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The governor says housing affordability cannot be improved by raising or lowering interest rates
Published on February 6th, 2024 • Last updated 8 hours ago • 3 minutes reading time
Tiff Macklem, Governor of the Bank of Canada. Photo by Nathan Denette/The Canadian Press Files
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Rising housing costs are currently the biggest contributor to above-target inflation, but Bank of Canada Governor Tiff Macklem said the central bank is powerless to address it. That was just one of the limits on monetary policy that Macklem laid out in a Feb. 6 speech to the Montreal Council on Foreign Relations about what the bank can and cannot do – an issue that is gaining urgency among the public and policymakers has gained calls for solutions to problems such as housing affordability. Here are three key takeaways from Macklem's speech.
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Interest rates cannot solve the housing crisis
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Housing affordability cannot be improved by raising or lowering interest rates, the Bank of Canada governor has said. Accommodation price inflation has been high for several years and has continued to increase over the past six months. But none of the underlying reasons for the country's housing supply shortage can be addressed by monetary policy, Macklem said.
He said that while the rise in housing prices partly reflected the impact of increases in the central bank's key interest rate on mortgage interest costs, it also reflected rising rents and other housing costs that are more related to the structural housing shortage.
“Monetary policy cannot fix this. But it is something we need to understand and factor into monetary policy because it impacts the cost of living for Canadians,” he said.
While monetary policy has a large impact on the real estate sector and changes in the base rate very quickly impact housing demand due to their impact on mortgages, Macklem said the impact of monetary policy on supply is much more limited.
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These shortages, combined with the recent increase in the number of new arrivals to Canada, also mean that price increases that would normally have reversed have now declined only slightly.
The pandemic has proven that monetary policy can control inflation
Canada experienced its worst recession ever and inflation fell sharply at the start of the pandemic, Macklem said. With the reopening, the economy then experienced its fastest recovery ever.
He said that amid the huge fluctuations in the economy, monetary policy has shown that it can control inflation in the medium term.
“The last few years have led some people to question monetary policy. “That’s not surprising,” he said.
The combined actions of governments in rolling out fiscal stimulus and the Bank of Canada in cutting interest rates to near zero have helped keep the economy afloat and prevent deflation, Macklem said.
He added that they probably could have started withdrawing stimulus measures sooner, but even if they had, the impact on post-pandemic inflation would have been minimal.
Reach the inflation rate of two percent every month
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Because interest rates affect everyone in every corner of the economy, Macklem says they inevitably impact demand and inflation.
Adjusting just one interest rate across the system sets off an effective chain reaction that ultimately controls inflation – but it doesn't work immediately.
Rather, monetary policy works with a delay of more than a year. This means that by the time a policy change affects inflation, the relative price shock that caused concern has typically already passed.
These relative price shocks are fluctuations in specific prices, often for energy and food, resulting from, for example, geopolitical events, droughts and transport disruptions. Unless these spill over into broader price changes, they would have a transitory or transitory effect on inflation, he said.
Macklem noted that central banks cannot prevent short-term inflation fluctuations caused by these relative price shocks.
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“Typically we look at them because a reaction would lead to even more volatility,” he said.
Aware that there will be temporary fluctuations, he said the bank is aiming for the middle of its one to three percent range so that inflation stays within that range most of the time.
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