Take a central role at the Bank of Canada with our current opportunities and scholarships.
Find out how we’re exploring the option of issuing a virtual form of the Canadian dollar, also known as a central bank virtual currency (CBDC).
We are taking steps to better understand the effects of climate change on the economy and our environmental footprint.
Learn what legal tender means, why legal tender changes, and how to redeem older bank notes.
Rising interest rates are helping to ease price pressures in Canada and inflation is falling; Progress towards the 2% target is slow. The Bank expects inflation to remain around 31/2% until mid-2024 and return to target in 2025.
New Year’s Eve Address: Governor Tiff Macklem speaks at the Canadian Club Toronto (approximately 12:40 p. m. m. , Eastern Time).
These forecasts are presented to the Governing Council in preparation for financial policy decisions and are published once a year with a five-year delay.
Economic activity came to a sudden halt due to the COVID‑19 pandemic. This has resulted in widespread income losses, creating a challenging situation for many Canadian households, especially those that are highly indebted. From a financial stability perspective, a key concern is whether households can keep up with their debt payments.
The potential for a trigger event to occur when household debt is high has long been cited as the biggest risk facing Canada’s financial system (Slive and Coletti 2018). But the pandemic is different than the triggers and related scenarios that economists typically use to assess the risks to financial stability.
We examine how the COVID‑19 shock affects Canadian households by drawing parallels between pandemics and natural disasters. We then assess the financial health of the household sector when the pandemic began. Finally, we run model simulations to illustrate how payment deferrals and the recovery of the labour market affect mortgage defaults.
The economic impact of COVID-19 is often compared with past recessions, but this pandemic arguably has more in common with natural disasters. The key feature shared by natural disasters and pandemics is a sudden stop of economic activity caused by a shock that is unrelated to economic factors—in this case, a public health crisis. This contrasts with the 2008 recession, which reflected an underlying fragility in the global financial system that resulted in a lengthy downturn.
We see this when we compare the number of Employment Insurance (EI) recipients in Fort McMurray, Alberta, after the 2008 recession and the 2016 wildfires, the costliest herbal crisis in Canadian history (Statistics Canada, 2017) (Figure 1). The maximum increase in the number of EI beneficiaries was much greater after the wildfires than after the recession. But this increase was completely reversed ten months after the wildfires. In contrast, the peak reached nearly 10 months after the onset of the recession.
Alternatively, the data is available for download in:
What Classes on Monetary Stability Can We Learn From Fort McMurray?To find out, we use TransUnion Canada’s anonymous credit files1 and apply what’s known as the artificial detection method. This means that we are comparing the effects at Fort McMurray to those of a monitoring organization of Albertans who had similar demographic and monetary characteristics (e. g. , age, credit score) prior to the wildfires. We need to take a look at the loan delinquency rate, which is explained as the percentage of loans that are at least 90 days old. Banks use this popularization to determine when a payment is delinquent. The Fort McMurray case study presents lessons from studies conducted primarily to understand the Bank of Canada’s understanding of the relationship between climate update and financial stability (Molico 2019).
The loan delinquency rate rose sharply after the wildfires, from 0. 3 per cent to a peak of 1. 4 per cent (Figure 2). Based on the difference between the delinquency rate at Fort McMurray and the comparison group, we calculate that 0. 9 is consistent with the building’s percentage emissions. By comparison, the peak rate of loan arrears nationwide after the last recession was just 0. 45 percent. But it’s important to note that the increase in loan arrears after the wildfires were short-lived. This likely reflects the transitory nature of the surprise and the effectiveness of crisis relief policies. In fact, the policies implemented to help the citizens of Fort McMurray were very similar to those implemented on a much larger scale during the pandemic (Table 1).
Alternatively, the data is available for download at:
Keep in mind that the gigantic but brief accumulation of loan arrears shown in Figure 2 is likely overestimated, as our knowledge includes loan payment deferrals that we explicitly identify. This may simply mean that Fort McMurray experienced greater economic effects from declining oil costs in 2015-2016 than the regions of Alberta represented in our comparison group.
This persistent accumulation of loan arrears is also consistent with the broader literature on the herb crisis, which shows the long-term adverse effects of errors in monetary fitness (Ratcliffe et al. 2019). For example, credit scores usually decline after an herbal crisis. This initial drop leads to additional drops as consumers lose access to the classic credit bureaucracy or face higher costs. This demonstrates why it is important to ensure that families receive sufficient financial assistance during this pandemic, especially considering the peak level of household debt at the beginning of the pandemic.
There are similarities in how the early economic effects of pandemics and herbal errors manifest themselves, but their economic recovery would arguably be different.
Disasters tend to be localized and pass quickly. They are also related to the physical destruction of capital that will then have to be rebuilt. This reconstruction procedure can begin soon after a crisis has occurred, thus contributing directly to a broader economic recovery.
In contrast, the COVID‑19 pandemic has a global reach, and its aftermath is much more uncertain. Economic activity will undoubtedly rebound as mandated lockdowns are gradually eased. However, this will likely be a sluggish process, meaning some of the macrofinancial effects of the pandemic could linger.
