Terence Corcoran: Bank of Canada provides ‘forward confusion’ about state of housing market…


In the end, the bank has added nothing to anyone’s understanding of the degree of overvaluation in the Canadian housing market

Many economists were heartened during the past year after Bank of Canada Governor Stephen Poloz announced that the bank would in the future avoid engaging in the once-fashionable practice of providing “forward guidance“ on interest rates. But it now looks like there’s a new hot fad in central banking theory: forward confusion.

Making predictions about the future, or offering firm conclusions of any kind about uncertainties in the economy, has always been a dangerous exercise. Last year at this time the bank boldly predicted that 2015 would see the Canadian economy break out of its slump, with growth rates charging up to 2.7%. Today the 2015 prediction has been cut back to a more moderate 2.4%. And that was before the totally unpredicted crash in the price of oil. Whether ‘elevated’ therefore means there’s a 50-50 chance of a 30% housing market crash is not clear

In many cases, when it comes to making bold statements about the economy, the less said the better — which is possibly what the Bank of Canada should have done this week regarding the state of the Canadian housing market.

The bank’s latest financial system review grabbed headlines Thursday, including this one in the National Post: “House prices overvalued up to 30%: central bank.” That’s totally accurate as a headline, but mostly inaccurate as a reflection of the somewhat confusing analysis from the bank on the state of the housing markets in Canada.

The confusion covers a lot of ground and is enhanced by the bank’s frequent warnings that “there’s a large degree of uncertainty inherent” in the housing price estimate, which is based in part on a complicated economic modelling exercise.

FE1212_Overvaluation_C_JRThe bank also trots out some risk language that is vague to say the least. The potential inability of Canadians to service their debt and drive housing prices down is Canada’s “most important” domestic financial system risk. This risk, says the review, “continues to be rated as ‘elevated’.”

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The bank puts “elevated” in quotation marks, but does not define the word other than to say that within a five-range matrix  it is greater than “low” and “moderate” but less than “high” and “very high.” Whether “elevated” therefore means there’s a 50-50 chance of a 30% housing market crash is not clear. Then, oddly, the bank goes on to say that “the probability of this [elevated] risk materializing is low.”

In a graphic the bank published, the range of overvaluation also covers a lot of real estate, from 10% to 30%. On the whole, such a large gap renders the estimate useless for anyone in the real estate market in any part of the country. Is housing uniformly up to 30% overvalued across the nation, or only in select areas? Maybe 5% in Montreal and 35% in Vancouver?
The bank’s description of its analysis, based on a “new model of house price determination,” does not instil confidence. The model is based on house price data from 43 different house price cycles in 18 countries since 1975, and as a result of limits in the data and other factors, the bank says the model “suffers from a number of shortcomings.”

Still, the conclusion is advanced: “The estimated amount of overvaluation in Canadian housing markets based on 95% confidence intervals … suggests a wide range of estimated overvaluation running from 10 to 30%.”  The bank goes on to say that this is within the “of external estimates” produced by other institutions.

The external estimates, however, are not so much a range as a scattering of calculations based on different methods. The 10% estimate is from Canada Mortgage and Housing Corp., the 30% is from The Economist. In between at 20% is the International Monetary Fund.

In the end, the bank has added nothing to anyone’s understanding of the degree of overvaluation in the Canadian housing market. Rather than clarifying future risk in the housing market, the bank seems to have provided forward confusion. It is not even clear that there is any overvaluation, which is no surprise in view of the bank’s warning about the “considerable challenges associated” with trying to calculate a concept as hairy as “overvaluation.”


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