Housing takes lustre off entire economy

alerted the markets to such consumer responses and explained a slowdown in housing sales in January 2018 would not “necessarily be a sign of weakening housing market, but rather a consequence of those purchases having been pulled forward ahead of the new regulations.”

While Poloz has projected strong growth in the second quarter, he expects the growth to shift from household spending to business investment and exports. Why? An expected increase in interest rates and higher mortgage payments might put brakes on household spending on consumer goods.

However, it is not just the expected increase in debt payments that may constrain household spending. A decline in housing markets could affect household spending and, as a result, the entire economy in more ways than one.

Housing prices are tied to a household’s overall wealth. Atif Mian and others, writing in the Quarterly Journal of Economics, identified the reasons behind a decline in household spending because of changes in housing wealth. They explained that in addition to financial wealth, proxied by stocks, bonds, and other investments, a household’s net worth also includes the equity it builds over time when housing values increase relative to the outstanding mortgage debt.

The equity in housing is often used as collateral for credit to finance other purchases of big-ticket items, for example, automobiles. When housing values decline, access to credit becomes difficult and, as a result, household spending declines.

When housing prices collapse, the spending doesn’t just decline for big-ticket items. Discretionary spending on restaurants and leisure also falls. As a result, local employment in nontradable sectors shrinks, and the cycle repeats, perpetuating slow growth, or even a decline in economic output.

As we mentioned in March, the public purse is also not immune from a decline in housing prices. A subsequent report by Toronto’s city manager also raised alarms about a $1.4-billion gap in local revenues over the next few years.

One of the culprits for the revenue gap is the Municipal Land Transfer Tax (LTT), implemented in February 2008 in Toronto. Since its implementation, the tax revenue has been growing gradually in step with the increasing housing prices and represented almost nine per cent of the $9 billion the City raised from taxes and user fees.

LTT revenue is expected to be lower given the sudden decline in housing prices after the province imposed new regulations to curtail foreign home buying and the stringent regulations for rental housing.

A decline in housing prices affects the overall economy through a decline in property-related public sector revenues, either from a decline in property or land transfer taxes or from indirect channels through lower income and sales taxes.

Thus, a single-purpose policy of slowing housing markets could slow the overall economy. The statement by the Bank of Canada governor also concurs.