Canada: Low rates, high housing and more government stimulus from Trump could lead to boom and bust

From strong job creation to roaring stock markets, North America under U.S. President Donald Trump is continuing to show signs of vigour, despite Friday's gloomy U.S. GDP numbers.

It's not just a U.S. phenomenon. The giant Ontario economy is exhibiting signs of life as tax receipts rise, and some experts say the western oil slump has been overdone.

But there are reasons to be wary. There is a danger that, like a three-year-old child high on sugary treats, the economy may be getting overstimulated. And as any parent knows, such euphoria can come to a bad end.

Inflation has been tame

This week Federal Reserve chair Janet Yellen, who has often seemed like the single voice of restraint on the effervescent U.S. economy, presents the central bank's new outlook. In spite of a surge in something called the employment cost index — an indicator of plentiful jobs and growing wages — inflation has been unexpectedly tame.

Just as for our own central banker, Stephen Poloz, weak core inflation may offer Yellen a good excuse to keep rates lower for longer.

Market-based predictions for U.S. price inflation, as indicated by bond prices, had been climbing but have presently retreated well below the Fed's two % target.
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In a lot of ways that is good. With U.S. unemployment bumping along near record lows, rising wages in the face of low general price inflation may finally begin to offer employees a bigger share of productivity gains, allowing them to buy additional with their weekly pay.

Whether intentionally or by accident, that would go some way to fulfilling Trump's promise of a better transaction for U.S. working people.

It's not entirely clear why inflation has remained so low. It is certainly not what a lot of have been predicting.

As economic analyst Mike Patton wrote in Forbes two years ago in an article titled Why Inflation Is Low, Despite The Fed's Massive Monetary Expansion, something seemed amiss.
Just wait

Patton put the possible blame on a weak world economy, falling oil prices next the 2014 price bust, or the possibility that the money being created by central banks just wasn't making its way into the economy. Others have suggested it has something to do with hidden effects of technology or the sudden addition of the developing world to world industrial capacity.

Poloz insists low interest rates really are stimulative and that we just have to wait a little longer to see their result. He says Canada will close the output gap — the point where the economy begins to use up its available resources of labour and capital — by early 2018.
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Bank of Canada governor Stephen Poloz is confident Canada's low interest rates are stimulating the economy, although some fear they have done little except create an investment boom. (Chris Wattie/Reuters)

If Poloz is right, holding interest rates near historic lows in Canada and the United States is only one of a lot of things that may be souping up the economy.

In Canada the federal government has an official policy of fiscal stimulus, the promise to spend additional than it collects in revenue so as to invest in Canadian jobs.

Provincial budgets have done something similar. In Ontario, despite a surging economy that has boosted revenues from gain tax, land transfer taxes and sales taxes, the government has promised to add fuel to the fire by pouring it all, plus money from investment sales, back into the economy.
Wealth effect

Canada's hot housing market, responsible for Ontario's transfer tax windfall, is as well stimulating the economy, half through the wealth result where people who feel real-estate-rich decide they can spend freely and half through the realized gains of those who sell and move someplace cheaper.

Cheap oil and a low loonie have had stimulating effects of their own.

In the U.S. there is even additional stimulus on the way, provided that Trump can get his proposition to cut taxes from 35 to 15 % and his promised market deregulation through Congress. A initial-quarter increase rate of just 0.7 % may strengthen that resolve.

In theory, tax cuts could be neutral if they move money from government to private hands. But Trump has promised not to roll back spending. That means borrowing from the next to stimulate presently.
Home Capital

Some analysts say Canada's sub-prime crisis, though different from the one in the U.S., could spell the end of the Canadian property boom. (Chris Helgren/Reuters)

U.S. large business is framing the deregulation plan as productive rather than stimulative because less red tape makes business additional efficient. But if it opens the door to the kinds of irresponsible practices seen in the U.S. sub-prime crisis, it too will be borrowing from the next the costs of patching up the next meltdown.

Although the causes may be different, Canada faces its own sub-prime crisis as trouble at Home Capital threatens an significant part of the Canadian mortgage market.

If, as so a lot of people have suggested, housing is a bubble nearing its end, that stimulative result — inclunding the Canadian construction boom — may be on the wane.

Stimulus is not meant to be a persistent economic strategy. Like giving sweets to a three-year-old, it is only a temporary solution.

But watch out at the same time as the sugar high ends.