interest rates

Canada’s 21st century wage miracle

In three of the world’s richest countries, average real wages are lower today than they were in 2010.

Homeownership in Canada—benefits and costs

Encouraging home ownership may deter the labour mobility vital for a dynamic economy.

Artificially lowered interest rates major cause of increased housing prices

The Bank of Canada and other central banks around the world have artificially lowered interest rates, making investment and risk-taking much cheaper.
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Impact of Higher Interest Rates on the Cost of Servicing Government Debt

An important fact to consider when assessing the medium-term fiscal plans announced by the federal and provincial governments is that interest rates are at historically low levels. A return to more normal levels would jeopardize promises for balanced budgets or surpluses and increase the proportion of revenues spent on debt interest payments (the “interest bite”). More revenue going to interest payments on the debt means less is available for programs that taxpayers value, such as health care and education, or tax relief.

This study analyzes the budgetary implications of interest rate risks faced by governments, using as examples the short- and medium-term budget plans (2016–17 to 2019–20) of Ontario and Quebec, Canada’s two largest provinces and the most indebted as a share of GDP. The study also provides a background discussion about interest rates and provincial debt maturity structures.

Two scenarios are considered where interest rates rise faster and/or higher than forecasted in Ontario’s 2015 budget. In Scenario 1, rates rise to 3.5 percent in 2016–17 and to 4.5 percent from 2017–18 to 2019–20. This compares to rates in the baseline case of 2.7 percent in 2016–17, 3.8 percent in 2017–18, 4.2 percent in 2018–19, and 4.5 percent in 2019–20. In Scenario 2, rates rise to 4.5 percent in 2016–17 and attain 5.0 percent from 2017–18 to 2019–20. (Quebec states its interest rate forecast only for 2016–17, but it projects its spending and revenues until 2019–20. The analysis assumes Quebec’s budget is based on the same interest rates as Ontario after 2016–17. While Ontario provides its medium-term interest rate forecast, it projects spending and revenues only to 2017–18. Hence, the analysis extends Ontario’s budget projections to 2019–20 by assuming that program spending and revenues will grow at the same rate as the economy.)

The interest rate shocks described by Scenario 1 would increase Ontario’s projected deficit by $264 million in 2016–17 and derail the government’s expectation of achieving budgetary balance in 2017–18. In Scenario 2, Ontario’s deficit increases by $616 million in 2016–17 and the expected budget balance in 2017–18 is replaced by a deficit of $857 million. In 2019–20, Ontario’s cost of interest rises by $498 million in Scenario 1 and to almost $1.2 billion in Scenario 2. Ontario’s interest bite would rise from its current value of 9.2 percent of revenues in 2015–16 to 10.1 or 10.4 percent in 2017–18 under Scenarios 1 and 2, respectively.

The Quebec government is projecting budget surpluses every year from 2016–17 to 2019–20. The effect of the interest rate shocks is to substantially reduce, though not reverse, the projected surpluses. Under Scenario 1, the surplus falls by $363 million in 2016–17 and by $440 million in 2019–20. In Scenario 2, Quebec’s projected surplus declines by $524 million in 2016–17 and by nearly $1 billion in 2019–20. Quebec’s interest bite would rise from its current value of 10.5 percent in 2015–16 to 10.8 or 11.3 percent in 2017–18 under Scenarios 1 and 2, respect¬ively. Thus, even relatively modest increases in interest rates would have important adverse effects on the short- and medium-term budgets of Ontario and Quebec, and would oblige the provinces to devote a larger share of revenues to financing interest payments on debt.

Provincial governments have been shifting the structure of their debts toward longer terms to maturity. In this way, they are able to postpone the need to refinance their debts at higher interest rates, if rates were to rise. However, in the long run all of the government’s debt eventually matures. The final part of the study explores the budgetary implications of interest rates on provincial debt ris¬ing to 5 percent permanently (with 2 percent price inflation), starting in 2016–17. The primary surplus (revenues minus non-interest spending) would have to be increased each year (forever) by about $3.5 billion in Ontario and by $2.1 billion in Quebec. Otherwise, provincial debt as a share of the economy would rise above the 2016–17 level in each province.

