Bank of Canada Governor Mark Carney is talking the talk about potentially using his powers to slow the growth of bubbles in assets such as housing and stocks, and now other central bankers are showing signs of walking the walk.
Mr. Carney sparked a big debate in markets and economic circles two months ago when he questioned the central banking orthodoxy that just keeping inflation low and steady is good enough to keep the financial system stable.
He raised the idea that central banks might need more flexibility to move away from just inflation targeting in case they have to get involved in trying to deflate bubbles by “leaning against the wind.” In fact, Mr. Carney has gone so far as to moot the possibility of changing the central bank's mandate of aiming for 2 per cent inflation when the job description, which is set out by the federal government, comes up for renewal in 2011.
For now, the debate is theoretical, but there are signs it soon may be a question of whether or not to act, even if the mandate hasn't officially been changed.
Both the central banks of Australia, which raised interest rates last week, and Norway, which many think could be the next major central bank to do so, have explicitly mentioned rising housing costs in recent statements. Neither pointed to the issue as a big red flag, but for those who parse the coded statements of central bankers, the mere utterance of words about rising asset prices by central banks that are charged with inflation targeting is enough to send a signal.
“Strongly rising asset prices may induce central banks to start lifting rates early from record-low emergency levels even if growth is still below trend and inflation below target,” opined Joachim Fels, the co-head of Morgan Stanley's global economics team, a theme echoed by economists closer to home at Toronto-Dominion Bank.
With markets betting that Canada might speed up rate increases in the wake of the Australian move, Bank of Canada senior deputy governor Paul Jenkins last week cautioned against drawing too many parallels between the two countries. And while it's true that Australia avoided a recession, in large part because of solid trade with China, while Canada did not, mainly because of close ties to the devastated United States, there is one key similarity. Both nations have had rip-roaring recoveries in their housing markets. So much so, that there are some who are talking about bubbles once again.
The Bank of Canada's stance is that surging housing prices will cool down once pent-up demand dissipates as those who were too afraid to buy homes during the peak of the crisis make purchases. But if that doesn't prove out, Mr. Carney too may be faced too with walking the walk.
Raising rates explicitly to cool growth in housing prices would contravene the letter of the Bank of Canada's mandate.
However, waiting until 2011 to change that mandate might be folly if there is indeed a second bubble in housing forming because of incredibly low mortgage rates that are a side effect of the bank's intentions to pump up other areas of the economy with cheap money.
The Norwegian central bank gave perhaps the clearest road map for how a banker charged with keeping inflation low can square that with fighting soaring asset prices. The governor of the Norges Bank, Svein Gjedrem, said two weeks ago that in his view, the happy medium may be to give “greater weight to credit growth and house price inflation in the reaction function.” That way, “so called ‘leaning against the wind' would not require adjustments to the Norges Bank's approach.”
The Reserve Bank of Australia has already been treading a fine line on asset prices. That central bank has steadfastly maintained that it only targets inflation, but there have been times that asset prices have entered the mix.
RBA Governor Glenn Stevens has acknowledged that in 2003 he went beyond just talking about his concern about rising housing prices. He acted with faster rate increases than otherwise might have been appropriate given the overall inflation outlook.
The higher rates “were going to come anyway because of the general inflation-targeting reasons but we at the margin erred on the side of being pretty prompt and were rather outspoken about them because the housing market dynamic was there,” Mr. Stevens said this year.
Even Mr. Carney's predecessor as governor of the Bank of Canada, David Dodge, did some jawboning when he was on the job, memorably stepping up in 2006 to call the federal mortgage insurance program's move to insure interest-only mortgages “unhelpful” because it was feeding soaring housing prices.
For Mr. Carney, the challenge is that it's his own policy of low rates that is helping to fuel house price gains, so there's nobody to jawbone.
If historically low mortgage rates continue to push housing price gains that are well above trend and lead Mr. Carney to see a bubble, he may have to drop the theory and bend the rules rather than waiting until 2011 to change them.