How well can families weather the storm? In the end, it depends on:
One way to gauge how well indebted households can cope with temporary income losses is to calculate the ratio of financial assets to mortgage payments. This ratio measures the number of months households can continue making mortgage payments by drawing only on their liquid assets. This simple metric does not consider other debt or essential expenses. Nevertheless, it provides a useful summary of available financial buffers.
Using the data from the 2016 Survey of Financial Security, we find that one in five households can only make up to two months of mortgage payments using liquid assets and about one-third can make up to four months of payments. We find that households in the occupations most at risk in the near-term—such as sales and trades—also have the weakest financial positions (Chart 3). Almost one-quarter of households in these occupations can only make up to two months of payments.
Alternatively, the data is available for download at:
Although many mortgage holders have limited financial buffers, home equity lines of credit (HELOCs) provide a flexible and relatively low-cost means of accessing cash. Lenders have been increasingly offering HELOCs as part of combined mortgage-HELOC plans, resulting in a large pool of untapped available credit (Al-Mqbali et al. 2019). Using new regulatory data, we find that about 65 percent of the funds authorized through HELOCs have not been used (Chart 4). This amounts to Can$310 billion, or roughly 20 percent, of households’ disposable income.
Alternatively, the data is available for download at:
From a monetary stability perspective, a significant increase in the use of HELOCs to address COVID-related earnings losses is not ideal, as it may worsen monetary vulnerabilities in the future. However, the emergency budget available through HELOC can help you save the A more serious threat of loan default for monetary stability. Government aid systems, combined with reduced household spending during the lockdown era, deserve to help restrict HELOC use in the near term.
Fiscal policy measures play a critical role in helping families through these difficult times. The maximum applicable of these measures is Canada’s Emergency Response Benefit (CERB), which provides others suffering a loss of source of income due to COVID-19 with a constant $2,000. with month for up to 4 months. Other federal measures provide more help to low-income families and families with children. Some provinces also provide direct cash assistance to families.
To put those policy measures in perspective, we used microdata from the 2017 Household Expenditure Survey to document typical monthly expenditures by lenders and renters in other income source groups (Table 2). We found that the amount of money supply is worth to cover expenses like food and housing, especially for low-income renters. While some lenders may find it more difficult to cover their expenses, payment deferrals filed through maximum lenders will provide a greater variety of money. Keep in mind that financial strain among tenants can also have indirect consequences for monetary stability. For example, some 700,000 families also own a home and 80% of them have a loan.
The link between the surprise of COVID-19 and the dangers to monetary stability caused by the debt of major households can be analyzed more formally using the Bank’s Household Risk Assessment Model (HRAM, Peterson, and Roberts 2016). As a component of the Bank’s stress testing toolbox, this style has the vital merit of being able to simulate the effect of macroeconomic surprises at the micro level. In other words, HRAM takes into account the wide diversity of household balance sheets, which is key to understanding how monetary vulnerabilities interact with a given macroeconomic scenario. The main result of HRAM is the delinquency rate of loans.
We simulate the rate of loan delinquencies using data on the effect of the COVID-19 surprise on the labor market and making illustrative assumptions about how the labor market might evolve. In HRAM, the unemployment rate is the most important variable in determining the likely maximum evolution of the loan delinquency rate.
The unemployment rate is, however, unlikely to fully capture the current scale of employment income losses. This is because many unemployed individuals are being classified as “not in the labour force” due to their inability to actively seek work during the lockdown period. In addition, a large share of the labour force remains employed but is losing all or most of their usual working hours.
Fortunately, Statistics Canada is calculating an alternative labour underutilization rate that we can use in our simulations instead of the traditional unemployment rate. We conduct our simulations with the assumption that April’s underutilization rate of 36 percent (Statistics Canada 2020) represents the peak and a full recovery will occur within four quarters.2 To be clear, this is not a prediction; it is simply an illustration of how much mortgage defaults could rise in a deep but short-lived recession.3
Another vital facet of our simulations is the ability of families to defer their loan bills. Most finalists in Canada are allowing families financially impacted by COVID-19 to defer their bills for up to six months. This means that the state of the labor market at the end of the six-month deferment period will end with loan arrears. To put the importance of this into perspective, we show our simulations with and without payment deferrals (Figure 5).
Alternatively, the data is available for download at:
Without deferrals, the loan delinquency rate peaks at 1. 3 percent. This is slightly higher than the all-time high of 1% seen in the early 1980s. Once payment deferrals are taken into account, the picture is much more favorable. Remaining, the arrears rate remained relatively strong for much of 2020, eventually peaking at 0. 5% in the second quarter of 2021. The accumulation of arrears in 2021 is due to the fact that, with the intention of the hard labour market for 4 quarters, the unemployment rate does not disappear completely after the end of the six-month deferral for the period.
Ultimately, this exercise illustrates that the effectiveness of deferrals in limiting the rise in arrears depends crucially on the speed of recovery in the labour market.
The Bank of Canada Staff Analytical Notes are short articles focusing on current issues similar to the existing economic and monetary environment, written independently of the Bank’s Board of Directors. These paintings may or may challenge the dominant political orthodoxy. Therefore, the reviews expressed in this note are solely those of the authors and would possibly differ from the official reviews of the Bank of Canada. The Bank does not deserve any duty in this regard.