Like many Canadians, you might be worried about rising prices, a.k.a inflation. Seeing prices go up can be an unpleasant experience. You’re working as hard as ever, but your paycheque doesn’t go as far as it used to. The price of everything - from food to furniture to gas - is rising. But nowhere is inflation more evident than in the housing market.
Unlike price increases for many other goods, rapidly increasing housing prices are nothing new. As your own experience might tell you, inflation in the housing market has been running rampant for many years. So why is it that the alarm bells are only sounding now?
The answer is that our economic leaders measure and monitor inflation using tools that don’t accurately account for rising home prices. One predictable result is that we continue to under-report this trend - and under-estimate how it has exacerbated Canada’s housing unaffordability crisis, especially for younger Canadians.
Rising home prices have added over $3.2 trillion to the wealth of homeowners since the late 1970s, but this growing affluence has tended to come at the expense of affordability. Many young Canadians are stuck with massive mortgages or with paying rent forever - if they are even able to find a place to call home within their budget - as home prices leave earnings from full-time work far behind.
Housing unaffordability isn’t just about lack of supply
When it comes to fixing housing unaffordability, most of the focus tends to be on increasing the supply of homes. If more homes were available, costs would go down, so the theory goes.
Certainly, it’s true that we need more homes to catch up - and keep up - with population growth. But increasing supply isn’t a silver bullet. Home prices are influenced by the demand for housing as well. Demand isn’t only the number of people who want to buy homes. It’s also the amount of money they are willing or able to spend on a home.
Conservative MP Pierre Poilivere recently pointed to the importance of housing demand when he asked, “Where is the money [to buy homes at today’s rising prices] coming from?” At first glance, this might seem like a silly question. Of course, the money comes from the person buying the house! If we dig a bit deeper, however, his question points to how monetary policies influence access to credit in the housing market.
Cheap credit is driving up home prices
Almost no one buys a home in cash. Mortgages are typically used to cover the difference between a cash down payment and the full cost of a home.
Banks charge interest on the mortgage money they lend out. The size of a mortgage for which someone is able to qualify (based on their income, assets, etc) is largely determined by the interest rate charged by the bank. For example, a $500k mortgage with a 5% interest rate costs about the same per month to the borrower as a $775k mortgage with a 1% interest rate.
So, one answer to Poilivere’s question is that the money to cover rising home costs is coming from banks that have been giving out big mortgages with low interest rates. Access to these large mortgages allows those buying homes to bid up prices, fuelling price inflation.
Why have interest rates been so low for so long?
To understand this, it’s important to know that interest rates are largely controlled by the Bank of Canada. The Bank uses interest rates as a tool to influence economic activity. Low interest rates stimulate the economy by encouraging borrowing, which is especially important during recessions. When rates are low, it’s cheaper to repay debt down the road as only a small amount of interest is accrued. Businesses have access to more money to invest in new technologies and workers, and consumers have access to more funds to buy things.
So if low interest rates are good for the economy, businesses and consumers, why not just keep them low forever? The answer is inflation. Making money easier to access tends to result in higher prices. When there are signs that inflation is coming, the Bank of Canada tends to raise interest rates to ward it off.
The Bank of Canada monitors inflation using the Consumer Price Index (CPI) which is published by Statistics Canada. The CPI shows that price growth has hovered around 2% annually for most of the last two decades. This suggests that the Bank is doing a great job controlling inflation using interest rates, since their inflation target is 2%.
But wait - didn’t we start this article by pointing to runaway increases in home prices? How is it possible that inflation has remained around 2% (until recently) when one of our major life expenses - housing - has been experiencing double-digit growth?
In short, the answer is that inflation hasn’t remained this low. It’s been higher than reported, but we weren’t aware of this because our economic leaders rely on a measure of inflation that doesn’t adequately reflect changes in home values. One key part of the problem with current inflation data is that Statistics Canada relies too heavily on the value of newly constructed homes, without adequately integrating price increases in already established homes. Additionally, home values receive a relatively small weighting within the CPI.
This simple oversight has enormous, cascading effects. The Bank of Canada relies on a flawed inflation measure, so downplays housing inflation when setting interest rates. In turn, interest rates remain lower than they might have, if home price inflation were more accurately captured. Higher interest rates could have helped to rein in the spiraling home prices harming younger and future generations, from whom so much more hard work is now required to pay for housing, as either renters or owners.
First steps towards solutions
There is no one simple fix for the way in which Canada’s cheap credit system is helping to drive up housing costs but there are some clear actions we can take.
Appropriate monetary policy decisions require accurate data, something we don’t currently have. To ensure monetary policy decisions are based on correct information, Gen Squeeze’s recently released report recommends 3 things:
- Statistics Canada should track changes in the value of both new and established homes. To present an accurate picture of inflation in home prices. Check out what the Business Council of BC has to say about the risks of the current approach that relies too heavily on the New House Price Index.
- Statistics Canada should develop a supplementary measure of housing affordability that monitors home values relative to typical earnings (especially for young people entering the housing system) to monitor whether homes are within reach of what hard work can earn.
- Statistics Canada should report annually on the relationship between monetary policy and home prices to help ensure that monetary policy decisions don’t cause collateral damage to housing affordability in the name of economic benefit.
These measures are important, because if we had accurate data we might have recognized sooner that rising home prices were driving up inflation. Our economic decision-makers could have used this information to inform policy decisions with everyone’s best interest in mind, rather than allowing our cheap credit system to cause collateral damage to housing affordability.
Everyone needs a roof over their head. Freedom from paying for this roof, monthly, forever, is increasingly out of the question for many young people, no matter how hard they work. This isn’t because Canada’s younger residents are lazier or more frivolous than previous generations. Instead, our broken housing system has made it nearly impossible for most young people to ever purchase a home similar to the one in which many grew up, no matter how hard they work. Their consolation prize is… rising rents.
Nearly 80 years ago, just after the end of World War II, the Canada Mortgage and Housing Corporation was established with the aim of making housing affordable to everyone in Canada. We have strayed far away from this goal, in part due to a few ill-advised tools and policies.
I volunteer at Gen Squeeze to fight for what I consider to be important causes, like fixing our monetary policy so that everyone can find a good place to call home. Join me. Gen Squeeze’s power to win policy improvements grows with the size of our network. If you haven’t already signed up, do so here. And ask your friends and family to join too so we can make Canada work for all generations.