No Bank of England governor has ever been installed in office with quite so much advance hype as Mark Carney. When he moves from running to the Bank of Canada to his new office in Threadneedle Street, expectations will be running high. Carney arrives with a reputation as a master of economic strategy, a man who can single-handedly steer an economy through the most treacherous of waters, and get a country growing again with a few deft strokes of monetary magic.
Certainly, George Osborne has invested his hopes in him. During Carney’s time as governor in Canada, the country was ‘acknowledged to have weathered the economic storm better than any other major western economy’, he said on announcing the appointment. Most of the financial commentators were happy to sing from the same hymn sheet. A brilliant technocrat, well worth the £874,000 a year the British taxpayer will pay him to run the economy, they chorused. No one has any doubt he is by far the best man for the job.
But is Carney really everything he is cracked up to be? Or is it that no one really knows very much about the Canadian economy — and certainly not enough to question how well it has performed since Carney was installed in 2008? Just as he is packing his bags, there are worrying signs that the Canadian economy is coming off the rails. Increasingly it looks as if he is getting out before it crashes.
True, on the surface, Carney’s record is impressive. He does appear to have played a better hand than most central bankers. Canada is a medium-sized, mature economy, with relatively high levels of welfare — very similar to the UK, but a bit smaller. And yet it sailed through the financial crisis without any of its major banks collapsing. The economy kept on growing — by 3.1 per cent in 2010 and 2.5 per cent in 2011 — whilst other major economies were flat-lining or slipping back into fresh recessions. The property market remained healthy, and unemployment low at just over 7 per cent of the workforce. If the UK had a record like that, we’d all be a lot happier.
In the past few months, however, the outlook for Canada has grown much darker. In the second half of last year, growth ground to halt, with the result that for the whole of the year expansion slowed to 1.8 per cent. Most forecasts predict growth of 1.3 per cent this year, very low by Canada’s historic standards. Only last month, the International Monetary Fund downgraded its growth forecasts for Canada, and warned that there were tougher times ahead.
But it is the state of the property market that is most worrying. In the past decade, Canada witnessed one of the biggest housing booms anywhere in the world. Average house prices doubled between 2000 and 2012. The housing bubble raged just as ferociously as it did in the US, in this country, or in Ireland and Spain. The difference is that in Canada it didn’t come to a juddering halt in 2008 and 2009. Prices kept roaring ahead as if nothing had happened.
Until this year, that is. Now the bubble is finally bursting. Construction of new homes fell by 19 per cent in January this year, to their lowest level since the end of 2009. Sales of existing homes nationwide fell 8.8 per cent from a year earlier. When demand dries up, prices fall. In most cities, prices are now flat, or else going down — in Vancouver, home prices have dropped by 8 per cent since their 2011 peak, and are still going down.
As we know from elsewhere in the world, once property markets start to fall, the banking system and then the economy are not usually far behind. Carney’s main claim to brilliance is that none of the major Canadian banks collapsed during the crash. But banks are usually fine so long as the property markets is booming — it is when the market turns down that they run into trouble.
Under the surface, there are signs the Canadian banks lent just as recklessly into the property bubble as ours did. Whilst most countries stopped racking up fresh debts in 2009 — at least personal and corporate debt, if not government borrowing — in Canada they kept going. Canadian households have been borrowing at record rates, and their debts are now 167 per cent of GDP, the sort of level the US was at before the crash. Debt as a percentage of household income is now higher in Canada than it is in either the US or the UK, and it is still going up.
The lending standards in Canada look to have been no more rigorous as any of the 125 per cent self-certified mortgages on offer here before the crash. Canadians are allowed to borrow against their pension and life policies to fund deposits on houses. Even credit cards can be used to finance downpayments. More than half of Canadian mortgages are now guaranteed by the government, and for high-loan-to-value mortgages, the percentage is even higher — meaning that the banks didn’t really have to worry too much about whether they were lending money to people who might never be able to repay it. As a result, the Canadian banks may well have made lots of loans that are about to go sour. Indeed, the rating agency Moody’s has already downgraded a string of Canadian banks because of their exposure to a wobbly real estate sector.
