As we bid farewell to Bank of Canada governor Mark Carney last week, Canadians across the land celebrated a man who has steered our fiscal ship well in rough waters. Despite the near collapse of the global economy, Canada and Canadians have been sitting pretty. Our unemployment rate is stable. Inflation is stable. House prices are on the up and up.
But perhaps we popped the champagne cork too soon. For one thing, Carney won’t take up his new post as governor of the Bank of England until the summer. For another, consumer debt being what it is, Canadians may not have seen the worst of this financial cycle. In fact, if experiments in behavioural economics are anything to go by, Canada may be in a bubble in more ways than one.
Earlier this fall, I interviewed Richard Deaves, a professor of finance and economics at McMaster University in Hamilton and bubble expert. Deaves says the tricky thing about bubbles is that people don’t recognize when they’re in the middle of one. Human nature being what it is we’re far more likely to find ways to justify overpriced stocks or exorbitant growth in housing prices than we are to look at it objectively. Just before the housing bubble burst in Florida, for example, real estate agents blamed demographics –-specifically, baby boomer demand -- for driving prices to unprecedented levels and they saw no end in sight.
In other words, people trick themselves into believing values will climb forever. And when the bubble is about ready to burst? Well, Deaves likens it to musical chairs.
“When the music stops, everyone rushes to the exits at the same time,” he says. The result, of course, is a plummet of values and often recession in the market where the bubble occurred.
Deaves and his colleagues have done a number of experiments on bubbles to examine conditions that perpetuate them. One of the most interesting findings is that people who have access to borrowed funds are likely to buy things at a higher value than they’re actually worth.
Put simply, having access to loans, lines of credit and mortgages causes people to purchase things at higher amounts than they would if they were using their own money.
And under what conditions are people most likely to borrow rather than save? When interest rates are low, of course.
You can hardly turn on the TV or radio these days without hearing federal Finance Minister Jim Flaherty at the Canada Club or a Bay Street luncheon lambasting Canadians for taking on big mortgages and running up consumer debt. But, frankly, delivering this punishing message while supporting The Bank of Canada’s prolonged low-interest rate policies is like telling your kids they’re too fat, while offering them freshly baked chocolate chip cookies.
If experiments in behavioural economics are anything to go by, Canada’s fiscal policies may have created the perfect conditions for a bubble in the Canadian economy. Let’s see if Flaherty and the next bank governor can offer up something other than empty rhetoric to keep it from bursting.