All right. How was that for a warm intro? Okay. Well, let's start by giving a big thanks to the CFA Society and the Chamber of Commerce for hosting today, for the warm welcome. Thanks to all of you for spending your lunch here. I am really happy to be giving this speech in Victoria today. This city is my home. I spend most of my time, of course, in Ottawa, but Victoria's been my home base for more than 20 years now. And I also started my public sector career here about 15 years ago. So, it's great to see a few familiar faces in the room and some old mentors of mine are here. So, it's a bit of a professional homecoming for me as well.
It also feels fitting to talk about Canada's housing affordability dilemma here in BC because it's where I first faced it as a public policy challenge. It's followed me for the last 15 years through different jobs, different cities and provinces, and even to another country. And housing affordability remains one of the biggest economic issues facing Canadians today. Housing affordability affects both people trying to buy a home and those trying to rent one. And affordability is not just about whether people can get into the market. When more household income goes to rent or mortgage payments, families have less room to spend, to save, and to absorb unexpected expenses. And over time, that weighs on growth and it makes our economy more fragile.
Now, more recently, house prices have started to come down a little, and that can bring some relief for buyers, but it can also reduce household wealth that weakens spending, and it can slow economic activity. So, it all feels a bit like a trap. High prices weigh on affordability and they leave households with less room for everything else, and low prices weigh on consumer confidence, wealth, and economic growth. And this really is the heart of the housing affordability dilemma. And it's why it's so hard to fix.
Housing and house prices have become about far more than just the cost of shelter. They're now deeply intertwined with household wealth, with the stability of our financial system, and with the strength of our economy. Mortgage debt makes up the largest share of household borrowing, and home equity underpins much of household net worth and access to credit. And this shapes how Canadians spend and save and borrow. And Canadian banks are also heavily exposed to mortgages. About half of all bank lending in Canada is tied to residential real estate. And that means that movements in house prices can affect lending across the economy. And it closely ties the health of our banks to the health of our housing market.
And housing's become a much bigger part of our economy. In the year 2000, residential investment accounted for just over 4% of our gross domestic product, while investment in things like machinery and equipment and innovation accounted for just over 8%. And today, that relationship has completely reversed. Canada's investing almost twice as much in residential housing than we are in the tools and the technology and ideas that grow our economy and improve our standard of living. In other words, housing sits at the heart of our productivity challenge here in Canada, too.
Now, my speech this afternoon won't deliver a solution to housing affordability. If there was an easy solution, it would be fixed by now. I'm also not going to assign blame. Our housing affordability problem is not the result of any one decision, one policy, or one institution. The policy levers that affect the housing market aren't concentrated in the hands of any single decision maker. They're spread across all three levels of government and many different agencies and regulators. The dilemma that we're facing today reflects years of choices and constraints across governments, regulators, borrowers, and lenders. And each was responding to the problem in front of them, often with solutions that were designed for a much narrower purpose.
What I will do today is try and illustrate this problem by drawing on my own personal experience over the last 15 years. I'll share what that experience has taught me about policy trade-offs and how it's shaped my view of the housing market that we have today. And then I'll end by talking about the implications for my current job, our job at the Bank of Canada.
Now, my experience starts here in BC on a weekend, Super Bowl weekend, I remember it, way back in February 2016. And the Globe and Mail ran an article that weekend, an investigative piece titled 'The Real Estate Technique Fueling Vancouver's Housing Market.' And it described a practice it termed shadow flipping. There's some of you in this room that might even remember that. Essentially, what shadow flipping was, was a buyer would enter into a contract to buy a home and then instead of closing on the sale, they would assign the right to purchase to a new buyer. And that new buyer could in turn assign the contract to yet another buyer. And each time this happened, the price would bump up a little. And the person who was assigning the contract would pocket the difference without ever taking possession of the home.
Realtors were arranging these transactions and making commissions on each assignment. And in some cases, they were themselves either the buyer or the seller. And the original owner that sold the home in the first place didn't benefit at all and often had no idea that any of this was happening. And all of this was legal. So you can imagine that this didn't go down well with the government or with the public particularly because it was happening amid a rapid price escalation and a growing concern in British Columbia about housing affordability. I was working at the Financial Institutions Commission at the time and after that story broke, I found myself leading an expert panel that was asked to make recommendations to put a stop to this practice and to try and restore public trust in the real estate sector.
The panel delivered a report that included 28 recommendations to strengthen the regulation protecting consumers and to hold real estate agents more accountable for acting in the public interest. The government adopted all of the recommendations and overall I felt like we had done some good. But the report was also very clear to note that none of the recommendations we made would meaningfully affect declining affordability. House prices weren't increasing because of the poor conduct of some in the real estate sector. Rather, the poor conduct of some in the real estate sector was driven by the fact that houses were being treated more like speculative investments than homes to live in.
Shortly after that report was delivered, I moved to a new job in Ottawa at the Office of the Superintendent of Financial Institutions, OSFI. OSFI's job is to design and implement rules to keep the country's banks safe. And when I arrived in the fall of 2016, housing was getting a lot of attention. OSFI's concern was that continually increasing house prices had lulled mortgage lenders into a sort of complacency. Banks were relaxing their underwriting standards and focusing less on a borrower's ability to repay their mortgage and more on the assumption that the collateral values, the underlying houses, would only ever increase.
