Path to recovery littered with debt risks, Bank of Canada governor warns

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That’s for sure. It’s a subject that should be the focus of constant discussion, starting now.

The financial risk that is currently getting the most attention — the federal government’s rapidly expanding debt — might be the least important, at least in the short term. The fear is mostly based on the premise that interest rates will spike, which would cause debt-servicing costs to rise, crowding out fiscal space that could be put to a better use than paying creditors.

It’s a plausible scenario, but one that would require economic growth to remain stagnant for an extended period. Otherwise, there is a deep well of cash out there that investment managers have exclusively reserved for high-quality government debt. That should keep downward pressure on borrowing costs.

The most present financial danger is probably lurking in the housing market. Low interest rates could tempt households to take on more debt than they can afford, or a prolonged “recuperation” phase following the recession could deflate the value of the assets on which so much debt currently rests.

Macklem made a point of stating that policy-makers have “several macroprudential tools,” such as the mortgage stress test, at their disposal “if too many Canadian households start to become dangerously over-leveraged.”

One problem: those bubble-squeezing tools belong to politicians, who have proved reluctant over the years to get on the wrong side of the housing lobby. The Bank of Canada can’t be certain when setting interest rates to stoke economic growth that governments will take care of the side-effects.

Another risk for the pile.

Financial Post

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