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andrew jackson

The Bank of Canada has once again warned that high levels of household debt "present a significant risk to financial stability." But rising consumer and mortgage debt remain major drivers of the economy This is not as it should be.

In a textbook capitalist economy, growth should be led by investment. Credit financing of investment increases demand in the economy, while also raising productivity. This sets the stage for higher wages, higher levels of consumer spending, and further rounds of investment.

The reality, however, is that the Canadian economy has been driven much more by the growth of household debt than by business investment for the past fifteen years. Data from the National Balance Sheet Accounts show that, since 2000, household debt has risen from 60 per cent to 94 per cent of gross domestic product. This has helped finance a housing boom and buoyant consumer spending.

Household spending has risen at a much faster rate than wages and incomes. This shows up in the frequently cited ratio of household debt to disposable (after-tax) income, which now stands at 166 per cent, up from 110 per cent in 2000.

Those who are not unduly concerned about growing household debt note that net worth has increased even more than debt, due mainly to rising house prices. And, given near record-low interest rates, the percentage of household income required to service debt has fallen to a very low level of just 7.1 per cent.

One problem with this benign view is that, as noted in recent reports on the Canadian economy by the Organization for Economic Co-operation and Development and the International Monetary Fund, elevated house prices are vulnerable to a significant correction. They have increased much faster than household incomes since 2000, and now average five times income compared to three times income back in 2000.

Another problem is that a significant proportion of household debt is in the form of consumer credit, which now amounts to 47 per cent of household disposable income. Unlike mortgages, this kind of debt is not balanced by a long-term asset.

Last and most importantly, averages can be very misleading since net worth is distributed highly unequally. Data from the recent Survey of Financial Security show that the top 10 per cent own almost one half of all net worth, while the bottom third own only 1 per cent of the total since their debts cancel out assets.

Younger households on modest incomes are often highly stretched financially, have little or no equity in their homes, are often carrying high levels of credit card debt, and are saving very little for retirement. When housing prices fall and/or interest rates rise, they will be highly vulnerable. By contrast to households, non-financial corporations are in good financial health, and have been net lenders to the rest of the economy in recent years. Credit market debt of non-financial corporations is 58 per cent of business equity, a ratio that has been stable for a decade, and these corporations are currently sitting on $656-billion of cash or what former Bank of Canada governor Mark Carney referred to as "dead money."

While the Bank of Canada has consistently said it hopes to see a "rotation" of demand from households to corporate investment, household debt continues to rise, driven by low interest rates and generally stagnant incomes. CIBC has noted a recent acceleration of consumer borrowing.

As the old saying goes, when something cannot go on forever, it won't. Households cannot continue to borrow so as to spend more than they earn, and house prices cannot rise indefinitely compared to incomes.

We risk a major shock to the economy when the day of reckoning arrives, not least because business investment is unlikely to grow rapidly at a time when household demand is weak.

Some part of the economy, be it households, corporations or governments, has to be borrowing at any given time so as to put savings to use and to maintain overall demand. If households are stretched and business are reluctant investors, it will be up to government to save us from a downturn through increased public investment.

Andrew Jackson is an adjunct research professor at the Institute of Political Economy at Carleton University, and senior policy adviser to the Broadbent Institute.