Monday, February 15, 2010

Evidence-based Economics Finally Arrives in Canada

Orthodox economics is based on simplifications that so distort the real world as to make it unrecognisable, yet its basic tenets are credulously repeated on an almost daily basis in national newspapers and on television news. A genuinely evidence-based approach to economic policymaking would not produce a system remotely like the one we have. (Andrew Simms)

Something has changed. No longer are we obliged to follow the dictates of the high and mighty school of orthodox economics. For example, the Canadian Government is actually contemplating changes to the rules governing home loans that would make it more difficult for some prospective home buyers to obtain a mortgage. Instead of putting down 5% of the purchase price, they would be required to put down 10%, and the time period in which the mortgage could be amortized would be shortened.

Two years ago, such talk would have been considered economic heresy. However, since the near collapse of the global financial system and the onset of a global economic recession, regulation is no longer a mortal sin. In fact, it should now be recognized that we have moved out of the economic discourse where the debate concerning less versus more regulation ruled the day, and we have moved into a discourse where the discussion now concerns the effectiveness of the proposed regulation. Pragmatism has triumphed over ideology.

Two years ago, there was precious little talk in the mainstream media of asset bubbles forming and then bursting. That was before the millions of foreclosures and underwater mortgages in the U.S. As a result, it seems only prudent that the Minister of Finance would muse publicly about the possibility of a similar housing bubble taking shape here in Canada. After all, interest rates are at a historic low, the return on debt securities is meagre, and the equity markets are flat. Given this context, residential real estate looks very good. Where else can we find a 50% return on the initial investment upon a successful flip of a residential property?

Yet, as recent experience in the U.S. has shown, an overheated market not only drives up home prices but brings into the market buyers who do not have the capability of meeting their financial obligations if the market goes flat or begins to decline. In short, the growing influx of the Ponzi investor engenders systemic risk within the housing market and possible severe economic fallout if the housing market experiences a sudden and precipitous drop.

So, if we connect the dots with regard to what the Minister of Finance is thinking, we can see that he is actually placing greater value upon stability within the housing sector than on the quick fix to the economy that a real estate bubble would most likely bring about. In other words, in this instance, sustainability trumps rapid economic growth.

Now if we could only get the Finance Minister and the Prime Minister to think systemically about the stability and resilience of the economy within the context of climate change, maybe, just maybe, Canada could regain its cherished international reputation.

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