In fact, it now looks as if all Carney really did was keep the debt-fuelled boom running longer than anywhere else. Rather like our departing governor Mervyn King, Carney warned Canadians about a housing bubble, and about the risks of taking on too much debt. But, again like King, he also encouraged it with lots of cheap money. In the wake of the financial crash in 2008, interest rates were slashed, and have now been held at 1 per cent since 2010. Given that there was no recession to deal with, it is hardly surprising there was a housing bubble — and Carney was mainly responsible for it.
In reality, Carney inherited an economy that was in perfectly decent shape, and allowed a property bubble to get out of control. It is now bursting with predictably messy results. Installing him at the Bank of England looks like one more desperate attempt to reflate the debt bubble. But what the UK actually needs is a governor who can work out how to get the UK growing again without the artificial stimulus of borrowed money. There is no evidence to suggest that Carney is the man for that task. And there is a worrying amount of evidence that he is getting out of Canada in the nick of time.
This article first appeared in the print edition of The Spectator magazine, dated 25 May 2013
Mark Carney on inflation, housing bubbles and how he shook up the Bank
Besides the Q&A session with British MPs this morning, there was a written part to Mark Carney’s job interview. For you reading pleasure, we’ve uploaded the entire 45-page document here. Below is a selection of intriguing and Canada-relevant bits.
Mark Carney on Mark Carney:
I have experience in risk management in the private sector and crisis management in the public sector. In Canada, I was part of a team, which rapidly assessed the risks and instituted an effective, coordinated response to the global financial crisis, despite Canada’s deep integration with the U.S. economy and financial system.
Serving as Governor of the Bank of England will mark the pinnacle of my career. I am a strong believer in the value of public service, and I firmly believe that this responsibility offers me the opportunity to contribute where I can make the greatest impact.
On asking for a shorter term (five rather than the customary eight years):
At the end of a five-year the term, I will have served as a Governor of a G7 Governor central bank for over a decade. In my experience, there are limits to these highly rewarding but ultimately punishing jobs. Second, the five year term has advantages given the ages of my children and the disruption that is involved in moving schools and countries.
On shaking things up at the Bank of Canada:
… I believe I know how to lead, when to delegate and how to forge consensus. My experience as Governor of the Bank of Canada demonstrates a willingness and ability to implement significant organisational change. I manage an organisation of about 1,200people across six offices, four time zones and in two official languages. Upon becoming Governor, I initiated a major reorganisation of our four policy departments, clarified the lines of responsibility of senior policy-makers, streamlined and delegated operating management.
With the Senior Deputy Governor, I led a process to re-engineer the Bank’s administrative and support services. As a result of that process, the Bank has achieved ongoing annual savings of $15 million and reduced staff by 7 per cent.
Since becoming Governor, our employee satisfaction has increased and we were for the first time recognised as a Top 100 employer in Canada. We have now held that position for the past 3 years running. I believe this reflects an enhanced focus on workplace environment, clearer lines of authority, the opportunity for greater personal initiative and a sustained focus on internal talent management and development.
I have a track record of attracting and retaining senior external talent to public life including leading academics, several managing directors from the financial sector and senior IMF staff. Since becoming Governor, the Chiefs of our four main policy departments have been developed and then internally promoted. We have instituted and extended a comprehensive talent management strategy for the top 50 employees.
On the occasional need to tolerate above- or below-target inflation, at least temporarily:
There are, broadly speaking, three sets of circumstances under which it may be desirable to return inflation to target, from above or below, over a horizon that is somewhat longer than usual.