The analysis indicates that a faster-than-expected rise in interest rates toward normal levels could upset Ontario’s already delicate path toward fiscal sustain¬ability. In Quebec, the danger is mitigated to some extent by the government’s commitment to fiscal reforms, announced in its latest budget, to achieve annual surpluses through spending restraint. Should the government waver on its com¬mitment, then the interest rate risk would exacerbate the province’s already very high debt-to-GDP ratio. The bottom line is that governments should not be san¬guine about the current low interest rates when forming their upcoming budgets.

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Why Are Interest Rates So Low

This paper is the latest version of my attempt to convey to others the sense of a model and my understanding about current financial markets that I have been developing and using for my own financial planning and my advice to others since 2009. It is an amalgam of some simple observations and statistical regularities with some comments about the economic theory toolbox that is in widespread use but which is not functional in current circumstances. One of my economist mentors and a founding member of the Fraser Institute’s Editorial Advisory Board, Harry Johnson, used to say that most things about economics are simple; the problem is to recognize simplicity when you see it.

At the core of this paper are a few simple observations. The first is that while the virtues of saving and the evils of indebtedness are widely understood and universally supported, the fact is that every saver who wants to earn a return needs a debtor as an accomplice. Because of the anonymity of financial institutions, the connection is not appreciated and indeed most people taking a loan or a mortgage think they are getting it from the bank or credit union. Of course, they are getting it from a saver/depositor who needs the borrower as much as the borrower needs the saver.

The second observation is that our theories or models for describing whole economies rely on the extrapolation to the national level what we observe in the behavior of individuals. So, the standard theory about interest rates and saving is based on how an economy would behave if it were the simple aggregation or summation of all households on the assumption they all behave like a typical household. As long as the typical household is representative, that is not a problem. However, there is strong reason to believe that in the current economy of the world, typicality, if I can call it that, has broken down; as a consequence, the inferences made using the standard model are incorrect.

The third observation, though not so obvious, is that the only time the representative household model will work for understanding interest rates and most likely for other economic magnitudes is when there is constant population growth. Constant population growth ensures that there will always be a “typical” relationship between borrowers and savers. That typical relationship is that there is always a greater volume of incipient borrowing than incipient saving. So interest rates perform the function of “rationing” the number/volume of borrowers/borrowing to pair up with the smaller number/volume of savers/saving or encouraging more savers/saving to occur. The paper explores the implications for interest rates when, as at present, population growth is not constant and when, as a consequence, a relative shortage of borrowers emerges as saver cohorts dominate the population.

The conclusions are that:

  1. Interest rates in the 29 economies that make up 90 percent of the world’s GDP are low because—and to the extent that—these economies are experiencing a dearth of borrowers and hence a relatively high saver-to-borrower ratio;
  2. The dearth of borrowers has removed the power of monetary policy to increase the inflation rate in many countries because the potency of monetary policy as currently operated is derived from loan growth in the banking system;
  3. The Japanese deflation experience has been badly misdiagnosed because the standard model used in the diagnosis does not work in Japanese demographic circumstances;
  4. The world’s largest economies are rapidly approaching Japan-like demographics—and the deflationary implications of that situation;

This paper explores various implications of these main points and performs several statistical tests that support the paper’s findings.

How will the Trudeau government handle challenging economic environment in 2016?

Even the prospect of small deficits relative to GDP may generate substantial investor uncertainty in an environment where interest rates are on the way up.

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A Longer-term Perspective on Canada's Household Debt

There is much concern about the increase in Canada of household debt to record levels. However, consumer credit is such a new device that debt has hit a record level in almost every year since 1961, so it is difficult to judge what is the optimal level.

By several metrics, household debt in Canada is not excessive. The burden of servicing debt is at a record low. Debt is often used to create wealth, and household assets and net worth have increased much faster than debt. Despite lower interest rates, the rate of growth of debt has slowed by one-third since the recession.

By international standards, the ratio of Canadian household debt to income is similar to that in the US but below that in many European countries. The problem with US debt leading up to its financial crisis was not that its ratio to income was high by international standards, but that its distribution was flawed, with too much issued by poorly capitalized financial institutions to high-risk borrowers. Lending standards have been tightened in Canada to prevent record low interest rates from tempting people and firms to take on excessive risk.

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