April 30, 2020 – While the effects of the COVID-19 outbreak on the housing market are yet unknown, a new C.D. Howe Institute report provides a blueprint for policymakers and regulators on the tools and timing of interventions in the housing market to address threats to financial stability.
In “Calibrating Macroprudential Policies for the Canadian Mortgage Market,” authors Scott A. Brave, Jeremy Kronick and Jose A. Lopez use four financial stability indicators – the house-price-to-rent ratio, the price-to-income ratio, the debt-servicing ratio and the household-credit-to-GDP ratio – to create a model to assist policymakers in anticipating future crises.
Macroprudential regulations aimed at ensuring financial stability have been on the rise since the 2007–09 global financial crisis. In Canada, the primary policy tools that have been employed are related to the residential housing market – namely, changes in mortgage loan-to-value ratios and loan maturity requirements. In this report, the authors use an analytical framework to forecast the probability of a state of low financial stability in the Canadian economy and to recommend when such a policy action might be taken in light of its costs and benefits.
“While COVID-19 is obviously a significant stress on economies all over the world, including Canada’s,” said Kronick. “It is too soon to gauge its impact on the housing market, and this type of black swan event is nearly impossible to predict for regulators and policymakers looking at financial stability indicators.”
The authors’ analysis instead focuses on the types of decisions policymakers and regulators face in normal economic times, which can then be applied once the pandemic ends. Using the second quarter of 2019 as an example, their model suggests a low probability of a lengthy period of financial instability.
Even in light of this low probability, it still might be prudent to enact macroprudential policies if the costs of a financial crisis were large enough. However, based on calculations of the policy costs, such as lost access to credit by borrowers and lost residential investment growth, the authors recommend only continued monitoring of mortgage market and financial stability conditions in the near term.
For more information contact: Scott A. Brave, Senior Policy Economist, Federal Reserve Bank of Chicago; Jeremy Kronick, Associate Director, Research, C.D. Howe Institute; Jose A. Lopez, Vice President, Head of the Financial Stability Research Section, at the Federal Reserve Bank of San Francisco; or David Blackwood, Communications Officer, 416-873-6168, email: dblackwood@cdhowe.org
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