Feature
Page 6 of 13
Focus — April 17, 2014
The Canadian Housing Boom’s Economic Impact
Aside from a few hotbeds like Toronto and Calgary, Canada’s housing boom
effectively ended in 2008. Since then, prices have largely kept pace with incomes,
consistent with a soft landing. This note examines the economic impact of the earlier
boom, with a view to sizing the possible damping effect in the event of a correction.
Sal Guatieri
Senior Economist
sal.guatieri@bmo.com
416-359-5295
After a prolonged period of weakness in the 1990s, home prices rose five percentage
points faster than personal income from 2002 to 2007 on average (Chart 1). The 72%
increase in prices over six years lifted household wealth, confidence and borrowing
ability, ergo supporting the economy. Using our quarterly GDP model, if no boom
had occurred and prices simply rose in line with personal income, the economy
would have grown 0.22 percentage points slower per year on average.1 The
supportive impact contrasts with that in the previous decade, when a prolonged
period of price stagnation shaved 0.15 percentage points from annual growth in the
1990s. It’s worth noting that the rapid price gains, relative to
income, paled in comparison with the U.S. housing boom from 2001 Chart 1
to 2006, when prices (Case-Shiller) rose seven percentage points House Prices Outran Income from 2002-2007
faster than income. Canada’s price boom was smaller than the
U.S.’s, and initially reflected some catch-up after a long period of Canada (y/y % chng)
Average Existing Home Price1 less Personal Income
weakness that left the market undervalued.
20
Since 2008, prices have climbed half a percentage point faster than
income, though not in a straight line. After falling 10% in the 2008
recession and softening after several rounds of tougher mortgage
rules, prices tended to rebound in response to lower interest rates
and steady demand from immigrants and millenials. Based on the
MLS home price index, prices are currently rising about one
percentage point faster than personal income, well short of boomtime conditions.
Besides the stimulative effect of rising home prices on wealth and
borrowing capacity, the economy was also supported by rapid
increases in home building, again after a lengthy period of
weakness. Residential construction rose 28% from 2002 to 2007,
adding 0.34 percentage points to annual GDP growth on average
(Chart 2). The economic boost was similar to that in the U.S. from
2001 to 2005. However, a key difference is that, while U.S.
homebuilding was fairly normal in the decade before its boom,
Canadian starts were well below average, suggesting the initial
boom in construction was a response to pent-up demand.
10
0
-10
Boom
Period
-20
82
1
87
92
97
02
07
12
CREA until 1998; Teranet HPI after 1998
Chart 2
Building Boom Abetted GDP Growth
Canada
(ppts)
Contribution of Residential Construction to
Real GDP Growth
1.0
0.5
1
The model regresses year-over-year percentage changes in quarterly real GDP on
year-over-year changes in U.S. real GDP, Canadian real interest rates, stock
prices, the exchange rate, commodity prices, existing house prices and residential
construction from 1988Q1 to 2013Q4. All variables are statistically significant
and have the correct sign. The model explains 92% of the variation in GDP
growth in the sample period. Like other studies, the model suggests house prices
have a much larger wealth effect than equity prices.
0.0
-0.5
Boom
Period
-1.0
82
87
92
97
02
07
12
Feature
Page 7 of 13
Based on the above estimates, the rapid increase in home prices
and construction added 0.56 percentage points to annual GDP
growth from 2002 to 2007, accounting for one-fifth of total
growth. This suggests a moderate correction could have a
meaningful slowing effect. However, to trigger a recession, prices
and construction would need to drop sharply. Based on our model, a
10% decline in prices and construction reduces annual growth by
one percentage point, with the two channels contributing about
equally. Given underlying growth of just over 2%, prices and
construction would need to fall more than 20% to spur a contraction.
Since 1980, the most that national house prices have ever fallen is
10% (using quarterly average data), and only during recessions
(Table 1). Since the housing market does not appear to be
egregiously overpriced, a 20% correction is unlikely under normal
economic conditions (Chart 3).2
Meantime, with homebuilding largely tracking household
formations, a downturn in residential construction also doesn’t
appear imminent (Chart 4). Housing starts averaged 175,000 in the
first quarter, in line with demographic needs. Aside from the
Toronto and Montreal condo markets, there is little evidence of
excessive overbuilding across the country.
Focus — April 17, 2014
Table 1
History of Canadian House Price Corrections
% Change in Average Existing House Price
1
-10.2%
2007Q4 to 2008Q4 1
-9.8%
1981Q4 to 1982Q3 1
-9.4%
1989Q1 to 1990Q2 1
-6.4%
1994Q1 to 1996Q1
-5.6%
2011Q2 to 2012Q3
denotes recession period
Chart 3
Bit Pricey
Canada
Average House Price-to-Personal Income
relative to Long-Term Average
30
The Bottom Line: Our analysis of the impact of the housing boom
suggests a moderate 10% correction in prices and construction
would slow economic growth by one percentage point, while a steep
20% plunge could pull the economy into recession. One caveat is
that feedback between falling home prices and elevated household
debt could make the economy more sensitive to a correction than
our simple model suggests. This speaks to the need for households
to manage their debt prudently. On this note, the recent slowing in
household credit growth in line with personal income is welcome.
Should home prices rise more slowly than income for a period of
time, as we anticipate, the economy’s vulnerability to a housing
correction would decline further.
(ratio : s.a.)
↑ overvalued
20
18%
13%
11%
10
0
-10
↓ undervalued
-20
87
92
97
02
07
12
Chart 4
Building Boom Fades
Canada
(3-mnth m.a.)
Housing Starts per 1,000 people 1
14
12
2
We estimate the ratio of average house prices to personal income at 13% above
its long-term mean in 2014Q1, compared with 29% for the comparable U.S. ratio
at the peak of the U.S. boom. A CMHC report that estimated valuations using
four separate measures of prices and five different measures of fundamental
factors (two rent indexes, per capita disposable income, mortgage payments, and
borrowing capacity) found an average overvaluation of 11% in 2013Q4. See,
Canada Mortgage and Housing Corporation, Housing Now. March 2014.
https://www.cmhc.ca/housingmarketinformation/
10
+1
standard
deviation
8
mean
6
-1 standard
deviation
4
90
1
95
age 15 and above
00
05
10
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