and Charybdis.”
It seems to be apt. On one side, Stephen Poloz, as our latter-day Odysseus, fears the multi-limbed monster Scylla, a symbol of an outof-control economy, chaotic and deadly. How long before one of this monster’s several arms — let’s say the housing bubble, stoked by years of low interest rates — drags down the Good Ship Canada?
On the other side, our intrepid central banker must navigate away from the vast whirlpool of deflationary forces, a Charybdis of foundering business investment, stagnant wage growth, excess capacity, incipient U.S. and global protectionism, and so on.
Against the whirlpool, the only weapon the Bank has is low interest rates. Against soaring asset prices and inflation, it can pretty much only raise rates. Fight Charybdis, and you run smack into Scylla. And vice versa.
Which course will Poloz choose?
Based on the Bank’s policy announcement this week, the simple answer is that he isn’t choosing — by holding the overnight rate at 50 basis points, he’s just treading water.
Some commentators, noting the Bank’s elucidation of stronger growth, see signs of nascent hawkishness, and called the rate decision a “hawkish hold.”
I think, however, that Poloz’s approach is more nuanced than that.
Yes, there were hawkish mentions in the Bank’s Monetary Policy Report (MPR). It noted that some of the data has surprised to the upside: jobs growth and consumption have been on fire. Meanwhile, the MPR singled out the overheated Toronto housing market, saying that price inflation there “seems to have entered a phase in which speculation is playing a larger role.” In part because of soaring housing prices, the Bank revised up its GDP projections for this year, to 2.6 per cent from 2.1 per cent, and it now figures “the economy will absorb its excess capacity sometime in the first half of 2018,” sooner than it expected in its last MPR, in January.
Yet the Bank also sees enough trouble to think the growth blip might be temporary. Business sentiment has improved, but investment remains weak; the Bank forecasts it to decline as a portion of GDP growth this year, as it did last year. Trade protectionism is on the rise in the U.S. and elsewhere, and uncertainty over trade, the Bank said, has led export growth to be “particularly muted” relative to past cycles. On top of all that, despite strong GDP numbers, the Bank’s preferred measures of inflation remain below its two-percent target.
All in all, that might seem to support a neutralhawkish interpretation. But in response to reporters’ questions about the aforementioned Toronto housing market, Poloz struck a tone that was far from activist.
Which, given all the handwringing over the Centre of the Universe from politicians lately, was kind of refreshing.
First, Poloz acknowledged that fundamentals don’t support a 30-per-cent year-overyear price increase for Toronto homes, which can only mean the market is “being driven more by investor demand than by just folks who are buying a house.” And then he warned: “I think it’s time to remind people that housing prices can go down as well as up.”
That sounds pretty tough. But there’s a big difference between saying the Toronto real estate market is unsupportable and actually doing something about it. And Poloz is clearly a long way from doing something.
At least I think so. Why? For one thing, he noted that macro-prudential policies, like the recent federal credit requirements for insured mortgages, are a “truly independent instrument” in the housing market. That implies monetary policy is not, and he’s right. It’s a blunt instrument, and might do more harm than good. Raise rates and you risk derailing growth more generally.
Also illuminating was the way Poloz outlined two scenarios for how a housing market correction might happen. One is that it occurs more or less organically: prices get so high that people stop buying, prices come down, and speculators get burned. In the other scenario, bigger problems — like widespread unemployment and a slowing national economy — cause a crash. That, Poloz said, would make a localized housing correction “more likely to be contagious” to the rest of the country.
Clearly, Poloz would prefer the former kind of correction to the latter. Raising rates — which might not even be effective in deflating the Toronto housing bubble — could very well be effective in creating the conditions that could lead to a much worse correction in the general economy. That stance suggests the Bank’s bias is likely to be dovish for some time.
Of course, this is all reading between the lines, but maybe Poloz has been brushing up on his Homer. In The Odyssey, Circe advises Odysseus to choose Scylla over Charybdis. Sure, you might lose a few sailors to her clutches, but get too close to Charybdis, and you lose your entire ship.
It’s a reasoned approach to what’s admittedly a non-optimal choice. But in the world of monetary policy, as in Greek myth, optimal choices rarely present themselves.