So in the fall of 2017, we decided to strengthen the mortgage underwriting rules for banks. The biggest change was introducing a stress test. And this required borrowers to demonstrate that they still had room to make their mortgage payments even at a higher interest rate than the one their mortgage was contracted to. The practical effect of the rule, of course, was that it reduced the maximum amount of mortgage debt that most people could qualify for. And in an environment where house prices were increasing, you can imagine this wasn't a really popular decision.
The criticism was loudest from the mortgage broker and real estate industries and their view was that the stress test was only going to make affordability worse and it risked cooling the housing market. On the other hand, there were economists and some banks that were a little more supportive, but many people saw the policy as an attempt to just offset low interest rates or to cool the housing market in certain cities. So my colleagues at OSFI and I spent the next year defending the stress test, explaining that it wasn't a forecast on interest rates and nor was it an attempt to try and arrest rising house prices. It was simply a way to make sure that borrowers had a margin of safety against a range of risks. Those risks could be higher interest rates, but they could also be a loss of income or an unexpected expense. This seemed prudent to us. It seemed prudent for borrowers and for banks. And our job was to keep banks safe.
Now, the experience since then has proven the value of the stress test. It did what it was designed to do. It strengthened mortgage underwriting. It gave borrowers a buffer that helped protect them and protect financial stability through a period of sharply higher interest rates. I'll come back to this point in a couple of minutes. But the stress test did very little to make housing more affordable and in fact prices continued to climb.
Then in 2019 I moved to Switzerland to work with the Basel Committee on Banking Supervision. This is an organization that brings together bank regulators and central banks from all over the world to set standards for the largest, most globally active banks. The lesson from that job was that the challenges Canada was facing were not unique. By 2019, many advanced economies were facing the same pattern. House prices had outpaced incomes. Mortgages were getting larger and larger, and household debt was reaching record levels. Australia, Sweden, New Zealand, the UK, and Switzerland were all looking at versions of the same problem.
Housing really had become the fault line running through the financial system. It was the biggest asset on household balance sheets and the main collateral supporting bank lending. A sharp correction could spread quickly from households to banks to the broader economy. And the global financial crisis just a decade earlier had shown just how damaging this could be. So regulators were of course focused on trying to build resilience. They were strengthening mortgage underwriting standards and some had introduced stress tests similar to what we had done here in Canada. Others were introducing loan-to-income or loan-to-home-value limits, and most were also requiring banks to hold more capital as the credit cycle matured. The objective was that banks needed to be strong enough to withstand the downturn when it came.
But the credit cycle we were preparing for never did arrive. And what arrived instead was a global pandemic. And that brought with it emergency interest rate cuts and fiscal measures aimed at supporting the economy through a once-in-a-generation shock. But these measures arrived alongside constrained housing supply and a sudden demand for more space as people were confined to their homes and later a surge in population growth from immigration. So instead of a downturn, Canada and many other countries saw a housing market boom. Mortgage credit surged as households borrowed at very low interest rates, adding more debt to balance sheets that were already heavily exposed to real estate.
Then, as economies reopened, demand recovered much faster than supply and inflation surged. So, central banks raised interest rates sharply to restore price stability. Now, Canada weathered that shock relatively well. Households and banks absorbed the interest rate increase. It was not without pain. Some borrowers faced real stress. But the losses that many feared didn't materialize and banks remained resilient and the financial system absorbed the shock. But the regulatory policies that had helped absorb the shock didn't prevent further deterioration in affordability. In Canada, the average house price rose about 50% in just two years.
Now if I look back across that 15 years and all three experiences starting right here in BC then to OSFI and then internationally to me the pattern is clear. Each set of policies was aimed at a real risk and each helped make part of the system safer, but none changed the underlying dynamic. Housing was becoming more and more tied to household wealth, credit creation, and economic growth. And the more this continued, the more that housing supported financial resilience and economic activity, the harder it became to restore housing affordability without creating new risks. And that brings me to our work at the Bank of Canada.
Now, let me start by dealing head-on with the argument that the blame for high house prices rests squarely with central banks who kept interest rates too low for too long, making it easier to borrow more and bid up the price of houses. There's no question that low interest rates played a role. After all, that's how monetary policy works. It supports the economy by stimulating demand and it works most directly on the things we need to borrow to buy. But interest rates were not the only force at work. That same period also saw strong immigration that contributed to housing demand, zoning and infrastructure constraints that limited housing supply, a variety of borrower incentives that stoked demand, and more speculative investment as more and more people saw housing as a way to build their personal wealth. So, the story is more complicated than simply low interest rates. But that doesn't absolve monetary policy.