First, the unfolding consequences of a shock could be sufficiently large and persistent that a longer horizon might be warranted in order to provide greater stability to the economy and financial markets. Stability considerations could lead the Bank to accommodate over a somewhat longer period, for example, the inflationary consequences of an unusually large and persistent increase in oil prices, or the disinflationary consequences of a severe global slowdown, including the possible constraints of the zero lower bound on interest rates.
Second, through a longer targeting horizon, monetary policy can also promote adjustments to financial excesses or credit crunches. For instance, there could be situations where, even though inflation is above target, ongoing monetary policy stimulus and a somewhat longer horizon to return inflation to target would be desirable in order to facilitate the adjustment to broad-based deleveraging forces that are unfolding.
Third, as the Bank of Canada has observed, the optimal inflation-targeting horizon will vary with the evolution of the risks to the outlook. Shocks to the economy, both observed and prospective, are inevitably subject to a degree of uncertainty. In some situations, risks to the inflation outlook could be skewed to the downside. In these cases, a balance must be struck between setting monetary policy to be consistent with the most likely outlook and the need to minimize the adverse consequences in the event that downside risks materialize. This would warrant a more stimulative setting for monetary policy than would otherwise be desirable in the absence of the downside risks. However, if the downside risks fade away rather than materialize, the resulting stronger inflationary pressures would merit returning inflation to target over a longer horizon. The opposite would be true under circumstances where risks to inflation are skewed to the upside.
In short, changing economic circumstances could demand some flexibility in the horizon over which the Bank seeks to restore inflation to target.
On the flip side, a tighter monetary policy that allows inflation to run below target for a longer period than usual could help to counteract pre-emptively excessive leverage and a broader build-up of financial imbalances. In recent months, the Bank of Canada has used such guidance to reinforce macroprudential measures implemented by the Government of Canada. By indicating that some tightening of monetary policy may be necessary, a degree of prudence in household borrowing has been encouraged. For example, the rate of household credit growth has decelerated and the share of new fixed rate mortgages has almost doubled to 90 per cent this year.
There are limits to this flexibility. The Bank’s scope to exercise it is founded on the credibility built up through its success in achieving the inflation target in the past, and its clarity in communications when it uses it. That links to the second important feature of a flexible inflation target regime – clear and open communication.
On housing bubbles and what the central bank can and cannot do about them:
...I view monetary policy as the last line of defence against financial imbalances.
The effectiveness of monetary policy in in this regard depends on the nature of the imbalances, the influence of monetary policy and prudential tools on these imbalances, and the interactions between them. When financial imbalances remain concentrated in a specific sector, well-targeted macroprudential tools should usually be sufficient. Monetary policy is not well suited to address such imbalances, since monetary policy affects the entire economy, meaning that the interest rate increase required to curtail sectoral imbalances would come at the cost of undue restraint on the economy as a whole.
A credit-fuelled housing bubble is a particularly relevant example of a financial imbalance. Bank of Canada research suggests that a significant increase in interest rates could be required to stem the build-up of credit, with material consequences for output and inflation. This illustrates that monetary policy might be too blunt a tool to stem financial imbalances emerging in a specific sector. By contrast, macroprudential policy is as effective in addressing financial imbalances in the housing market without causing any undershoot in output or inflation. Rather, macroprudential in this scenario acts as a complement to monetary policy dampening the increase to output and inflation generated by the shock.
In this way, prudential measures will go a long way to mitigate the risk of financial excesses, but in some cases, monetary policy may still have to take financial stability considerations into account. For instance, where imbalances pose an economy-wide threat and/or where the imbalances themselves are being encouraged by a low interest rate environment, monetary policy might itself be the appropriate tool to support financial stability. Such could be the case when the risk-taking channel of monetary policy is present. The stance of monetary policy may itself lead to excessive risk taking by economic agents, which, in turn can lead to financial instability. Specifically, monetary policy could influence the degree of risk that financial institutions decide to bear by influencing their perception and pricing of risk.