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Bank of Canada Governor Stephen Poloz speaks during a news conference in Ottawa, Canada, April 13, 2016.CHRIS WATTIE/Reuters

The federal government's new measures to tighten mortgage lending rules will reduce the risk of economic shocks to Canada's financial system, says Bank of Canada Governor Stephen Poloz.

"In effect, what the new policy measures do is they guarantee that any new mortgages that are granted in the near-term – well, from now on – will be of higher credit quality than they might have been without the rules," Mr. Poloz said Tuesday during a news conference in Vancouver.

Last month, federal Finance Minister Bill Morneau announced the revamped mortgage rules, such as a tougher standard for gauging whether home buyers can handle an eventual increase in interest rates. Those changes took effect on Oct. 17.

"If the stock of debt is improving in credit quality, that makes the vulnerability less, even if the level is the same. And so that means that for us, the assessment is about how does that vulnerability translate into a problem for the financial system or for the economy if there's a shock," Mr. Poloz said.

Applications from borrowers are now being stress-tested at the Bank of Canada's posted interest rate of 4.64 per cent for insured mortgages. That is well above current rates available to consumers, with lenders offering 2.5 per cent or lower for five-year fixed terms.

"Let's say a global slowdown happens, some layoffs occur, people with big mortgages get laid off and they're not available to service their debts. That large stock of debt, if it's low-quality, can magnify that effect on the economy. So that's what we mean by financial stability risk," Mr. Poloz said.

Residential prices have been surging in the Greater Toronto Area while home values remain high in the Vancouver region.

The Bank of Canada Governor said it is difficult to predict the amount of mortgage lending that looms and also hard to get a read on how the federal policy on reducing maximum borrowing eligibility may affect housing prices in Canada's two largest housing markets.

"We have not taken a position on how prices may or may not be affected by the policy, but resale activity is expected to be lower," Mr. Poloz said, emphasizing that it is unclear how individuals will respond in the months ahead.

"Will they simply just shop for another house that costs a little less or a smaller home or in a different location? It's hard to predict how all this will shake out. So, I really don't want to speculate on that," he said.

During his speech to the Business Council of British Columbia, he said there is no good alternative to the central bank's 2-per-cent inflation target in spite of years of anemic economic growth and soaring mortgage debt.

"I recognize that even after years of very low interest rates, the economic recovery in many economies remains weak," Mr. Poloz told the audience of more than 400 people in Vancouver. "But to date, we have not seen convincing evidence that there is an alternative approach that is better than our inflation targets."

Last week, the central bank renewed its policy of using the midpoint of a 1-per-cent to 3-per-cent inflation band – or 2 per cent – as the focus of monetary policy. The Bank of Canada was among the first central banks to strategically target inflation, beginning in 1991. It adopted a 2-per-cent goal in 1995.

And the policy has done its job, allowing Canadians to spend and invest with confidence, Mr. Poloz insisted.

Nonetheless, he said the target is not "set in stone," and would be reviewed again in 2021.

Annual inflation averaged 7 per cent between 1975 and 1991, and often swung wildly. Since then, inflation has averaged 2 per cent a year.

During its review, Mr. Poloz said the bank considered a higher target for inflation, as well as focusing on other indicators, such as economic growth or financial stability.

The bank ultimately rejected the idea of boosting the target to 3 per cent because it's confident it has a range of other unconventional tools, including negative interest rates, to deal with another economic slump, he said.

"A higher inflation target would mean higher nominal interest rates and more room to manoeuvre, on average, but also would entail imposing a higher inflation tax on the economy," he explained. "I think of this as paying dearly, every day, for insurance against the low probability risk that another very large macroeconomic shock could occur in the future."

Today's rock-bottom interest rates are great for borrowers and homeowners, who can load up on cheap debt. But they impose a cost on many savers, especially those on fixed incomes, whose investment returns are getting squeezed.

Mr. Poloz said the bank also rejected the idea of focusing more on financial stability, including the record-high debt levels of Canadians. He said "macroprudential" policies, such as Ottawa's recent crackdown on access to mortgage insurance, are much better suited to deal with specific financial risks.

"Adjusting interest rates is a very blunt tool with widespread effects," he pointed out.

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