And the intersection of monetary policy and housing is something we think a lot about at the Bank of Canada. And my colleagues and I recently tackled this exact topic as part of our review of our monetary policy framework. Our framework is really just the approach. It's the tools and targets we use to keep inflation low and stable, and we review it every five years to make sure it's still serving Canadians well in a changing economy. This year, we decided to ask ourselves two questions, and questions we were pretty sure were on the minds of Canadians, too. The first was could or should monetary policy do more to lean against rapidly rising house prices? And second, does the way that shelter costs are measured in inflation give us the right signal about the cost pressures that Canadians are facing?
Now, both questions brought us right back to the dilemma I've been describing to you today. A housing market that's become deeply tied to wealth creation, credit and economic growth creates very tough policy trade-offs. I'll start with the first question, whether monetary policy should do more to lean against house price increases. Now, interest rates obviously matter for house prices. They affect the cost of borrowing. And when prices are high and mortgage debt is large, interest rate changes move through the economy in powerful and uneven ways. If the bank raises the policy interest rate, credit gets more expensive and that can take some pressure off house prices because it reduces demand. But higher rates also make it harder for new buyers to qualify for a mortgage and they increase the payments for some existing borrowers.
Now, a rate cut has its own trade-offs. Lower rates can improve housing affordability by making it easier to qualify for credit and reducing borrowing costs. But if housing supply is constrained, adding demand by easing credit costs can end up just pushing prices higher. So, this is the first trade-off. The second is that the effects of interest rate changes don't stop at housing. Higher interest rates will slow spending and investment across the economy and lower rates will boost demand more broadly and so they can add to inflationary pressure. Monetary policy is really a very blunt tool. We set one interest rate for the whole of the economy. We can't set one for housing and one for everything else. And interest rates work far more directly on demand. They're not very good at addressing supply constraints. They can't build homes, rezone land, or speed up permitting.
Now, let's look at the second question. What's the best way to capture housing costs when we measure inflation? And here, too, we ran into trade-offs. Canada's consumer price index, the CPI, measures housing mainly as the cost of shelter over time or as something that we consume. For renters, that's very straightforward. It's the price of rent. For homeowners, it includes ongoing costs such as property taxes, insurance, maintenance, and mortgage interest. The purchase price of a home is treated differently because a home is also an asset. Now, that distinction has some logic to it, but it's also a bit at odds with how people experience housing affordability. High house prices affect whether Canadians can afford to buy a home, how long it takes to save the down payment, and how much debt they have to carry. So house prices may not be consumer prices, but they most definitely shape how Canadians experience affordability.
But including house prices in the CPI would risk mixing two different things. The cost of living today and the value of an asset that may rise or fall over time. A second measurement challenge is the effects of mortgage interest on the CPI. When we raise interest rates to try and bring inflation down, mortgage interest rates of course go up. And because those costs are included in the CPI, higher interest rates will temporarily add to inflation even while they're working to reduce inflation more broadly. So put simply, the tool we use to reduce inflation will for a time add inflation to the CPI. And this can be very hard to explain to people. Now, taking mortgage interest costs out of the CPI would be an easy way to avoid this problem, but it would also remove a real cost that households are paying.
So, as part of our review, we looked at alternative ways to measure shelter costs, including approaches that other countries use. Some measures put more weight on house prices. Some treat mortgage interest costs differently and others simply use rental values as a proxy for owner-occupied housing. What we found was there's really no silver bullet. Every option had advantages, but each came with new problems. So the bottom line, our review was a very clear reminder that there's no easy fix to our monetary policy framework that will make difficult policy trade-offs disappear. Interest rates can influence house prices, but they're too blunt to target housing affordability directly. And shelter costs matter for inflation, but there's no magic measure that will fully capture the affordability challenges that people feel.
Rather than a simple fix to our framework, the important lesson we took away from our review is that the bank needs to do a better job of explaining these trade-offs to Canadians, and we need to be more clear about what monetary policy can do and what it can't do.
Now, let me close by coming back to where I started. Housing affordability is difficult to solve. Not because no one is trying and not because the problem is poorly understood. It's hard because over a very long period of time and a long period of rising house prices, housing has become tied to many other things we care about: household wealth, financial stability and a growing economy. Rising prices made housing less affordable, but they also supported household wealth and economic growth. Falling prices may improve affordability, but they'll also reduce household wealth. They'll slow economic activity, and they can put stress on borrowers and lenders.
Now, regulators can make markets fairer. They can strengthen borrowers and banks and they can help the financial system prepare for shocks, but they can't restore affordability. And for central banks, the best contribution is still overall price stability. Low, stable, and predictable inflation gives households, businesses, builders, and governments a better foundation for decision-making. Housing will remain an important input to our monetary policy decisions, but targeting house prices directly with interest rates would risk imposing a broad cost on the economy.
The lesson I take from all of this is that housing affordability will not be restored by asking any one policy to do more than it can do, more than it's designed to do. The goal has to be a policy mix that increases supply, protects resilience, and reduces the economy's dependence on rising house prices. That's going to take some patience and some coordination. It will require choices that are consistent across policymakers and over time. And it's going to take a willingness to look beyond the immediate symptoms to the deeper forces driving affordability challenges. If we can do that, we will have a better chance at building a housing market that provides shelter, supports stability, and contributes to prosperity without asking housing to carry so much of the economy on its back. Thank you.
