Worthwhile Canadian Initiative

Cheap talk and the exchange rate

Why does the Loonie appreciate when the Bank of Canada tightens monetary policy (relative to what was expected)? And depreciate when the Bank loosens monetary policy (relative to what was expected)?

Before you conclude I've lost it, by asking such an easy question, consider the following weird thought-experiment.

Flashbacks to the 1970's: the Bank of Canada and the deficit

Doug Peters and Arthur Donner (names I remember from the 1970s debate over inflation in Canada) have an opinion piece in the Toronto Star on the role of the Bank of Canada in reducing the budget deficit. It starts out fine, but ends in a non-sequitur.

Does CMHC have big enough reserves?

This post is more of a bleg; because I'm sure someone reading this knows more about the answer than I do.

An insurance company doesn't need reserves if it is insuring a large number of short term uncorrelated risks. The Law of Large Numbers ensures that its annual claims will equal its annual premiums, if it prices its insurance correctly. Every year exactly 5% of all cars insured will crash, so if you price the insurance at 5% of the claim, plus admin costs, you will break even every year.

But suppose there is the same 5% annual risk of a car crashing, but the risks are perfectly correlated. Once every 20 years, on average, all the cars crash. Then you need reserves. If you price the insurance at 5% of the claim, plus admin costs, you would need to keep at least 20 years' worth of premiums, net of admin costs, in reserve. (That's a minimum, because you might get 2 or more crash years in a row.)

The house price bounce is (mostly) real - for now

I have been checking almost daily for the Teranet-National Bank May house price data, and now it's out. Their national composite price index increased 0.72% from April to May. This confirms the less accurate and more anecdotal data we've been hearing about the Canadian housing market improving this Summer.

Risks to Canadian recovery

The Bank of Canada says it believes the recession has ended. Maybe they are right; I haven't checked, but I get the impression that their forecasting has been better than most over the last year. This doesn't mean that output and employment will immediately return to normal, of course. But it does mean, if they are right, that output and employment will stop falling. Or at least, that output will stop falling, because employment normally lags output.

I don't know if the Bank of Canada is right. It might be. And I'm certainly feeling less worried than I was back in the Fall and Winter. I want to ask a different question: what are the biggest risks to recovery? Here is my list of things that might still go badly wrong:

Why the Bank of Canada should 'rise' interest rates

I don't want tighter monetary policy; I want looser. I don't want the Bank of Canada to raise interest rates, but I do want the Bank to do something that would cause it to want interest rates to rise. I want it to buy real assets.

We have become so accustomed to thinking about monetary policy in terms of interest rates, both as monetary policy instrument, and as the monetary policy transmission mechanism, that it's hard to find the right words to describe it any other way. Which is why I abused grammar in the title of this post.

And this matters. Monetary policy is about expectations, and it works when people understand what it means. And right now people don't understand what it means, so it doesn't work.

Rambling thoughts on Canadian house prices and global savings gluts

This isn't a very focused post. There are two sets of thoughts bubbling through my mind this morning. The first is about Canadian house prices; the second is about global savings gluts. But the two topics are very definitely related.

There is a lot of anecdotal evidence of a pick-up in at least some Canadian housing markets over the last month or two. Like this story in today's Globe and Mail for example, about record sales, bidding wars, and rising prices in Toronto. I won't fully believe that these stories are real and representative of the whole housing market until I see it confirmed by a rise in the Teranet-National Bank price index, but the most recent Teranet numbers are for April, and show no rebound yet. (You can have accurate data or quick data: pick one.)

The economic impact of canoeing

Seeing the path on the rocks worn by millions of passing feet on an old portage just upstream of Ottawa reminds you that what is now a short detour off a recreational walking trail was once the trans-Canada highway. Canoes once had a very large economic impact in Canada. Now they have very little.

Too much household debt? Again.

As far as I can tell, the Bank of Canada's Financial System Review (pdf) has basically got it right. At least in the way it is looking at household debt. Provided you ignore the aggregate numbers that make the headlines, and focus on the disaggregated numbers instead.

Talking down the Loonie?

The Loonie (Canadian dollar) has appreciated against the US dollar recently. The Bank of Canada expressed its concern in Thursday's Announcement.

"In recent weeks, financial conditions and commodity prices have improved significantly, and consumer and business confidence have recovered modestly. If the unprecedentedly rapid rise in the Canadian dollar (which reflects a combination of higher commodity prices and generalized weakness in the U.S. currency) proves persistent, it could fully offset these positive factors."

Can the Bank of Canada "talk down" the Loonie? If exchange rates are determined by fundamentals, it's not clear how talk could matter. But I don't think exchange rates are determined by fundamentals. I think the exchange rate is determined by the forex market's current belief about the Bank of Canada's current and future beliefs about the fundamentals. So talk can matter, because it lets the Bank of Canada let the market know what the Bank of Canada believes.